If you’re an investor in commercial real estate like I am, you’ve probably been biting your nails trying to figure out how the looming tax code changes will affect your business.
While there are a couple of pinches, the bottom line is the changes are likely to create more cash flow, investing and buying opportunities.
On December 22, President Trump signed the Tax Cuts and Jobs Bill, which is effectively the largest overhaul of the tax code since the Tax Reform Act of 1986.
The changes to the tax code in 1986 made it harder for investors to falsely use real estate to lower their effective tax rate. An example of this would have been a doctor who bought a burned-out apartment building in a rough area knowing it would always lose money so he could use it to lower his tax bracket. Since that doesn’t apply to you or I, let’s keep going …
While I was doing my research, I found six ways that the new tax bill might affect our business. Here are my predictions and analysis.
No. 1: Low Income Housing Tax Credits Will Suffer
If you use the Low Income Housing Tax Credit (LIHTC) program to build or develop affordable housing, the new policies may threaten the private activity bond fund which allows housing finance agencies to issue the bonds that provide debt financing for your projects.
Tampering with the program could also cut the number of affordable apartments produced by the program in half. It could also threaten projects where affordable units are mixed with luxury units in locations like NYC or Miami.
No. 2: Historic Rehabilitation Tax Credit Wiped Out
If you like to rehab historic buildings, you may be in for a shock when it comes to funding sources. Many downtown areas have relied on this type of funding to rebuild their charm. Since the inception of the Historic Tax Credit (HTC) in 1978, over $131 billion has been spent in the rehab of 42,293 historic properties and have created more than 2.4 million jobs. A recent report by Rutgers University stated that the tax credits have generated more than $29 billion in federal taxes.
No. 3: Maximum Tax Rate for Pass-Through Entities Slashed
A large portion of real estate investors use the Limited Liability Corporation (LLC) to shield their properties and provide a legal pass through entity. As a result of the new tax plan, we will see our tax rate reduced from 39.6 percent to a much more reasonable 25%. I don’t know about you, but a saving like this motivates me to make more improvements to my properties. Those improvements will ultimately make our properties more valuable and provide us with much more income. I love that kind of domino effect, don’t you?
No. 4: The Almighty 1031 Exchange is Alive and Well
If you’ve invested in real estate for any length of time, you may have heard of the 1031 exchange, which allows you to take the profits from the sale of a property and move them tax free into a like-kind property.
This break has allowed real estate professionals like us to keep building our wealth year after year by deferring taxes on our gains indefinitely.
No. 5: We Can Depreciate Our Costs Faster
As a result of the new legislation, bonus depreciation rises from 50% to 100% for assets with a useful life of less than 20 years. Well, what exactly does that mean?
If you buy personal property (carpet, appliances, tools, equipment, etc.) or if you make land improvements (landscaping, driveways, parking, etc.) you can now immediately write off the entire costs of those assets.
The ruling does not allow you to write off the cost of buying a rental property and its key components because they have a useful life of 27.5 years.
No. 6: The South May Rise Again
As crazy as this sounds, investing in the South may become the next big thing. I’m from Mississippi and we have an unlimited amount of land we can use for development. We also have a burgeoning car manufacturing industry just like other states such as Alabama and Georgia.
There are some states such as Texas and Florida that don’t have state income taxes. These will be the new hotbeds of growth for the tech industry when the cost of doing business in places like California and New York become too expensive.
Just picture the hub of the movie industry leaving California and moving to Georgia. Twenty years ago, you would have laughed if I said that.
The Road Ahead
In closing, I think this is going to be a wonderful time to be a real estate professional. The changes in the law will allow us to recoup our investments faster through depreciation which will give us more money to use in improving our properties.
Although some affordable housing programs will feel the strain of finding new ways to fund projects, and the historic tax credit will be limited. I feel that we are a creative bunch and we won’t let these changes interfere with our real estate visions.
Since the ink has not dried on some of the new laws, I would advise you to consult with your tax professional to see how these changes may affect your business and portfolio.
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