Craig Young, CCIM / February 28, 2019
The tax reform bill entitled “Tax Cuts and Job Act (TCJA)” that passed in December of 2017 represents the most sweeping reforms since the tax act of 1986. The new measures are set to have a significant impact on both individuals and businesses.
The bill will lower income tax rates for most individual tax payers, double the estate tax exemption to $11,200,000 per person, and double the child tax credit to $2,000. But it will undermine previous advantages such as the mortgage interest deduction for mortgages over $750,000. The bill will also reduce itemized state and local taxes to $10,000, and repeal moving expense deductions (except for members of the armed forces).
Businesses in general will be impacted in a number of ways, while some changes specifically affect commercial real estate. A few overall business changes include doubling bonus depreciation and eliminating the deduction for business entertainment; however, food and beverage business deductions remain intact.
From a commercial real estate perspective there are a number of advantageous changes, including a new tax deferral strategy called Opportunity Zones, and a change to how business parking costs are written off—you may want to revisit the terms of your lease.
Recent changes affecting commercial real estate include:
In essence, if you sell something and incur a capital gain—real estate, a business, stocks, artwork—within 180 days of the sale, you can place the money into a qualified opportunity fund and defer the taxes on your gain until 2026. You also will not pay taxes on the interest income earned within the investment timeframe. There are, however, several qualifying conditions, which include investing in a designated Opportunity Zone. There are 32 Opportunity Zones in Maine (and more than 8,700 in the US). An investor can buy into a fund or directly purchase a property. The purchase also requires a significant investment in the redevelopment of that asset, which generally means an amount equal to or greater than the purchase price. In addition, the investment cannot be in a “sin” business—country clubs, golf courses, liquor stores, massage parlors, race tracks, or any gambling venue.
The final bill retains the current rules for real estate, but repeals the use of 1031 exchanges for personal property such as artwork, vehicles, animals, or other non real estate sales. Therefore, real estate like-kind exchanges remain a very valuable tax-deferral opportunity for real estate investors.
A new 20% pass-through income deduction for real estate investors and businesses other than C-Corporations, including sole proprietors, LLCs, and S Corps. There may, however, be limitations on single taxpayers with over $157,500 in adjusted gross income and those married, filing jointly with income over $315,000.
This tax break provides certain flow-through business income a 20% deduction, which essentially makes the first 20% of the profit tax-free. It applies to people who buy and flip real estate, landlord rental income, and 1099 independent contractor income (real estate brokers). It does not apply to W-2 wages, interest income, dividends, or capital gain income.
The final bill repeals the current law’s 10% credit for pre-1936 buildings. It retains the current 20% credit for certified historic structures, but modified, so that it is allowable over a five-year period, based on a ratable share, i.e., 20% each year.
The final bill says that no deduction can be taken for separately itemized parking costs associated with a business lease, but seems to allow the deduction if the parking costs are embedded within the lease and not separately identified. This change could be significant enough for a business to consider renegotiating its lease so that parking is included in the monthly/annual lease rate and not separately itemized and billed.
The IRS issued temporary guidance on the new tax reforms in August 2018. The final law is still not finalized and is subject to additional IRS changes and clarifications. As such, we encourage you to speak with your tax and real estate advisors to more clearly understand what the tax reform act means for you.