By Bendix Anderson (MultiFamilyExecutive.com Article) — The first comprehensive reform of the federal tax code in a generation left the apartment business largely unscathed.
“We were worried that tax reform would be quite disruptive … it turned out quite favorably for the real estate industry,” says Matthew Berger, vice president of tax at the National Multifamily Housing Council (NMHC).
The Tax Cuts and Jobs Act, signed into law by President Trump on Dec. 22, 2017, didn’t cut a long list of provisions in the tax code that are important to the real estate business. The legislation, in fact, will directly benefit many real estate companies with a generous tax cut. The demand for rental apartments may also rise because the new law includes less of a reward for homeownership.
However, it’s not as clear how much the reform measures might benefit the broader U.S. economy.
“The economic lift is likely to be short-lived, as most economists believe the tax bill will prompt the Fed to raise interest rates more quickly to slow inflation. The greater national debt from the unfunded tax cuts also will tend to raise interest rates,” says Andrew Nelson, chief economist for Colliers International.
The Suspense Is Over
Lawmakers had been talking about a comprehensive reform of the federal tax code for several years.
The business of buying and selling apartment buildings will certainly benefit from the end to the suspense. Immediately after the presidential election of 2016, as Republicans in Congress and the White House promised to act swiftly to reform the code, the volume of dollars spent to buy apartment properties fell sharply.
“There are many who sat on the sidelines waiting to see what would [happen],” says John Chang, first vice president of research services for Marcus & Millichap. Now that the uncertainty is resolved, investors who had held back may return to buying and selling properties. “This could be a very dynamic investment market over the coming year,” he adds.
Corporations and companies of all sizes will also benefit from the lower taxes. The new law lowered the corporate tax rate from 35% to 21% starting in 2018. The effective tax rate for companies, averaged across all industries and weighted by size of industry, will decline this year, from what would have been 21.2% to just 9.2%, according to the nonpartisan Penn Wharton Budget Model.
It’s not immediately clear how much the lower corporate taxes will benefit the general economy. Historically, reductions in the corporate tax rate haven’t had a clear effect on economic indicators like gross domestic product. “It’s really hard to discern any relation between corporate tax rates and the overall economy,” says Chang.
Real estate firms will benefit from the new law a bit less than the average company. The Penn Wharton model projects that taxes for the property sector will drop 30% in aggregate over the next decade against the baseline, versus 32% for all industries. Tax reform also continues to allow many real estate investors to report the income from their properties as “carried interest,” which is taxed at a lower rate.
Commercial Real Estate Keeps Most Tax Benefits
Apartment investors can also celebrate the passage of tax reform because Congress didn’t wipe out many tax breaks that owners of apartment properties depend on.
These include tax-free 1031 exchanges, commercial mortgage interest deductibility, and asset depreciation. “At various points over the last year, all these special benefits for the real estate sector seemed threatened,” says Nelson. “Most prevailing special tax benefits enjoyed by the real estate sectors have been retained.”
For example, unlike many businesses, property owners can still deduct from their taxable income the interest they pay on loans. “We were able to generate a carve-out for real estate,” says the NMHC’s Berger. That even includes financing for real estate such as senior housing, in which operations like medical services and food make up a large part of the business.
Tax credit reform also includes accelerated depreciation and bonus depreciation for many parts of real estate properties. “It’s a massive benefit,” says Michael D’Onofrio, managing director of Engineered Tax Services. “You’re going to see that uptick of increased expenditures into these properties, which puts the roofers to work, which puts the construction trades and all the different architectural and engineering services to work.”
The new law also continues programs such as the New Markets Tax Credit and the federal historical rehabilitation tax credit for fixing up landmark buildings. Congress also preserved the largest federal program that builds new housing that’s affordable to low-income households, the low-income housing tax credit program—including the private-activity bond program, which was threatened in the first tax reform bill put forward by the House of Representatives.
Less Competition From For-Sale Housing
The new tax law will also reduce the competition rental apartments will face anytime soon from for-sale houses and condominiums.
“The multifamily sector looks to gain from tax law changes that will reduce the benefits of homeownership in many markets, and thereby raise the incentives for apartment rentals for some households,” says Colliers’ Nelson.
The changes will affect both expensive homes and more modest houses. Homeowners can now only deduct from their taxable income the interest on the first $750,000 of their home mortgage debt. That’s down from $1 million under the old law. It also limits to $10,000 the amount taxpayers can deduct for state and local taxes, including property taxes.
The new law also doubles the standard deduction for all taxpayers. That means many households won’t get any benefits from homeownership on their income tax. “There may be a slight reduction in first-time home buyers because they’re not able to deduct,” says Chang.