The Tax Cuts and Jobs Act of 2017 (TCJA) was the most substantial tax reform legislation enacted since 1986, when the Tax Reform Act of 1986 was passed to simplify the income tax code. Changes to the tax code by the TCJA are effective for tax years after December 31, 2017.
Here’s a quick overview of how the new tax code benefits commercial real estate investors.
Original Use Requirement Removed
The original use requirement for assets that were acquired and placed in service after September 27, 2017 was removed by the TCJA. Cost segregation studies can now be performed on newly acquired property and new construction to identify the personal property assets in the building and accelerate the depreciation.
Depreciation for Qualified Improvement Property
The definition of qualified improvement property was consolidated to make it eligible for bonus depreciation. Previously, improvements needed to be in qualifying leasehold, retail, or restaurant property. The TCJA changed that to allow for all improvements to the interior of commercial rental real estate – except for inside structural framework, elevators and escalators, and building enlargements – to be classified as improvement property.
On its website the IRS details section 179 and temporary bonus expensing for certain business property and assets.
Commercial real estate investors are now able to deduct 100% of the mortgage interest paid on their commercial properties. However, for businesses with more than $25 million in gross revenues, the net interest expense deduction is now limited to 30% of earnings (before interest, depreciation, taxes, and amortization).
Pass-through entities such as real estate partnerships and LLCs will now pay a top individual tax rate of 37%, with the pass-through business income eligible for a 20% deduction. The net effect of these changes is that the top tax rate on business income could be 29.6% compared to the previous top rate of 39.6%.
Historic Preservation and Rehabilitation Tax Credit
Developers renovating certified historic structures will still receive a 20% tax credit claimed over a five-year period. On the downside, the previous 10% credit for non-certified property constructed prior to 1936 was eliminated.
No change was made to section 1031 of the tax code. Commercial real estate investors can still benefit from using like-kind tax deferred exchanges to defer the payment of capital gains tax by selling an investment property and replacing it with another.
Impact on Multifamily Investments
While the TCJA provides several tax benefits to commercial real estate investors, homeowners didn’t benefit nearly as well.
While interest on existing mortgage debt of up to $1 million can still be deducted, interest can only be deducted on new mortgages of up to $750,000 and home equity loan deductions are no longer allowed. Deductions for state and local taxes are now capped at $10,000.
The reduction and elimination of these homeowner tax deductions makes owning a home more expensive in urban centers and high-tax states such as California. Multifamily real estate investors may benefit by offering alternative options to homeownership in central business districts, and by meeting the demand for housing as residents move from expensive city centers to more affordable suburban areas.