As you would expect, the tax changes that took effect in 2018 are different for commercial real estate than for residential. Residential related changes were previously highlighted in the article “Have You Updated Your 2018 Tax Strategy?” Here, we take a look at significant changes that commercial investors need to be aware of with insight from Trey Webb, partner at Bennett Thrasher in Atlanta.
Commercial real estate professionals are generally pleased with the Tax Cuts and Jobs Act. Tax liabilities for most commercial property owners and investors will decline under the new tax law as tax rates are lowered for all businesses and most individuals. At the same time, most prevailing special tax benefits enjoyed by the real estate sectors have been retained. Most commercial real estate businesses are already structured as pass-through corporate structures like partnerships, S Corps, and limited liability companies (LLCs). These structures are critical for individuals wanting the benefit of the 20 percent pass through tax deduction.
There are income limits to the pass through deduction along with phase out ranges for incomes exceeding the full deduction limit. The income limit for the full deduction is $157,500 for individuals ($315,000 married filing jointly). The deduction only applies to qualified business income (QBI). The QBI does not include income generated through Specified Service Trades or Businesses (SSTB). Since the tax bill was enacted, real estate professionals have been concerned their income could be excluded from the 20 percent pass through deduction based on SSTB. On August 8, the IRS released the highly anticipated proposed regulations governing QBI. Favoring taxpayers, the SSTB definition is being narrowly interpreted. Although there are several important restrictions related to SSTB, the IRS interpretation generally favors banking, real estate, and insurance agents.
Webb, of Bennett Thrasher in Atlanta is fully tuned into the pass through deduction and other changes. He also shares his professional opinion that many commercial property owners and investors need to be aware of the new tax laws effecting Like Kind Exchanges and Low Income Housing Credits. Regarding 1031 Like Kind Exchanges, Webb finds, “good news that real property used in a business or held for investment still qualifies for like kind exchanges.” The law continues allowing commercial real estate owners to defer capital gains tax on real property. However, other types of property t such as furnishings are going to require more scrutiny when included with a property sale.
Webb also finds an interesting development emerging where low income housing credits are being coupled with historic rehabilitation projects in qualified opportunity zones. There is a strong business strategy here for commercial real estate professionals. Qualified opportunity zone investments require a long term holding period to take advantage of the tax incentives. By including tax credits, investors can get a more immediate return on their investment. Webb’s take on this is, “I expect that you will see a fair amount of low income housing credit developments going into qualified opportunity zones over the next several years.”
Additional important changes – Two key areas Webb and Bennett Thrasher are following closely are the interest limitation rules and the carried interest rules. Some business owners do not think that the interest limitation rules apply to them because their business income is below the income threshold. However, many real estate investments with passive investors are going to be subject to the limitation regardless of the amount of income from their business. Fortunately, there is an election out of the limitation for real property trades or businesses. Webb is waiting on further guidance from the IRS on how to apply the election.
Carried interest is essential for promoters in real estate development. The new tax law changes the holding period for long term capital gains on carried interest from one year to three years. This change can have an enormous impact in the current real estate environment where several investments are being sold in a one to three-year time frame. Webb says, “We are waiting to see the types of sales that the new law impacts and if real estate promoters will need to change how they manage and sell real estate investments.”
Some analysts view this tax reform as a once-in-a-career opportunity for commercial real estate investors to grow their businesses while preserving their existing assets. But in order to derive the maximum benefit available under these new provisions, you need to structure your holdings in such a way as to reap all tax deductions possible.
Please comment with your views on the tax reform. Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to [email protected].
Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 12 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. With the Pacific Ocean a couple of miles in the opposite direction.