As the House and Senate move closer and closer to reconcile and pass the Tax Cuts & Jobs Act, I’ve been pouring over research on what this means for real estate. There will still be some small modifications in the bill until it’s signed, but at the time of this post we have a good idea on what’s in there. As always, I’m not a CPA or an attorney and don’t play one on TV so please consult your tax professionals on exact impact it’ll have on you. Feel free to contact me if you need referrals.

I’m not going to get political here. Overall I’m neutral to slightly positive on this bill, with lots of reservations. I do believe the wealthy individuals and corporations are the ones with the means to research and take advantages of the tax system, regardless of what’s written in there. Hopefully the little guys or the average Joe’s can use this summary to their advantage.

From a macro perspective, this bill could stimulate the economy through a combination of greater liquidity for corporations and a lower cost of capital through accelerated depreciation. 1031 Exchange and commercial mortgage tax deduction are staying, which should not shock the market. Demand for office and multifamily sector should improve as a result of this bill, but the elimination of state and local tax (SALT) deductions could have major adverse impact for high earners.

MacroEconomics Impact
  • Lower corporate taxes (from current 35% down to 20 – 22% as the Senate and House hash out the final number, most likely it’ll be 21%).
  • Repatriation of corporate profits currently held in overseas accounts (some estimate as much as $3 trillion) by imposing a one-time tax rate of as low as 10%.
  • Accelerated depreciation for new capital expenditures to stimulate spending.

Theoretically this will stimulate economic growth in the near term by increasing liquidity and lowering the cost of capital. Accelerated depreciation should increase the demand for property, plant and equipment (experts estimate by 12% to 19%) and incrementally improve GDP and productivity through capital expenditure. Some estimate that this new spending will increase GDP by 0.3% to 0.4% per year, with a total increase of 3% to 5% of additional GDP over the next decade.

There are differences in the House and Senate bills on when the corporate tax decrease will kick in, either 2018 or 2019. It is uncertain how or whether corporations will spend the money from tax savings. If you’re more cynical like me, they’ll probably just distributed it amongst their executive and shareholders bc there’s not a lot of positive NPV projects to invest in nowadays. Cost of capital has never been cheaper than it is today, and this hasn’t stimulated strong demand for spending on long-term capex so I’m doubtful this will do much as well.  Secular (demographics, global excess supply of cheap labor and capital) and late-cycle issues will provide a counterweight.

Commercial Real Estate IMpact
  • 1031 “like-kind” exchange remains intact.
  • Commercial mortgage interest deduction maintained.
  • Depreciation rules changed slightly (from 39/27.5 years to 25 years).
  • Carried interest still receives capital gains treatment under a three-year hold window (used to be one-year hold period).
  • REIT dividends is treated as pass-through income by dropping the top marginal tax rate (from 39.6% to 25% – 31%).
  • Limitation of mortgage interest deduction (to interest on mortgages of up to $500,000), combined with raising the standard deduction to $24,000 for married couples.

These changes reduce the attractiveness of buying single-family homes at both the low and higher ends of the market, however they could provide marginal benefit to the multifamily sector. Stronger corporate earnings should stimulate office occupier demand, particularly in financial services through lower corporate taxes and tech industries in the form of repatriation of foreign earnings. Tax benefit to lower income individuals should spur retail sales, as lower income earners spend a higher percentage of earnings than high income earners.

Another thing worth noting here, is the deduction for pass-through entities. Over 60% of the US commercial real estate is held in such entities. Not only are S corps and partnerships not taxed at the business entity level, they are entitled to a deduction equal to 20% of their allocable share of business income to be equitable of the tax break C corps are getting. Both the Senate and House approach are complicated with numerous caveats. It’s also weird that engineers and architects qualify for it but not accountants, lawyers, and doctors.

Residential Real Estate Impact

This is the single most controversial area of the bill. By limiting deductibility of property taxes to $10,000 and eliminating the deductibility of state and local income taxes (SALT), upper-income earners in high-income states (New York, California, Illinois, etc) may suffer. Mortgage interest deduction (MID) has also been reduced from up to $1M loan to $750K. For most people this is probably a wash because of the doubling of the standard deduction.

Section 121 capital gain exclusion is staying, which is great because it gives homeowners the ability to trade up so to speak as their families grow without the worry of capital gain tax. If you’re not familiar w/ Section 121, it’s a part of the tax code that exclude up to $250k filing individually or $500k for married couple filing jointly if you lived in your primary residence 2 of the last 5 years and it has appreciated.

It’s important to note the effect of these changes are marginal at your respective tax bracket. $250K difference in mortgage limit at let’s keep it simple 4% is $10,000 but the net impact on your tax bill is say 32% of that at $3,200. It’s not exactly chump change but these high-income states are largely price-insensitive due to their availability of high-quality labor, live-work-play environments, top universities, transportation infrastructure and 24/7 characteristics. While some marginal demand shift to lower tax locales like Texas, Florida and Tennessee should be anticipated it won’t be a tectonic significant amount.

The one last note worthy change is in estate tax. It used to be tax exempt up to $5.5M and now it’s essentially doubled to $10M. I personally think it’s not that significant, except maybe if you’re an estate tax lawyer now you might lose some business. At that level most of the individuals I know have already put assets in trusts or some kind of tax shelter.

It’s not over until the fat orange man signs the fat lady sings. There will probably be more last minute minor negotiations and changes, but it’s looking more likely than not this bill will become law maybe as early as this week. It COULD benefit the economy overall but from previous failed experiments in Kansas and Reagan era I have my doubts. This is definitely a good thing for real estate though if you know how to structure your entities properly.