SAN DIEGO—The Tax Cut and Jobs Act is comprehensive and far reaching, with many provisions directly impacting the commercial real estate industry, Phil Jelsma, a partner and chair of the tax practice team at Crosbie Gliner Schiffman Southard & Swanson LLC, tells GlobeSt.com. We recently spoke with Jelsma about how the legislation affects CRE businesses. Now, we speak with him about the specifics of the legislation and its potential impact on the real estate economy, investments and developments.

GlobeSt.com: What is the impact of the Tax Cut and Jobs Act on the various CRE sectors?

Jelsma: Not every real estate sector will benefit equally under the tax overhaul, which provides benefits to some real estate business and detriments to others. With the tax benefits of homeownership curbed—by limiting deductions for mortgage interest and property taxes—the tax plan is poised to have a negative impact on homeownership while favoring multifamily landlords. By reducing taxes on companies that rent space—and ideally leaving consumers with more money in their pockets—it should benefit retail landlords as well.

In general, real estate businesses appear to fare better than other pass-through entities under the new bill; however some of the new provisions—such as 1031 exchanges—may definitely limit the ability of these enterprises to operate in a business-as-usual fashion.

In general, office and industrial landlords should benefit by having more money to reinvest in their businesses. In addition, some land improvements may be entitled to bonus depreciation.

GlobeSt.com: How do the new pass-through deduction and its benefits work?

Jelsma: Beginning in 2018, pass-through entities such as sole proprietorships, partnerships, limited liability companies and S corporations are eligible for an additional special 20% deduction on domestic qualified business income. Owners and developers especially stand to gain from a new tax break for “pass-through” entities because they typically don't pay corporate tax. Instead, they will pass income through to their owners' individual tax returns. Companies may either structure the loan to take advantage of the 20% deduction to qualified business income pass-through entities or look to sell loans to REITs that can generate qualified business income. The 20% deduction is limited to the higher of: 1. 50% of the W-2 wages paid by the business to employees; or 2. 25% of the W-2 wages plus 2.5% of the acquisition cost of depreciable property (including depreciable real property) used in a trade or business that has not been fully depreciated for federal-income-tax purposes. Note that the calculation is 2.5% of the acquisition cost, not the depreciable basis of property.

GlobeSt.com: Has the law for like-kind exchanges of properties changed?

Jelsma: Beginning January 1, 2018, like-kind exchanges are available only for real property exchanges, so gain from the sale of personal property such as furniture, fixtures and equipment will be fully taxable.

GlobeSt.com: How does the reduction of the tax rate on business income work?

Jelsma: The new 20% deduction for pass-through income reduces the highest marginal rate on qualified business income from 37% to 29.6%. Dividend income from REITs is included in qualified business income. Therefore, commercial-loan originators may look to REITs as purchasers of loans.

Real estate businesses that are currently C corporations considering becoming S corporations may want to rethink this option since the Act reduces the highest corporate tax rate from 35% to 21%. Individual rates remain generally the same, except the highest marginal rate is reduced from 39.6% to 35%.

GlobeSt.com: How does tax reform impact carried interest?

Jelsma: Beginning in 2018, capital gains allocable to a carried interest or profits interest in a partnership or LLC that would otherwise be entitled to capital gains rights will only be available if the partnership or LLC interest is held for more than three years. If held for less than three years, the capital gain will be subject to tax as short-term capital gain rather than long-term capital gain. Exceptions exist for a capital interest attributable to capital contributed by the taxpayer.

GlobeSt.com: What are the implications of the business-interest deduction?

Jelsma: Generally, the Act limits the interest deduction to the sum of business interest income plus 30% of adjusted taxable income. Adjusted taxable income is intended to resemble earnings before interest, depreciation, taxes and amortization (EBIDTA). Disallowed interest deductions are carried forward indefinitely in future years. Adjusted taxable income is taxable income increased by 1. the deduction for net interest expense, 2. deductions for nonbusiness items, 3. the deduction for net operating losses, 4. the 20% deduction for pass-through income discussed earlier and 5. depreciation and amortization deductions. The limitations do not apply to businesses with average gross revenues of $25 million or less for the last three years. Real estate businesses can elect out of the business interest limitation, but at the cost of electing out is longer depreciable recovery periods for certain assets (i.e., 30 years for residential real property and 40 years for non-residential real property). Real estate businesses will need to determine which is better: electing out of the business interest or the cost of less annual depreciation.

GlobeSt.com: What will be the impact of the net-operating-loss deduction?

Jelsma: Beginning in 2018, net operating losses of corporations or individuals are only allowed to offset up to 80% of taxable income for that year and may no longer be carried back, but may be carried forward indefinitely. This could lead businesses to maximize net operating losses for 2017—which are not subject to either the 80% limitation or the limitation on NOL carrybacks.

GlobeSt.com: In general, is the tax overhaul good for real estate?

Jelsma: Overall, commercial real estate will benefit significantly from the tax overhaul, which by lowering tax rates should generate new investment. Commercial real estate owners will receive a large tax break under the new law—with most of its provisions impacting investors in the form of tax savings—but how much still remains to be seen. Simply, broad-based incentives for investment should accelerate demand, allowing real estate to remain a primary driver of economic growth and job creation.

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