The US is gearing up for what could be the first major federal tax reform since 1986.
Days after the House of Representatives released its draft of the tax package, called the Tax Cuts and Jobs Act, private equity real estate observers are scrutinizing the 429-page document. As the House marks up the bill, PERE examines critical points of the proposed legislation and the implications it has for the industry.
“We remain skeptical that such fundamental changes to the tax code can be passed into law in that short of a timeframe due to both the size and complexity of the proposed changes.”
– Commercial Real Estate Finance Council
- Macroeconomic growth through tax reform: Republicans’ overarching goal is to simplify the tax code and boost the economy, an endeavor industry lobbying group Real Estate Roundtable supports because of its spillover effects in commercial real estate. In a statement Thursday, the group said: “If the final bill is similar to the one introduced today, our industry will put more people to work modernizing and improving existing properties… to meet the changing and growing needs of American businesses and consumers.”
- Continuity of beneficial programs: While the first version of the tax bill includes myriad changes for corporations and individuals, many parts of the bill relevant to real estate remain intact, including allowance of deduction of interest expense, IRS Section 1031 exchanges and the commercial property cost recovery depreciation program, according to the Commercial Real Estate Finance Council. “CREFC considers these key provisions as a major steps in the advocacy effort to allow for continued commercial real estate market liquidity and supply/demand balance.”
- Carried interest: The first version of the bill did not include changes to how carried interest is taxed – but David Saltzman, a partner in law firm Ropes & Gray’s tax practice, noted the House Bill was subsequently amended to propose a three-year holding period in order for carried interest to qualify for capital gains rates in certain investment partnerships.“Carried interest is something that has been raised as a ripe area of reform for over a decade now,” he said.
- Reduced pass-through entity tax rate: Retail investors in private funds could benefit from a reduced effective tax rate if the rate for pass-through businesses is lowered, said John Hart, a partner in Simpson Thacher’s tax practice. “Real estate operating income in pass-through entities would generally be eligible for the maximum 25 percent rate for individuals who are partners in the owning entity. Individual investors in a private fund that holds real estate in pass-through structures may enjoy a lower effective tax rate.”
- No action on FIRPTA: In late 2015, President Barack Obama signed into law Protecting Americans From Tax Hikes Act, which included significant reforms to the Foreign Investment in Real Property Tax Act. The updated tax code included stipulations about the types of pension funds that quality for a reduced rate, but those rules have yet to be clarified by the government. Hart said industry observers hoping to see FIRPTA addressed in 2017’s tax reform will likely be disappointed, as the House version of the bill includes no FIRPTA changes other than conforming the withholding rates to the new lower rates provided in the bill.
- Outcome of negotiations: The bill faces multiple rounds of revisions and voting before it can land on the president’s desk, with much subject to debate and pressure from voters and lobbyists. “Having been in Washington for almost 40 years, I know that what starts out likely to be a tax bill isn’t what often emerges as the final tax bill,” Curt Buser, the Carlyle Group’s chief financial officer, said on the firm’s third-quarter earnings call last week.
- Timeline: Congressional leadership said they want to finish tax reform before year-end, but most political observers are pessimistic about that timeline. In a statement, CREFC said: “We remain skeptical that such fundamental changes to the tax code can be passed into law in that short of a timeframe due to both the size and complexity of the proposed changes.”