Tax reform expected to boost CRE profits, investment

The biggest U.S. tax law change in more than three decades should benefit the commercial real estate industry — though not, perhaps, as much as some would expect with a real estate developer occupying the White House.

The Tax Cut and Jobs Act contains many gray areas and will likely require further Internal Revenue Service guidance to implement, several experts say. But commercial real estate practitioners and tax preparers believe the reforms will undoubtedly boost the industry's owners and investors, thanks to a series of provisions that either left unchanged or simply tweaked rules regarding commercial properties.

Perhaps the biggest modification stems from a change that will allow limited liability companies (LLCs) — a standard structure for owning commercial real estate — to deduct 20% of their qualified business income. That change alone could spur future activity in the sector by generating higher after-tax yields than other investments.

“It appears from the way I read it that roughly 20% of an LLC's profits will be tax free, and that will really add up,” says Dr. Mark Kauffman, owner or lead investor in more than a dozen Sarasota office and mixed-use buildings. “So anyone using an LLC will benefit. I think, too, that it will generally increase the value of real estate as an investment.”

Likewise, the new law allows landlords to expense depreciation from year one on certain improvements to their properties' roofs, security systems, heating and air conditioning systems and alike, over 15 years.

By comparison, standard depreciation has been either 27.5 years or 39 years for commercial assets, and qualified improvements could be accounted for only after several years.

“Those improvements will be eligible for deductions of up to $1 million a year, so it's a lot, and beneficial to property owners,” says Michael Goldstein, a shareholder in Sarasota-based accounting firm Kerkering Barberio & Co.

Real estate investors who buy into real estate investment trusts and who use tax-deferred exchanges also will benefit somewhat under tax reform. For example, shareholders in REITs, which must distribute some 90% of their income to stock owners, will see their taxes on company dividends under the new law drop to between 25% and 31% — from the current 39.6%

Several analysts believe the reforms also will spur future investments. Investors of all kinds also should benefit from the continuation of deductions for mortgage interest, experts say.

“From a commercial real estate perspective, we are neutral to positive,” commercial real estate brokerage firm CBRE Inc. states in a call with clients. “We believe that overall occupier demand will improve, particularly for the office and multifamily sectors.”

CBRE and others note, however, the law failed to accelerate depreciation from the current 39 years to 25 years, which would have been a boon to property owners. Also, major changes to so-called “carried interest” provisions — while debated in the U.S. House of Representatives — failed to make it into the final bill.