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Updated Guide to Tax Reform

​The Updated JLL Guide to Tax Reform (January 8, 2017)​

What's the current status of tax reform?

The Tax Cuts and Jobs Act (TCJA) was passed by Congress on December 20, 2017 and signed into law by the president on December 22, 2017.​

What's in the final version of the bill?

For individuals

Maintains seven tax brackets, but lowers the statutory rates across most of the income brackets. Individual tax cuts would expire after 2025.

Nearly doubles the standard deduction to $12,000 from $6,350 for individual filers; for married couples filing jointly it increases from $12,700 to $24,000. This should reduce the number of filers who itemize deductions.

Personal exemptions of $4,050 per person for oneself, spouse, and each dependant have been eliminated. This could limit the amount of tax relief, particularly for larger families.

Cap the deduction for state and local taxes (SALT) at $10,000.

Reduces the limit on mortgage interest deduction to the $750,000, down from $1 million, for the purchase of first and second homes starting January 1, 2018. Home equity loan interest is no longer deductible.

Doubles the child tax credit to $2,000 for children under 18 through 2024. Raises the income threshold to $400,000 so more families can claim this credit.

Creates temporary tax credit of $500 per individual for each non-child dependent supported.

Reduces the number of filers impacted by the alternative minimum tax (AMT) by raising the exemptions for singles (from $54,300 to $70,300) and for married couples (from $84,500 to $109,400).

Maintains the estate tax, but doubles the threshold (roughly $11 million for individuals and roughly $22 million for couples) so that very few households will qualify for the tax. Higher thresholds sunset in 2026.

Expands the medical expense deduction by reducing the threshold to 7.5 percent (from 10 percent) of taxpayer's adjust gross income (AGI) for 2017 and 2018.

Uses chained consumer price index (CPI) to measure inflation. The chained CPI assumes that consumers constantly substitute away from more expensive goods to lower-quality cheaper goods. The conventional CPI does this on a periodic, not continual basis. As a result inflation in the chained CPI increases more slowly. This would reduce the value of deductions, credits, and exemptions because inflation-adjusted measures of eligibility would grow more slowly.

Eliminates the mandate to buy health insurance that was required by the Affordable Care Act (ACA). 

For businesses

Reduces the statutory corporate tax rate from 35 percent to 21 percent beginning in 2018. Repeals the AMT (currently 20 percent) on corporations.

Reduces taxes on owners of pass-through businesses (whose owners pay taxes via individual tax returns) via a 20 percent deduction. This provision prohibits anyone in a service business from claiming the deduction above an income threshold ($157,500 if single, $315,000 if married) and prevents owners who also draw a salary from a business to avoid the tax on that salary.

Moves the U.S. to a territorial tax system so that U.S. multinationals overseas profits are not taxed by the U.S. government. Anti-abuse provisions are included. The bill also included a one-time, reduced tax rate on existing overseas profits (15.5 percent on cash assets and 8 percent on non-cash assets).

Can fully and immediately deduct the cost of equipment purchased after September 27, 2017 and before January 1, 2023. Thereafter, the percentage of cost that can be immediately deducted will gradually decline.

What does this mean for the real estate industry?

​By business type and legal structure

For CRE businesses set up as pass-throughs, the 20 percent deduction would boost after-tax income. Pass-through entities are popular among CRE owners. Some of this increased profit could get recycled back into CRE investment and this new deduction could increase the use of pass-throughs as an investment vehicle for CRE.

The like-kind 1031 exchange remains in place.

For CRE lending institutions, particularly banks, the lower corporate tax rate would improve after-tax profits and if stronger growth puts upward pressure on interest rates that is likely to increase the net-interest margin which should also support bank profits.

For CRE private equity firms, the bill extends the holding period of investments for carried interest from one year to three years. Carried interest allows the firms' owners' profits that they personally earn from investing client capital to be taxed as long-term capital gains and not ordinary income. This incurs a lower rate.

For CRE investment management firms, who typically pay a relatively high corporate tax rate, the lower rate would be a boon to after-tax profits.

The bill also caps the business deduction for debt interest payments to 30 percent of taxable income, without regard for deductions for depreciation, amortization, and depletion.

The bill preserves the tax-deductible status of private activity bonds (PABs). These are often used to fund real estate investments such a low-income housing, hospitals, and other related medical facilities.

How will individual sectors be affected?

Overall, stronger economic growth (even if marginal) would benefit the entire commercial real estate (CRE) industry.

Retail would benefit from an increase in consumers' discretionary income. However, because the historic multiplier for tax cuts is estimated to be less than one, the exact impact on consumer spending is unclear.

Office could benefit by reducing the statutory tax rate on tenants. However, there is little empirical evidence to support the notion that tax cuts leads to increased hiring. Additionally, companies continue to create jobs that go unfilled because of a lack of qualified labor. Creating more jobs would largely result in many of them remaining unfilled.

Industrial should benefit from the increase in discretionary spending by consumers and businesses accelerating investment to capitalize on the temporary accelerated depreciation before that provision expires.

Hotels should benefit from the increase in consumers' discretionary income.

Multifamily could capitalize on any short- to medium-term disruptions while the housing market adjusts to changes to SALT and mortgage interest deductions. Properties in the suburbs could benefit as potential homeowners lease units in desirable towns while they wait for prices to adjust. But we should not expect to see a shift away from home ownership solely because of tax policy changes.

Medical facilities could see some disruption in the short-run with the repeal of the individual insurance mandate. But demographics continue to drive the sector so the long-term outlook remains positive. The continuation of private activity bonds should also support medical property development.

Many of the potential negatives for student housing were removed from the finalized bill. One small potential negative remains – the taxing of university endowments. This could limit scholarships (and potentially enrollment) and university development of student housing, but any impact should be minor.

Limiting the mortgage and property tax reduction should reduce the value of for-sale residential housing, particularly in high-tax states but the exact implications are uncertain. While this could reduce the incentive to purchase housing in short-term while buyers wait for any price adjustment to occur, in the medium-run it could create more demand for housing by incentivizing buyers who could more easily afford to purchase a home at reduced prices. In the long run, home ownership remains a cultural norm in the U.S. Many countries, such as Canada, have similar homeownership rates as the U.S. but without tax incentives.

What are the overall impacts to the economy?

The current versions of the bill could add up to 50 basis points to economic growth above 2017 levels (estimated to be 2.5 percent).

Although many household should receive an income boost, a significant percentage of the tax savings should accrue to high-income households who are more inclined to save tax savings than lower income households. That should somewhat limit the boost to personal consumption.

The impact of the corporate tax cuts remains more uncertain because the empirical relationship between income and spending is not as tight as it is for consumers. Companies currently boast financial assets at record highs and credit conditions remain relatively easy. Repatriation of earnings should not have much impact because they are already predominantly held in dollar-denominated assets. The previous repatriation program in 2004 did not result in significant changes in corporate investment.

That static scoring shows that the deficit and debt over the next 10 years will increase by roughly $1.5 trillion dollars. Dynamic scoring, which aims to take into account economic feedback effects, shows the deficit and debt rising closer to $1 trillion over the next 10 years. All other things equal, this will increase Treasury debt outstanding and put upward pressure on interest rates, especially at the long end of the yield curve.

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