Federal tax reform means multiple benefits to the real estate industry, although some further guidance is needed for investors to fully understand what that means.
After President Donald Trump signed into law the most sweeping changes to the U.S. federal tax code since 1986 with the Tax Cuts and Jobs Act, experts pointed to the real estate sector as one of the winners with the reforms.
“I think businesses as a whole have been perceived to be winners under tax reform,” said William Lentine, a partner specializing in tax law at Warner Norcross & Judd LLP and a former accountant.
In part, Lentine attributes the real estate sector’s perceived advantage in the tax reform law as stemming from a section on pass-through deductions, which also benefits other sectors. The new section allows for a 20-percent deduction for qualified business income of pass-through entities, a benefit that did not exist previously under the code, Lentine said.
The change will reduce the overall tax burden individual owners of businesses will experience. Prior to the tax reform, an individual owner of a pass-through entity might be taxed at the highest rate, Lentine said. Now with a reduced overall tax rate for individual owners, there is a reduced rate in each tax bracket. Assuming a business qualifies for the 20-percent deduction, the overall tax rate is then reduced.
“That pass-through deduction allows the individual owner to have that reduced tax rate on the aggregate earnings of the pass-through entity,” Lentine said. “I think that’s one of the reasons tax reform is perceived to make real estate owners, the real estate industry, a winner.”
This year, Lentine is advising clients and specifically real estate clients to analyze with their accountants and tax attorneys whether they are best structured as a C-corp or a pass-through entity.
Another possible benefit for real estate investors comes with the creation of Opportunity Zones, although Lentine said the industry still is waiting for additional guidance in 2019. According to the Internal Revenue Service, an Opportunity Zone is an economically-distressed community where new investments, under certain conditions, might be eligible for preferential tax treatment.
Areas that qualify have to be nominated by the state, and the nomination needs to be certified by the U.S. Treasury Secretary via delegation of authority to the IRS.
Opportunity Zones are meant to be an economic development tool, according to Lentine.
“(They’re) not exclusively for real estate, but it is typically being used for real estate kinds of investments,” he said.
The IRS released proposed regulations in the fall, but they are “a little fluid” currently, Lentine added. The Treasury Department and IRS are expected to provide further details and legal guidance on Opportunity Zones in the coming months.
Proposed regulations released in October by the IRS clarify that almost all capital gains qualify for deferral, although the amount depends on how long the investment is held. Generally, to qualify for a deferral, the capital gains to be deferred must be invested in a qualified Opportunity Fund, which must be an entity treated as a partnership or corporation for federal tax purposes.
The Opportunity Fund must hold at least 90 percent of its assets in Opportunity Zone property.
“The interesting aspect is those funds can be a large fund, like a private equity hedge fund, or it can be as small as two people forming a partnership or corporation,” Lentine said. “That kind of program is very different than tax incentives have been in the past, like new market tax credits, historic tax credits.
“It allows for the taxpayer itself — the partnership or the corporation — to make the election, so long as it meets the tests it qualifies for the tax benefit.”
The tax reform law also expands bonus depreciation for qualified property placed in service between Sept. 28, 2017 and Dec. 31, 2022. Businesses can claim the entire bonus depreciation in the first year on qualifying new and used property.
Before the tax reform, taxpayers could only claim a 50-percent bonus depreciation deduction in the first year, and used assets did not qualify.
The changes have provided savings for contractors like Grand Rapids-based Pioneer Construction.
According to Executive Vice President Chris Beckering, Pioneer used the extra savings “to offer raises and special bonuses to our employees, retain our ‘Cadillac’ health benefits plan with no employee premiums and reinvest in our operations through the purchase of new equipment.”
That includes buying a new crane that will be used in the development of a parking ramp for Spectrum Health on Michigan Street.
“Essentially, all tax savings to the company have been passed along to employees and/or gone to support other parts of the economy through capital investments,” Beckering said.
According to Lentine of Warner Norcross, many businesses will be able to capitalize on immediate savings from the changes to bonus depreciation.
“That’s certainly going to be a benefit that as many taxpayers as possible are going to try to take advantage of, and certainly real estate businesses may benefit from that as well,” Lentine said.
Despite new benefits from federal tax reforms, some industry sources point to the change in administration at the state level as possibly affecting companies more.
“I’m not seeing a ton of changes in our industry regarding federal taxes influencing real estate decisions,” said Chip Hurley, associate broker and vice president of Signature Associates. “I would think that the leadership change at the state level would influence decisions more. I suspect many have a wait-and-see attitude regarding what the new administration’s changes are going to be.”