Contributed By Allen Matkins Leck Gamble Mallory & Natsis LLP
The 2017 “Tax Cuts and Jobs Act” is the most significant change to US tax law in 30 years, lowering the maximum federal corporate tax rate from 35% to 21%. According to the Winter/Spring 2018 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey, the tax bill is expected to increase the rate of return on commercial real estate and make investment more attractive, as it reduces taxes for commercial real estate owners and developers.
1031 Exchanges Remain for Real Estate
While there was talk of eliminating this advantage, real estate capital gains remain tax-deferrable to the extent a qualified investment is timely made in like-kind replacement property.
Developers who organise their businesses as pass-through entities, such as partnerships and LLCs – as most do – can now take a deduction of up to 20% of their "qualified business income," subject to limitations. This does not include short- or long-term capital gains, but it does include certain REIT dividends.
Business Interest Deduction
Under the new law, the business interest deductions of a taxpayer with average annual gross receipts of more than $25 million are limited to the sum of business interest expense plus 30% of "adjusted taxable income" (roughly compared to EBITDA in years through 2021 and EBIT beginning after 2021). Disallowed deductions are carried forward. Real estate businesses can opt out of the limits by slightly extending the period over which they depreciate real property.
Extension of the “Carried Interest” Holding Period
Under the new law, the holder of a “carried interest” in a partnership or LLC is taxed at long-term capital gains rates on their allocable share of any gain recognized by the partnership on the sale of its investment property, but only if the property was held for more than three years (rather than one year under the prior law).
State property taxes are governed by California’s Proposition 13. Passed by voters in 1978, Prop. 13 caps annual property tax increases at 2%, meaning a property is only reassessed for tax purposes at the time of sale. While there is perennial debate about reforming Prop. 13 to eliminate its application to commercial real estate, which could allow for more equitable tax burdens while increasing the share borne by commercial real estate, there are no legal changes pending. Reformers say they hope to introduce a ballot measure changing the law in 2020.