November 7, 2017 Real estate considerations on the House tax reform bill The November 2, 2017, release of a comprehensive tax reform bill, the Tax Cuts and Jobs Act (the House Bill) kicks off formal tax committee action on long-awaited tax reform. While tax reform is still evolving and provisions may be added, removed or altered, there are significant items that taxpayers should begin considering now, including items that may be of particular interest to the real estate industry. The House Bill includes provisions to lower individual tax rates and lower the corporate tax rate to 20%, while eliminating many current tax benefits. Further, the US tax system would move to a territorial system of taxing foreign earnings with an anti-base erosion provision and a one-time transitional tax on accumulated foreign earnings. For an overview of the House Bill, and its potential application to accounting methods and various other sector implications, please see Tax Alert 2017-1831. Individual tax proposals The individual tax proposals in the House Bill include certain items that may be of particular interest to the real estate industry: — The itemized deduction for real property tax would be limited to $10,000. — The itemized deduction for mortgage interest for a principal residence would be limited to interest incurred on maximum indebtedness of $500,000. — The $500,000 exclusion of gain from the sale of a principal residence would be subject to a phase out for higher income taxpayers, and eligibility requirements would be tightened. — Qualified business income of an individual taxpayer (whether received through a sole proprietorship, partnership or S corporation) would be subject to a 25% maximum income tax rate. In general, qualified business income includes 100% of any net business income derived from a "passive" business activity and 30% (or other determined amount) of any net business income derived from an "active" business activity. Individual investors in a rental real estate or other real estate businesses will want to investigate the availability of the 25% rate. In addition, it appears the maximum 25% rate would be made available to dividends received from a REIT to the extent that the dividends do not constitute capital gain dividends or qualified dividends (which qualify for the existing 15%/20% maximum capital gain rate). Corporation tax proposals Taxpayers that conduct their real estate business activities through a C corporation (including a taxable REIT subsidiary of a REIT) will want to take note of several significant provisions. The House Bill would permanently reduce the top corporate federal income tax rate from 35% to 20% for tax years beginning after 2017. The House Bill also would repeal the alternative minimum tax, and would allow indefinite carry forward of NOLs arising in tax years beginning after December 31, 2017. The House Bill would repeal all carrybacks for losses generated in tax years beginning after December 31, 2017. The House Bill would limit the amount of all NOLs that a taxpayer could use to offset taxable income to 90% of the taxpayer's taxable income (computed without taking into account the NOL deduction) for tax years beginning after December 31, 2017. Other general business reform proposals General business reform proposals that may be of particular interest to the real estate industry include: — 100% expensing of certain qualifying personal property placed in service after September 27, 2017 and before January 1, 2023, would be allowed. However, the expensing would not apply to any personal property used in a "real property trade or business" which includes any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage trade or business. — Businesses (regardless of entity type) generally would be subjected to a disallowance of a deduction for net interest expense in excess of 30% of the business's adjusted taxable income. However, this provision would not apply to a real property trade or business, which is of great relief to the real estate industry. — The like-kind exchange rules would be modified to provide that only exchanges of "real property" (and thus, not personal property) would qualify for non-recognition treatment under Section 1031. Thus, any personal property (e.g., furniture and fixtures, appliances, etc.) included in an exchange of real property would not qualify for non-recognition treatment under Section 1031. Other Absent from the Bill are any material changes to the current tax treatment of carried interests, FIRPTA and the Section 460 rules governing use of the completed contract method, but those provisions may well appear as the bill proceeds. Next steps The House Ways and Means Committee is expected to begin its deliberation on the House Bill on November 6 and, separately, a Senate Republican version of a tax reform bill is expected to be released shortly. ———————————————
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