November 16, 2017 Real estate industry implications of the Senate Finance Committee Chairman's Mark of the 'Tax Cuts and Jobs Act' On November 9, 2017, the Joint Committee on Taxation released a description of Senate Finance Committee Chairman Orrin Hatch's (R-UT) Chairman's Mark of the "Tax Cuts and Jobs Act." Although this release follows the same framework as the bill approved last week by the House Ways and Means Committee (the House bill), it does include significant differences in the design of provisions and their timing. The Senate Finance Committee began marking up its plan on November 13, with the stated objective of reporting the legislation by the end of this week. For a general overview of the Chairman's Mark, please see Tax Alert 2017-1907; for a general overview of the House bill, see Tax Alert 2017-1831; and for an overview of real estate implications of the House bill, see Tax Alert 2017-1860. Provisions of the Chairman's Mark that are notable for the real estate industry include: Corporate tax rate: The reduction in the corporate tax rate to 20% would not occur until 2019. Specifically, the reduced rate would apply to tax years beginning after December 31, 2018. Individual tax rate: The Chairman's Mark (and subsequent amendments) would include six tax brackets, compared to four under the House bill, and with the top individual tax rate pegged at 38.5% compared to 39.6% under the House bill. Pass-through tax rate: For pass-through entities, the Chairman's Mark would establish a 17.4% deduction for pass-through business income as opposed to the 25% maximum tax rate for pass-through business income under the House bill. This deduction would be subject to a 50% wage limitation, although the mechanics of the wage limitation are unclear. In addition, the Senate's plan, like the House's bill, would limit the deduction where the income is attributable to service businesses. Importantly, REIT dividends (other than capital gain and qualified dividends) would be treated as qualified business income under the Senate proposal. AMT: Like the House bill, the Chairman's Mark would repeal AMT for both individuals and corporations, with favorable rules for taxpayers regarding the use of existing AMT credit carryforwards. Net interest expense: Deductibility of net interest expense would, like the House bill, be subject to a 30% limitation, but applied to a different measure of adjusted taxable income (one that is reduced for depreciation and amortization). In the Chairman's Mark, the exception to the 30% interest limitation for real estate trade or businesses would be elective on the part of the taxpayer, as opposed to mandatory in the House bill. As was seen in the House bill, the Chairman's Mark would subject the interest limitation to a world-wide limitation, and when both the Section 163(j) and worldwide interest limitations apply, the one that yields the highest limitation on interest deductions would apply (meaning a larger portion of interest is carried forward). In a positive turn, the Chairman's Mark would permit an indefinite carryforward of disallowed interest as opposed to a five-year carryforward under the House bill. Immediate expensing: Under the Chairman's Mark, bonus depreciation would be increased from 50% to 100% for "qualified property" placed in service after September 27, 2017 (the date the Unified Framework was released). The increased allowance would remain until 2022. Excluded from the definition of qualified property for these purposes is certain public utility property. A transition rule would allow for an election to apply 50% expensing for one year. Real property cost recovery: In an important deviation from the House bill, the Chairman's Mark would reduce the recovery period for nonresidential real and residential rental property to 25 years for real property placed into service after December 31, 2017. The Chairman's Mark also would provide a 10-year recovery period for qualified improvements. Real estate trade or businesses that elect the exception from the net interest expense limitation under the Chairman's Mark proposals would be required to use the applicable ADS recovery period to depreciate its residential real property, nonresidential real property and qualified leaseholds. State & local taxes and home mortgage deduction: The Chairman's Mark would fully repeal the state and local tax deduction, but retain the $1 million cap on the mortgage interest deduction (although it would repeal the deduction for interest attributable to home equity lines of credit). Like-kind exchanges: Like-kind exchanges would be limited to those involving real property only under the Chairman's Mark. Transactions involving like-kind exchanges currently underway would be allowed to complete the like-kind exchange. Net operating losses: For losses arising in tax years beginning after 2017, the NOL deduction would be limited to 90% of taxable income. The carryback provisions would be repealed, except for losses incurred in a farming trade or business, which would be allowed a two-year carryback. An indefinite carry-forward would be allowed, but the provision does not address whether NOL carryforwards would be increased by an interest factor as proposed in the House bill. Excess business losses of taxpayers other than a C corporation would not be allowed in the tax year they arise, but would be carried forward. An excess business loss would be the excess of aggregate deductions of the taxpayer attributable to trades or businesses, over the sum of aggregate gross income or gain of the taxpayer, plus certain threshold amounts based on filing status. For a partnership or S corporation, the proposal would apply at the partner or shareholder level. Each partner's or S corporation shareholder's share of items of income, gain, deduction or loss of the partnership or S corporation would be taken into account in applying the limitation. Real estate tax credits: Like the House bill, the Chairman's Mark would retain the low-income housing tax credit (LIHTC). In a slight deviation from the House bill, the Chairman's Mark would modify the credit for the rehabilitation for old and/or historic buildings. Specifically, the credit for pre-1936 buildings would be repealed and the credit for certified historic structures would be reduced from 20% to 10% for amounts paid or incurred after 2017, with transition rules to be applied in the case of property owned or leased by the taxpayer on or after 2018. Partnership related items: Although the Chairman's Mark does not contain a provision relating to carried interests or partnership technical terminations, it does contain partnership proposals that set forth rules that: (i) would require a hypothetical sale and look-through approach be used when determining the taxation of gain from the sale by a foreign partner of its partnership interest where the partnership conducts a US trade or business; (ii) would require partnership "built-in loss" under Section 734(d) to be determined at the partner and partnership levels, and (iii) would require a partner to take its share of partnership charitable contribution into account when determining basis in order to determine the amount of partnership losses that a partner is eligible to deduct. International provisions. Like the House, the Chairman's Mark would propose moving to a territorial tax system for foreign earnings, including a one-time transition tax that would apply to a US 10% shareholder's pro rata share of the foreign corporation's post-1986 tax-deferred earnings. The tax would be determined at the rate of either 10% (for accumulated earnings held in cash, cash equivalents or certain other short-term assets) or 5% (for accumulated earnings invested in illiquid assets (e.g., property, plant and equipment)), both lower than the 14% and 7%, respectively, rates proposed in the House bill. The Chairman's Mark also includes a number of different approaches to preventing base erosion. It is possible that the full Senate could consider the final product of the Finance Committee deliberations after Thanksgiving. How reconciliation instructions and the Byrd Rule affect the path forward in the Senate remains to be seen. The differences between the House and Senate plans would need to be ironed out in a compromised version so a final bill can be approved by both chambers and sent to the President for his signature. ———————————————
| |||||||||||||||||||
| |||||||||||||||||||
