Commercial real estate industry expected to benefit from tax changes

By: Jennifer Sharpe//The Journal Record//February 16, 2018

Oklahoma City downtown skyline. (Photo by Brent Fuchs)

Experts say the new tax laws taking effect in 2018 are generally advantageous to corporations and should be beneficial for the commercial real estate industry. However, one drawback could come in the area of interest expense deductions.

“The new laws are making it easier for businesses to do things quicker,” said Denise Felber, partner with HoganTaylor. “On the real estate side, what we are seeing in the tax reforms is a clearing-up and a tightening of definitions, including making special rules for real estate.”

Depreciation changes will have a significant positive impact.

“The changes in the depreciation rules within the tax legislation are very taxpayer-friendly,” said Todd Pefferman, partner with BKD Oklahoma City. “They’ve enhanced the ability to take the bonus depreciation, changing from a 50-percent deduction to a 100-percent deduction through 2025, and they’ve expanded the definition of the types of properties that qualify for the 100-percent bonus depreciation.”

J. David Chapman, associate professor of finance and real estate at the University of Central Oklahoma, concurred.

“The shorter depreciation schedules will help save tax money on the commercial side,” Chapman said.

The preservation of the 1031 exchange is another aspect of the legislation that has a positive impact on investors.

“From a construction or real estate perspective, the changes in the 1031 provisions are very beneficial to the industry,” Pefferman said.

The tax law changes have raised questions for business owners looking to save money.

“It’s well-known that C corporations are going to be taxed at a flat 21 percent, whereas pass-through entities are still taxed at the individual tax rates of the owners, but there’s a new pass-through deduction that’s attributable to these S corporations and partnerships,” Pefferman said. “So the biggest question people are asking is, ‘Will I pay less taxes as a C corporation or more tax?’”
David Greenwell, partner with RSM US LLP, elaborated on the issue.

“A new provision that came out in the tax reform act is the ability to reduce your income from a pass-through entity by 20 percent for income tax purposes if it meets certain requirements, so that could lower the effective tax rate for investors in commercial real estate from a 37-percent bracket down to a 29.5-percent tax bracket,” Greenwell said.

Despite this benefit, the appeal of the 21-percent tax rate, plus the elimination of the corporate alternative minimum tax, may spur some companies to consider seeking C corporation status.

“To the extent corporations do invest in commercial real estate, I think they certainly are in a more advantageous position,” Greenwell said. “You might see some developers convert to a C corporation depending upon the various facts and circumstances just to take advantage of that lower rate.”

The changes in tax law are not all positive for the industry.

“A negative consequence of the tax law change as it relates to construction and the real estate industry is the ability to deduct your interest expense,” Pefferman said. “There’s a new limitation for all businesses if their gross receipts exceed $25 million so your interest expense deduction is limited to 30 percent of your adjusted taxable income on a given year. This could slow down development if the taxpayer is highly leveraged and relying on that interest expense deduction or getting a benefit from the interest expense deduction.”

“In the past, there was never any limitation on the ability to deduct interest expense, so that’s a new potential game-changer,” Greenwell said, but the impact may not be all that significant. “Usually, since we are able to add back interest expense, depreciation, amortization and taxes in determining what our adjusted net income is, it usually isn’t as great of a limitation as it might be in other settings.”

Despite all the buzz about the new tax laws, Felber said it will be some time before we see the actual impact of the new tax laws since they were only passed in December, and the IRS has not had time to figure out the specific rules and details that will go hand in hand with the new laws.

“Around April and May, there will be more clarification from the IRS,” she said.

Pefferman agreed.

“I would expect that reaction and changes from a significant standpoint will happen sometime in the middle of 2018,” he said. “People are not going to know how the changes will affect them personally until they file their 2018 tax returns a year from now.”

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