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December 6-19, 2017 Page 33

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A

s we are quickly

approaching the end

of 2017, we are faced

yet again with uncertainty

around income taxes. Not an

unfamiliar feeling for many

taxpayers this time of year,

especially those investing in

and operating commercial real

estate.

Since the last presiden-

tial election campaign, much

attention and energy has been

focused on potential changes

that were viewed as extreme

as they relate to the real estate

industry. Preliminary discus-

sions about tax reform includ-

ed ideas such as elimination of

Section 1031 exchanges, ordi-

nary income on carried inter-

ests, immediate write-off of

property costs and removal of

interest deductions on levered

real estate investment.

Uncertainty aside, the House

bill is favorable on many

fronts. Although the recently

passed bill still needs to find

its way through Congress,

and almost undoubtedly will

see changes during that pro-

cess, most of the extreme pro-

visions that previously were

discussed, and in large part

were lobbied against by the

industry, are not included in

the bill’s current form. Section

1031 exchanges are preserved,

interest on commercial real

estate loans is still deductible

and, although some expan-

sion to depreciation is indi-

cated, the immediate write-off

approach appears to be passed

on. Although some comments

from House Ways and Means

Chairman Kevin Brady open

the door to a two-year hold-

ing period concept for carried

interests to qualify for long-

term capital gain, the bill in its

current form does not affect

current treatment of carried

interest, which is great news

for real estate private equity

managers.

The House bill also includes

corporate tax relief, which

should have

less of a

direct impact

on real estate

owned

by

p r i v a t e

i n v e s t o r s

and opera-

tors. C corpo-

rations have

long been the

least desir-

able choice

of entity in the real estate

industry due to issues with

double taxation when profits

are distributed. Since most

real estate investments today

are held in LLCs and other

tax partnerships, the corporate

tax rate is less relevant in the

near term. The bill, however,

does include a 25 percent rate

on income from pass-through

entities. For ordinary income

items, this means a potential

14.6 percent tax break from

current law. Many view the

concept, which includes cer-

tain exceptions, as an item

that might not make it to the

final draft, assuming that Con-

gress can even get anything

done this year. Many investors

could find little benefit to this

rate if they are investing today,

especially if they are invest-

ing in new buildings. Even

under current law, it is not

unusual to have losses passing

through on K-1s, even when

the investment is cash-flow

positive and distributions are

being received by investors. In

these cases, and with poten-

tially even more liberal depre-

ciation rules, tax rates become

irrelevant when there is no

taxable income being passed

through.

One of the most talked about

items in the proposal has to

do with limiting an indi-

vidual homeowner’s ability

to deduct mortgage interest.

Although this is less of a direct

effect item on commercial real

estate, indirectly it has poten-

tial to effect behavior when

it comes to decisions about

whether to buy or rent. In our

current political climate, this

issue could, and likely will, be

widely politicized and create

some level of panic for home-

buyers, whether they are even

effected by the change. How

exactly the market reacts will

depend on the final form of

the change, assuming it makes

into law.

Also relating to housing, the

current proposal also retains

the low-income tax credit

program. Many view this as

a win, especially in the eco-

nomic realities we have seen

over the past five or so years

where housing costs have

gone up considerable, while

most wages have stayed flat.

This reality is one that Den-

ver, as well as other markets

attracting new residents, has

seen first-hand. The LIHTC

market isn’t unscathed in the

current proposal however. In

its current form, the bill does

remove tax exemptions for pri-

vate activity bonds, which is a

major financing source in the

low-income space. The remov-

al of the exemption would

increase the cost of capital and

could make it harder for low-

income developers to finance

projects even with the benefit

of the credits generated.

Given the general profile of

individuals investing in and

operating commercial real

estate, estate tax has been an

item that has been a staple of

tax planning. Although many

commentators believe the cur-

rent proposal, which complete-

ly repeals the “death tax” over

time, may be a stretch to make

it into law, many believe that

the current exemptions may

go up through the process,

which could further diminish

the number of people, in an

already very exclusive group,

that have exposure to the tax.

Since even current law with

Looming and uncertain tax changes for the CRE industry

Scott P. Grimm

Partner, ACM, Denver

Please see Grimm, Page 46