What do federal tax plans mean for real estate?
There’s no indicator that the changes will structurally affect values
There has been much debate over the merits of the U.S. House and Senate tax plans coming out of Washington. For me, this forum is not to judge good or bad, but to give some insight on what the proposals are and what the likely outcomes could be.
In my role as a commercial real estate broker and volunteer for the Commercial Investment Board of Realtors, I visited Washington each of the last six years to discuss real estate issues with our representatives. This gives me a good insight as to which way the leaves are blowing.
First a quick disclaimer and civics lesson: While there has been a push to “get the bill passed before Thanksgiving” and now to “get the bill passed before the end of the year,” we really have no idea when or even if it will pass. If everything passes, the House and Senate will have to reconcile before anything gets sent to the president. Users and investors should not take this article for investment advice, as it is the equivalent of trying to pick today who will win the 2018 World Series. There is just no way to know. (Except it should be the Boston Red Sox.)
Also, taxation is like a Whac-A-Mole. You may see savings in one area, but expense in another, so seek your tax adviser for a look at the whole picture.
While the focus of this article practice is commercial real estate, many folks have questions on residential real estate. Both plans call for the elimination of deductions on home equity line debt. In addition, the House calls for the amount of interest on debt in excess of $500,000 to be nondeductible (currently the limit is $1 million). It also eliminates outright the deductions on second homes. Also of importance to the state of New Hampshire is that the House and Senate plans cap real estate tax deductions at $10,000.
One key issue that came as a surprise on the commercial real estate front was proposed changes to depreciation. Currently, commercial real estate depreciation schedules are either 39 years or 27.5 years. Don’t ask me why those are the numbers – no one ever accused the tax code of making sense. The proposed change would have a nominal impact on multifamily investment assets, however on the office, industrial and retail front, we will see that you will be able to depreciate 4 percent of your asset’s value each year as opposed to roughly 2.5 percent. That is a considerable shelter which could increase the value on those asset classes.
Realtors have often been concerned about changes to Section 1031, which allows investors to sell an asset and defer taxation so long as they invest back into the economy with another “like kind” asset. Both plans offer no changes to this policy for real property. However there are some subtle changes for personal property that could affect items like equipment and specialty fixtures such as lighting. Best to consult your tax advisor with any questions here.
On the speculative side of the investigation is the Senate’s proposal to combine this tax plan with changes to the Affordable Care Act. While the details of this are not specific, there is a tax on investments that is embedded in the ACA. If a reconciled bill comes before the president, it is not certain at this time if that tax will remain or if it will go. The formula is somewhat complicated, but in short, the tax is 3.8 percent on investment gains above a certain dollar amount, based on earnings. Most folks are not even aware that this exists now, so it is unclear what impact this will have.
There is a saying that you should “never let the tax tail wag the investment dog.” I think the proposed changes are a good example. The changes here can have a major effect on your commercial real estate assets, both as investors and users. Tax reform could affect a small 2,000-square-foot office condo or a 100-unit multifamily investment. However, at this juncture there is no indicator that a sweeping change (such as the passive income/loss rules in the mid-1980s) will structurally change values. Yes, there will be market fluctuations as a result and some asset classes will win and some will lose, but the macro factors of supply/demand and interest rates will trump these proposed changes (pun intended). Stay the course on your real estate goals. Your needs are likely more important than these tax changes.
Chris Norwood is president of NAI Norwood Group, Bedford. Greg Bryant of Bedford Cost Segregation and Lynne Bagby of Asset Preservation Inc. both assisted in helping to explain the subject.