New deductions and lowered corporate tax rates have given many employee-driven businesses an incentive to go out and hire new workers and grow their companies.
For example, deductions for S corporations are dependent on payroll. In essence, businesses with higher payrolls and more employees can deduct more from their business income.
What it means for property owners is a potential bump in real estate investments. The deductions and expensing options will provide landlords the ability to reinvest in their current holdings or additional property. It will also benefit them in lowering taxes for tenants, as well as providing consumers more discretionary income.
For investors that are not currently involved in the commercial real estate sector, the implications of reform offer prospects of higher after-tax yields than some other investment options. This could very well draw much more capital and activity into commercial real estate.
Some of the biggest growth drivers for commercial real estate will be:
Under the new bill, individuals will be allowed to deduct 20% of "qualified business income" from a partnership, S corporation, or sole proprietorship - common structures for owning commercial real estate. Individuals will also be able to deduct 20% of qualified real estate investment trust (REIT) dividends, qualified cooperative dividends, and qualified publicly traded partnership income.
Section 179 doubles the amount a taxpayer may expense a qualifying property, from the previous $500,000 to $1 million. It also expanded the expensing options for qualified real property to include improvements to such items as roofs, HVAC, fire protection and alarm systems, and security systems.
Qualifying property is defined as depreciable tangible personal property that is purchased for use in the active conduct of a trade or business, and includes off-the-shelf computer software and qualified real property (i.e., qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).
The Tax Cuts and Jobs Act limits the deduction for net business interest expense to 30% of adjusted taxable income, but real property trades or businesses are eligible to elect out of the limitation.
The exception is defined broadly to include any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.
The new law extended and modified bonus depreciation, allowing businesses to deduct 100% of the cost of qualified property in the first year it is placed into service through 2022. This provision also now applies to used property (previous rule applied to only new property).
The amount of allowable depreciation will be phased down starting in 2022, as follows:
80% for property placed in service after Dec. 31, 2022 and before Jan. 1, 2024
60% for property placed in service after Dec. 31, 2023 and before Jan. 1, 2025
40% for property placed in service after Dec. 31, 2024 and before Jan. 1, 2026
20% for property placed in service after Dec. 31, 2025 and before Jan. 1, 2027
The tax bill preserves the 1031 tax-deferred exchange rules that allow investors to defer capital gains on the sale of a property by reinvesting proceeds into another qualifying “like-kind” property.
* The Tax Cuts and Jobs Act is a complicated issue with many provisions that are still being assessed and analyzed. This article is simply meant to address some of the major issues impacting the commercial real estate industry as we best understand them at this time. This information is provided based on sources from The Journal of Accountancy and AICPA.