Commercial Real Estate a Winner in Tax Bill
December 6, 2017 | James Sprow | Blue Vault
The House and Senate tax bills appear to benefit businesses in general, but one sector that may be the biggest winner is real estate. Both bills have steeply reduced rates for corporations, partnerships and family-owned firms. But, when it comes to the elimination of special breaks or imposition of tighter standards, real estate was largely exempted.
Most businesses were hit with new limits on deductions for interest payments, but not real estate. Most industries lost the ability to defer taxes on the exchange of similar kinds of property, but not real estate. Domestic manufacturers and pharmaceutical companies lost some industry-specific breaks, like the tax credit for so-called orphan drugs, in exchange for lower rates.
The real estate industry ended up with an even more generous depreciation timetable, allowing owners to shelter more income. Rental and mortgage-interest income qualifies for a lower tax rate, benefits that have traditionally been reserved for long-term capital gains and certain qualified dividends.
According to Daniel N. Shaviro, a professor of taxation at New York University Law School, who as a congressional staff member helped write the 1986 tax overhaul. "Real estate does great. It's hard to imagine what they might have asked for that they don't have."
Real estate investment trusts, known as REITs, have good reasons to be pleased. They are companies that make money by owning, financing and operating real estate. A REIT functions like a mutual fund, but instead of assembling a portfolio of stocks, it allows people to invest in a bundle of real estate assets, both buildings and mortgages. More important is the way they are taxed. They pay no separate business tax and instead are required to pass along virtually all of their taxable income to shareholders, who pay the tax when they file individual returns.
The Republican proposals sharply lower the top tax rate on the income that REITs and other businesses pass through to their owners and shareholders. Currently, those investors must pay taxes on that income at rates as high as 39.6 percent. Under the Senate provision, it would drop to 29.6 percent. (The House bill drops the rate even lower, to 25 percent.)
That's a big savings, and a big advantage. Those receiving mortgage-interest income outside a REIT would have to pay taxes based on ordinary rates.
Kurt Koegl, a partner at the national accounting firm Marcum, noted that a lower corporate tax rate would enable other kinds of companies to better compete with REITs.
But REITs are favored in other ways. Individuals who borrow money to invest in a REIT will be able to deduct the interest they pay on the loan at the top individual rate. When it comes to paying taxes on the interest income they earn from that REIT investment, however, the new, lower pass-through rate would apply.
"That's a great deal, and it's going to create giant new tax shelters," said Steven M. Rosenthal, a tax expert at the nonpartisan Tax Policy Center. The tax code generally tries to prohibit this kind of tax rate arbitrage, he added.