From: Multi Finance Executive
By: Brian Croce
Date: March 21, 2018
The industry avoids major changes under the new Tax Cuts and Jobs Act.
When the issue of tax reform started percolating once more in our nation’s capital soon after the 2016 presidential election, National Apartment Association president and CEO Robert Pinnegar was concerned.
He, like a host of other multifamily industry veterans, was thinking about the last time a major tax system overhaul was passed. Last May, Pinnegar told Multifamily Executive that the Tax Reform Act of 1986 destabilized commercial real estate and severely affected the apartment industry. “It’s one of those things that people who were in the industry [at the time] and actually had to survive the downturn that was created … it’s a very real issue for them, and they’re very concerned about what that will do to the industry,” he said.
So now that a new tax law has been enacted, how does Pinnegar feel 30-plus years later?
Pretty good, overall.
That good feeling, he says, is mainly due to the fact that the Tax Cuts and Jobs Act didn’t change things much for the multifamily industry.
“I think that from where we started, we did a very good job in maintaining as much as we possibly could of the previous structure so we didn’t have any damage to the industry,” Pinnegar says. “So I was happy with the results.”
John Isakson, chief capital officer at Preferred Apartment Communities, is also pleased with the legislation. His father is Johnny Isakson, a U.S. senator from Georgia who sits on the Senate Committee on Finance.
“I thought a lot of the changes that they made were thoughtful, and they weren’t overbroad or sweeping, and they didn’t make any big mistakes,” the younger Isakson says. “In fact, I think most of what they did was very positive.”
The biggest part of the legislation for the multifamily industry, Isakson says, is the preservation of the 1031, or like-kind, exchanges, which had reportedly been on the chopping block. “I think what they ended up doing by scaling back the 1031 exchange and having it applicable just to real estate, which was the original intent of the rule when it was introduced, was a smart solution and clearly very favorable to everybody in real estate,” he says.
The new law repeals the use of 1031 exchanges for personal property such as art work, auto fleets, and heavy equipment but keeps real estate untouched.
“[The exchange] was created as a way for real estate–driven businesses to continue as operating businesses and to defer paying taxes on transactions they were using to grow their business,” Isakson explains. If the exchange were eliminated, some owners would incur a much higher tax bill.
Sepi Ghiasvand, an attorney with Hopkins & Carley, based in Palo Alto, Calif., says the legislation will be a boon for pass-through businesses, like partnerships, limited liability companies (LLCs), and S corporations. The bill lowers the corporate tax rate from 35% to 21%, and, as the National Association of Realtors notes, members of Congress believed the business income earned by sole proprietors, such as independent contractors, as well as those pass-through businesses, should also receive tax rate reductions.
In addition to lower tax rates, the law provides an up-front deduction of 20% for business income earned by many of these businesses. Income that was previously taxed at higher rates and treated as ordinary income, like REIT income, is now more valuable.
Carried interest, as the Tax Policy Center explains, is “a contractual right that entitles the general partner of a private investment fund (often a private equity fund) to share in the fund’s profits.” That income is treated as capital gains, which means it’s eligible to be taxed at a lower rate.
While the bill was being negotiated, carried interest was unpopular with some because of the hedge-fund compensation structure that was in place. But real estate investors who have carried interest take far more risk than hedge funds because of their obligation under the debt, Isakson notes.
Under the law, businesses must hold investments for at least three years before becoming eligible for carried interest. That could affect merchant builders and firms that look to buy and sell properties quickly.
But Isakson doesn’t expect the three-year rule to have a big impact on the multifamily industry. “I’m not particularly concerned about a three-year hold period because by the time you get an asset built or if you buy an asset and you want to renovate it, or even if you’re just buying something to hold, very few—especially multifamily—deals are held for less than three years, whether it’s a new build or an acquisition,” he says.
There are still questions surrounding this portion of the bill and others like it, Isakson adds, before the Treasury and Internal Revenue Service promulgate the codes and regulations sometime this year.
Last May, the NAA launched the “Protect the Lease” campaign. Using a grassroots approach, the campaign mobilized 11,000 people and orchestrated the mailing of 33,000 letters, according to Pinnegar. Also, members with existing congressional relationships pressed politicians on what the apartment industry wanted to see in a tax bill.
“It was really an all-hands-on-deck effort,” says Pinnegar. “We’ll see when the regs are finally written, but I think at this point it was beneficial to the entire industry across all segments.”
And perhaps most advantageous of all for multifamily professionals: The new law doubles the standard deduction.
“By doubling the standard deduction, Congress has greatly reduced the value of the mortgage-interest and property-tax deductions as tax incentives for homeownership,” says the National Association of Realtors. “Congressional estimates indicate that only 5% to 8% of filers will now be eligible to claim these deductions by itemizing, meaning there will be no tax differential between renting and owning for more than 90% of taxpayers.”
Ghiasvand calls it “another disincentive” for people considering a home purchase, while Isakson says doubling the standard deduction is going to “keep people who rent renters for longer because it takes away one of the bigger incentives to own a home.”
The bill also limits mortgage interest deductibility (MID) at $750,000, down from $1 million, and caps state and local tax (SALT) deductions at $10,000; there was no cap previously. “Even though there’s been some talk about the mortgage interest deduction and state and local deductions that impact individual taxpayers, I think on the whole the real estate industry is going to benefit from the changes,” Ghiasvand says.
Only time will tell if the tax bill leads to more people renting apartments and renting them for longer periods of time, but, overall, Pinnegar is content with how the industry made out under the legislation.
“Based upon what we see at this point in time … we’re actually in very good position compared to others,” he says.