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Tax Cuts and Jobs Act - Summary and Analysis

Tax reform summary and Analysis

House Republicans released tax reform legislation this week that would cut tax rates for individuals and businesses. In particular, a portion of multifamily business income that is earned by the pass-through entities that dominate the industry (i.e., LLCs, partnerships, and S Corporations) would be eligible for a 25 percent tax rate. As currently written, the Tax Cuts and Jobs Act would preserve interest deductibility, like-kind exchanges, and carried interest. The 27.5-year depreciation period for multifamily properties is left unchanged; and the estate tax is repealed in 2024, while stepped-up basis is retained.

Notably, the Act would retain the Low-Income Housing Tax Credit. However, as currently drafted there is concern that the equity generated by the credit could be reduced given that the corporate rate is proposed to fall to 20 percent. Additionally, the Act would eliminate tax-exempt bonds, which could jeopardize the efficacy of the 4 percent LIHTC.

The House Ways and Means Committee intends to begin marking up the package beginning next Monday, which would be followed by floor action. Senate Finance Committee Chairman Orrin Hatch today said he would introduce his chamber’s version of tax legislation once the Ways and Means Committee completes its markup.              

Tax Rates on Pass-Thru Income:
The multifamily industry is dominated by pass-through entities (e.g., LLCs, partnerships and S Corporations) that pass through a company’s earnings to owners who are taxed at individual rates of up to 39.6 percent. The Act would allow a portion of this income, which would be designated as business income, to be taxed at a maximum rate of 25 percent. The remaining income would be considered compensation and taxed at ordinary income tax rates.

The Act specifies the following:

  • Active owners would have to separate business income from compensation. Under one option, active owners could designate 30 percent of their total income as business income eligible for the 25 percent rate. The remaining 70 percent would be taxed at ordinary income tax rates. Alternatively, and positively for real estate, a higher capital percentage would be available for capital-intensive businesses. It would be calculated based on a rate of return (Federal short-term interest rate plus 7 percent) multiplied by the capital investments of the business. The Act would maintain current definitions of active and passive income.
  • Passive income would be fully eligible for the 25 percent rate.
  • REIT dividends would be taxed at 25 percent, down from today’s maximum 39.6 percent rate.
  • Income attributable to brokerage services would be ineligible to use the 70/30 split but could use the alternative method to calculate business income attributable to capital invested.

Business Interest Deductibility:
The Act preserves the full deductibility of business interest for the multifamily industry. That said, the Act generally limits net interest expense to 30 percent of an entity’s EBITDA.

The Act retains current law that depreciates multifamily real estate over a 27.5-year period.

Like-Kind Exchanges:
The Act preserves like-kind exchanges for real property, though eliminates them for non-real estate assets.

Carried Interest and Capital Gains Taxes:
The tax treatment of carried interest is unchanged as is the maximum 20 percent tax rate on capital gains.

Estate Tax:
Under current law, the estate tax provides for a $5.49 million ($10.98 per couple exclusion), a 40 percent top rate and stepped-up basis. The Act doubles the exclusion amounts before repealing the estate tax in 2024. Inherited assets would retain the benefit of stepped-up basis before and after repeal of the estate tax.

Low-Income Housing Tax Credit:
The Low-Income Housing Tax Credit is not changed under the Act. However, this may pose concern given that equity raised could drop given the proposal to cut the corporate tax rate to 20 percent. Additionally, private activity bonds issued after 2017 would lose their Federal tax exemption, which could harm 4 percent LIHTC deals.

State and Local Income and Property Taxes for Business:
The Act retains the ordinary and necessary tax deduction for state and local income and property taxes attributable to a business.

Rehabilitation and New Markets Tax Credits:
The Rehabilitation and New Markets Tax Credits are repealed.

Corporate Tax Rate:
The corporate tax rate is reduced to 20 percent from 35 percent.

Individual Income Tax Brackets:
There are currently seven tax brackets ranging from 10 percent to 39.6 percent. The Act provides for tax brackets of 12 percent, 25 percent, 35 percent and 39.6 percent. The 39.6 percent bracket would begin at $500,000 in taxable income for single filers and $1 million in taxable income for married couples. The 12 percent bracket would be phased out for single filers earning over $1 million and married couples earning over $1.2 million.

Standard Deduction / Personal Exemptions:
The standard deduction is doubled, taking it to $24,400 for married couples. The Ways and Means Committee estimates that whereas approximately one-third of taxpayers today itemize their deduction, this would fall to fewer than 10 percent. Personal exemptions are repealed.

Employer-Provided Housing:
The employee tax exclusion for employer-provided housing is limited to $50,000 and is phased out for individuals earning over $120,000.

Provided by NMHC as part of the NAA/NMHC Joint Legislative Program