James Nelson James Nelson

NEW YORK CITY—For the January 2017 Full Nelson, I had the pleasure of sitting down with Jeff DeBoer, President and CEO of Real Estate Roundtable, to discuss the impact of the Presidential election on the New York City real estate market.

James Nelson: What can you tell us about President Elect Trump’s plan to reform the Tax Code, repeal and replacement of Obamacare, and turning back regulations?

Jeffrey DeBoer: My general view on these things is it usually takes longer than people think, because it is usually much more complicated, whatever the issue is. I expect the sequence to be with Obamacare first, and I think that Republicans in the House and Senate very much want to deal with that first. Simultaneously, I believe that there will be some efforts around the regulations. President Elect Trump has talked about executive orders that President Obama issued that because they are executive orders he could, if he wanted to, quite quickly deal with and reverse, repeal, or reform them, however he wanted to do that. Other regulations, whether it deals with Dodd–Frank or some of the tax regulations regarding estate tax, or land-use issues at EPA that are in regulation form, will take longer to deal with. I expect debate on Obamacare and the regulations to occupy the first five, six months.

Tax reform will require an awful lot of activity below the surface with the tax writing committees, hearings and industry meetings, and the Treasury Department forming its opinion in a more detailed way than we had seen on the campaign trail. There is going to be a lot of backroom activity but probably not a lot of full-scale in the face of the public activity until maybe March or April. At which point, that will really gear up and probably occupy the balance of 2017.

Nelson: What can you tell us about the “A Better Way” plan tax reform?

DeBoer: The House wants to bring rates down substantially. They want to bring the corporate rate down to 20 percent, and bring individuals down to 33 percent. With that being said, since much of American business is conducted through non-corporate format LLC or partnership or sole proprietorship, they do recognize that they need to set up a new category of pass-through income, and they want to tax that at 25 percent. While there is a lot of detail from the House Republicans, some items do not have enough detail. For real estate, we presume that they are talking about rental income and capital gain income that is received by someone who is actively in the real estate business from their partnership, but we do not really know. The reason for this pass-through rate is because they are proposing a big spread. This will create complexity with what is a pass-through, what kind of income and so forth. Also, only 50 percent of your capital gain would be taxed. Therefore, if you are in the top ordinary rate of 33 percent, your capital gain would be 16.5 percent as opposed to 20 percent under current law.

Nelson: The plan further calls for repealing the 1031 exchange, but my understanding is that in its place counting would move to cost recovery. Can you explain how this would work?

DeBoer: Currently, when you buy an asset that you use in your business, you depreciate it. Whether it is a computer, plane, tractor, or a building that you are using in your trade or business, you can depreciate the cost of acquiring that asset. For real estate it is 39 years for an office building, retail building, or an industrial building. And it is 27 and a half for a multifamily property. However, under current law, land is non-depreciable. The House is talking about is replacing the entire depreciation system. They are proposing that you would expense the investment in the structure to the extent that you had income less than the cost of the building. You would carry forward the unused expense to future years. You would no longer deduct the interest on the debt used to acquire that building. And when you ultimately sold that building, the theory would be that you would have ordinary income up to original purchase price, and then you would have capital gain for any gain over original purchase price. And if you sold the building you would probably acquire another building. You would perhaps use the expensing on a new building to offset the gain on the sale of the first building. So the theory is 1031 would not be needed. These three things are C-change for our industry. They are a big difference from the way that current law and the way that buildings have been financed and developed and bought and sold in America forever. Expensing with the carry forward is simply a reverse of depreciation. We are analyzing whether it’s a big positive change or a big negative change. We do recognize though that one of the major questions is what would happen to an investment that you have been depreciating and that you have been writing off the interest on the mortgage debt on that asset. How is that treated in the new world? How is it transitioned from the old world to this proposed new world? What does it mean? How are property values affected and on and on? And on that score there’s really not much detail, except to say that certainly we’re very sensitive to the potential disruptions that might occur. And law makers are sensitive to it as well. But there is not much detail on exactly what people want to do right now – if in fact we do change this tax code to go into this expensing no deduction for interest world.

Nelson: How will carried interest work and what will be the impact?

DeBoer: Right now the Blueprint is silent on carried interest. So absent something else happening, carried interest would, under the Blueprint, the House Republican plan, continue under its current law rules. Obviously, though there will be a lot of pressure and interest in reforming the carried interest rules. It is hard for me to say right now what the impact would be if they changed the carried interest rules or anything. We have to take a big step back and look at all of that.

Nelson: Where is the Senate in all of this? There’s a lot of talk about needing 60 votes, but how much of this is going to pass through?

DeBoer: Correct, the Senate, typically, you need 60 votes to move legislation in the Senate. Right now the House of Representatives sort of has the action because they have been, for lack of a better word, more advanced in their thinking on where they want to go with tax reform. The Senate is going to have a very big say in whatever, ultimately, takes shape. They are going to want to put their imprimatur on a tax reform. I would think that they would want to take a closer and harder look at the overall budgetary impact of tax reform. What does it do to our deficit, our national debt?

Nelson: Can you tell us about the expense deduction and specifically as it relates to construction and imported goods?

DeBoer: This is the so-called border adjustability aspect of the Blueprint. It has to do with bringing manufacturing back to the United States, bringing jobs back to the United States, and increasing the demand here. The theme of what President-elect Trump is trying to do is bring the corporate tax rate down where it is competitive globally, bring the overall corporate tax system into line with the way that corporations and other businesses are taxed around the world in different countries. And in this situation, this border adjustability, bring imports and exports a taxation more into line in the U.S. in the way that it is dealt with around the world. These are very new topics for Congress, and they are new topics for the American public to wrap their arms around. It is a significant shift in American federal tax policy. It would essentially levee a heavier tax burden on goods that are brought into the United States, and these good will either be put into something that is manufactured here in the United States, or it is an imported good that is just outright sold. The tax that they are talking about is a pretty heavy penalty on imported goods. We in the real estate industry have some interesting questions that we are all trying to think through and how would it really play out. This border adjustability is certainly something that the retail industry, in particular, is sorting out and trying to figure out whether it is net positive or maybe it is a negative in a short run but in a long run maybe it is good. In fact, this is the way that many countries around the world treat imports into their countries.

Nelson: In an ideal world, what should tax reform do to promote real estate investing? How are you going to really make sure that the real estate community’s voice is heard?

DeBoer: We have a lot of very smart people looking at the Blueprint and trying to understand what it means. We expect to be at the table, and we will make our voice known on things. The real estate industry is an integral part of America. It is an integral part of communities, a lot of jobs, direct and indirect, in our industry. A lot of people’s retirement, savings through 401(k)’s or pensions are linked up to success or failure in the real estate asset class. So we will have an informed view, and it will be a factual view. And we will go about our business, like we always have, talking to Members of Congress. Regarding how real estate should be taxed, our view comes down to two things: tax the asset fairly and economically, and if you are going to change it, do not do it abruptly but allow existing investments to move forward in an orderly transition to the new system. Our industry does best when we have tax policies that are fair and rational and tax the asset on an economic basis, not on a subsidy basis, and certainly not in a penalized format. We want the rules to apply to the transactions economically, and we want to make sure that existing investments and existing investors are treated fairly and are not somehow whipsawed and penalized for making investment decisions based on a set of laws that the United States had agreed to in the past.

James Nelson is vice chairman at Cushman & Wakefield. The opinions expressed here are his own.