Last week, House Republicans released H.R. 1, their long-awaited 429-page tax reform proposal. The bill, which is titled the ‘Tax Cuts and Jobs Act (“TCJA”) leaves 1031 “like-kind” exchanges intact!
The TCJA proposal calls for Section IRC 1031 to apply to only “real property” (i.e., investment properties). As the IRS Code reads now, investors can do 1031 exchanges on virtually any type of property (without the word “real”), which includes rental car fleets, heavy machinery, airplanes and even works of art. In essence, this change means that investors would no longer be able to do like-kind exchanges of personal property.
Other Tax-Reform Considerations for Real Estate Investors
Beyond 1031 exchanges, the other provisions of the TCJA bodes well for commercial real estate investors.
- Interest Expense Deductibility.
Investors would continue to be able to deduct commercial mortgage interest expense without any limits. - Potentially Lower Taxes on Pass-Thru Entities.
Investors who hold real estate in pass-thru entities like Limited Liability Companies (LLC’s), Limited Partnerships and presumably Delaware Statutory Trusts (DST) may see their taxes go down. As proposed, the TCJA has pass-thrus paying 25% on taxable income at the entity level. However, the income would not be taxed a second time received by the individual owners of these entities. If passed, this means that owners of pass-thru entities with marginal tax rates higher than 25% would theoretically see a reduction in the taxes. - Investment Property Depreciation Would Not Change.
Commercial and residential investment properties would continue to be depreciated over 39 and 27.5 years, respectively.
On a related note, the TCJA would allow for either five-year or immediate expensing of “qualified property.” While the devil is in the details, this may include fixtures and furniture used in the operations of investment properties, which could result in slightly lower taxes for some real estate investors.
- Carried Interests.
Taxation of carried interest has been a hot political topic over the past few years. As of this morning, a group of lawmakers proposed that only carried interests held for more than three years would get taxed at the capital gains tax rates.
Where Tax-Reform Stands
The Senate is expected to release their tax-reform bill this week, which most political pundits agree will closely mirror the House version. House Speaker Paul Ryan (R-KY) and Senate Majority Leader Mitch McConnell (R-KY) are pushing to pass tax-reform legislation by Thanksgiving and have a bill on the President’s desk by Christmas. Speaker Ryan reported this week that they believe they have the votes in the House. Where tax-reform currently stands in the Senate is somewhat less clear. What is clear is that passing tax-reform by yearend may be feasible given that Republicans in both chambers need a “win” after failing to pass healthcare reform.
Final Thoughts
The team at Realized® will work hard to keep you informed as tax-reform legislation moves through Congress. Although it appears that 1031 exchanges and the other tax benefits afforded real estate will continue, now is not a time for investors to be complacent. Tax-reform is going to happen very quickly and unfortunately, will be very opaque to most voters. Even so, Realized® believes it is in the best interest of real estate investors to do their best to follow this legislation as it moves through the House and Senate during the next month or so.
To read the full legislative text of the Tax Cuts and Jobs Act, click here; or for a summary of the respective sections, click here.
If you have any questions regarding 1031 exchanges or how upcoming tax reform could impact them, please contact Realized® at 877-797-1031 or log onto www.realized1031.com.
