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Tax Reform Blueprint: The Good, the Trade-Offs and the Bad News on LIHTC

Tax Reform

House Republicans released their tax reform blueprint on June 24, which has significant implications for owners, operators and developers of apartment housing. NAA/NMHC are currently evaluating the blueprint and see some undeniable positives in the form of lower rates on business income and capital gains, some trade-offs on cost recovery and the unacceptable elimination of the Low-Income Housing Tax Credit (LIHTC). Although the blueprint has little chance of enactment this year, it is likely to form the basis for legislation House Republicans hope to move in 2017.

Of course, the next president, and the party controlling the Senate following this November’s elections, will also have a critical role to play in shaping any tax reform legislation that may ultimately be enacted.

NAA/NMHC would appreciate any reaction you may have to the blueprint as we frame our reaction. Here’s a description of the proposals in the blueprint that would have the most impact on the apartment housing industry:

Tax Rate on Pass-Through Businesses Income: The apartment housing industry is dominated by “flow-through” entities (e.g., LLCs, partnerships, S Corporations, etc.) instead of publicly held corporations. This means that the company’s earnings are passed through to the partners who pay taxes on their share of the earnings on their individual tax returns. The blueprint would tax pass-through business income at a 25 percent rate, which is down from a current-law maximum of 39.6 percent. Notably, the blueprint would tax individual wage income at a maximum rate of 33 percent with intermediate rates of 12 percent and 24 percent.

Capital Gains Tax Rates and Carried Interest: The blueprint would tax capital gains, dividends, and interest at ordinary income tax rates subject to a 50 percent exclusion. Thus, capital gains would effectively be taxed at maximum rate of 16.5 percent, which is lower than the 20 percent current-law maximum rate (not including the 3.8 percent net investment income tax). The proposal does not indicate any changes to the tax treatment of carried interest, seemingly leaving such income subject to the proposed capital gains rules.

Depreciation, Business Interest Deductibility and Like-Kind Exchanges: The proposal would radically overhaul the tax treatment of depreciation, business interest deductibility and like-kind exchanges. Most notably, business investments with the exception of land purchases, but including the purchase or construction of an apartment building, would be fully expensed instead of depreciated over 27.5 years. Losses could be carried forward indefinitely and would be increased to account for inflation and return on capital. Business interest would no longer be deductible. Like-kind exchanges are not specifically addressed in the blueprint but would implicitly remain in the sense that if a property were sold and another purchased, income would be recognized on proceeds from the sale but be immediately deductible up to the cost of the replacement property.

NAA/NMHC are analyzing this piece of the House proposal in particular. On one hand, expensing and the resulting upfront deduction would encourage the production of apartment housing and help alleviate the shortage of workforce housing. On the other, eliminating depreciation and business interest as expenses may have the effect of promoting the churning of multifamily real estate, particularly once a property has stabilized and the developer is recognizing income with fewer offsetting deductions. The elimination of a business interest deduction could also impact borrowing costs and disproportionately impact a capital-intensive apartment housing industry that relies on debt.

Estate Tax: The proposal would repeal the estate tax. The current-law rules call for a $5.45 million ($10.9 million per couple) exemption level, a top tax rate of 40 percent and stepped-up basis.

LIHTC: The proposal unacceptably eliminates the LIHTC, a public/private partnership that leverages federal dollars with private investment to: produce affordable rental housing and stimulate new economic development in many communities. The LIHTC has financed nearly 2.8 million apartments and served 13.3 million residents since its inception in 1986, and its elimination would have a tremendous negative impact on the production of affordable housing.

NAA/NMHC will remind lawmakers about the critical role the LIHTC plays and make the case that it should be expanded rather than repealed.

Mortgage Interest and Charitable Deduction: The proposal eliminates nearly all itemized deductions, including the write-off for state and local taxes. Notably, the mortgage and charitable deductions are maintained but will be indirectly impacted because far fewer taxpayers will itemize due to an increase in the standard deduction.  

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