What Would Tax Reform Mean for Apartments?
Tax reform is expected to take center stage in the next Congress based on signals from President-elect Donald Trump and congressional Republicans. NAA/NMHC have made tax reform a top priority as well given that changes to the tax code have the potential to seriously impact the apartment housing industry’s ability to meet the nation’s housing needs.
The blueprint for tax reform released last June by House Republicans is expected to be the starting point of the upcoming tax debate. Briefly, the proposal would reduce the top tax rate on the pass-through businesses that dominate the apartment sector to 25 percent; enable all investment except for land to be immediately deducted from income instead of depreciated; and eliminate the deductibility of business interest.
NAA/NMHC are working closely with other real estate organizations to analyze the blueprint’s impact on our members by commissioning a study that will examine the trade-offs between a lower tax rate and full expensing but the loss of interest deductibility.
While most observers agree tax reform is a top priority for legislators, it remains to be seen how much change will actually be enacted. Some lawmakers would like to move the House Republican blueprint, which includes both corporate and individual tax reform. Others have floated the prospect of tackling a corporate reform measure first that would also fund an infrastructure bill by repatriating offshore holdings. Under this scenario, a second bill focusing on pass-through businesses and individuals could follow separately.
NAA/NMHC are already reaching out to lawmakers to make the case that any tax reform should promote economic growth and investment in rental housing without unfairly burdening apartment owners and renters relative to other asset classes. We are also pushing them to preserve the pass-through tax structure, sensible cost recovery rules and the Low-Income Housing Tax Credit (LIHTC).
A more detailed description of the provisions in the House Republican blueprint that would have the most impact on the apartment industry follows.
- Tax Rate on Pass-Through Businesses Income:
The apartment industry is dominated by “flow-through” entities (e.g., LLCs, partnerships, S Corporations, etc.) that pass the company’s earnings through to the partners who pay taxes on their share of the earnings on their individual tax returns. The blueprint would lower the maximum tax rate for pass-through business income from 39.6 percent to 25 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, lower than the 20 percent current-law maximum rate (not including the 3.8 percent net investment income tax). The proposal does not propose changes to the tax treatment of carried interest, seemingly leaving such income subject to the proposed capital gains rules. However, this could change given that President-elect Trump has indicated support for taxing carried interest as ordinary income.
- 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, except for 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 and our industry partners are paying particular attention to this section of the proposal. On one hand, expensing, and the resulting upfront deduction, would encourage apartment housing development and help alleviate the workforce housing shortage. 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 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.
The proposal unacceptably eliminates the LIHTC at a time when the nation is facing an affordability program. NAA/NMHC are reminding them that the LIHTC has financed nearly 2.8 million apartments and served 13.3 million residents since its inception in 1986. Instead of eliminating it, we are asking them to expand it by 50 percent.
Provided by NMHC as part of the NAA/NMHC Joint Legislative Program