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How the New Tax Reform Will Impact Commercial Real Estate

How the New Tax Reform Will Impact Commercial Real Estate

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  •   Feb 23, 2018
Commercial property loan provider

On December 22nd, 2017, The Reagan-era Tax Reform Act of 1986 was tweaked and the Internal Revenue Code (IRC) was reformed. It has been an age or more since the tax system was given a thorough overhaul. Immediately after the election, the ‘Trump bump’ on Wall Street experienced sharp gains, which mirrored and intensified the market’s expectations. Back then, in the eyes of many, lower rates, tax cut plan, and less regulation were expected to bolster profits, goad growth, and limit downturns.

However, just after the first 55 days of promulgating the bill, a conclusion was made that this system managed to close some loopholes, while opened others. According to multiple reports, a number of Republicans and half of Americans believe that the GOP tax bill is a mere talking point and will increase the country’s deficit even further. Conversely, many others conclude that the tax plan is a gigantic victory for globalization. The great debate on the tax proposal is still smoldering and is expected to be lengthy.

So, let’s not dilly-dally any longer and cut to the chase to know how the Tax Cuts and Jobs Act will impact commercial real estate and financing sector in future.

Retail Sector

If any open door exists for contrarians, it must be in the retail sector because a centerpiece of this scheme is the rock-bottom corporate tax rate, ranging from 35 to 21 percent. The bill slashes a massive cut for companies with a stated goal of 15 percent by the administration and 20 percent by party leaders in the House of Representatives. According to the Tax Foundation, the statutory rate will now be 26.5 percent (combined with both state and local taxes) under the new law.

Many economists believe that this sweeping change in the tax code will act as a catalyst for retail growth in 2018. The legislation also extends tax cuts to small businesses which have less than 20 employees. For commercial real estate sector, however, there are certain challenges that investors and realtors need to overcome.

The law has temporarily raised the property tax exemption for single filers to $11.2 million in 2018, which was $5.6 before. This change will be reversed after 2025. There is a prediction that around 1.5 million Americans who were forced into foreclosure will re-enter the housing market this year. This opportunity is most appropriate for commercial real estate agents who pursue an opportunistic investment strategy, even if retail remains challenging for hard-core passive investors.

Multifamily Sector

According to the National Association of Realtors, the tax plan is a direct threat to millions of homeowners and consumers because of the decrease in mortgage interest deduction. Not only will homeowners hardly get any benefit from it, many others will also get a tax increase.

In addition to that, they can lose substantial equity which would cause them more than 10 percent drop in their home values. Although somewhat irrational, the bill’s negative consequences (on singular homeownership) will really profit the proprietors of multifamily residential buildings. According to Zillow, families that benefit from the standard deductions have dropped to 14.3 percent under the new tax legislation.

Let’s take a look at the standard deductions which are raised by the House bill:

  • For married couples: From $12,700 to $24,000 (if filing jointly in 2018);
  • For single filers: From $6,350 to $12,000, and;
  • For heads of household: From $9,550 to $18,000.

So, how these deductions would help commercial property loan providers, investors, and owners? By bringing down the moral appeal of homeownership, many first-time buyers will be benefited from renting in multifamily buildings like lofts, flats, and condos. Another reason is that banks and other depository institutions hold approximately 36 percent share of all mortgage loans and 61.1 percent pro-rata share of non-residential commercial mortgages in the multifamily sector.

Current and potential owners were somewhat appeased when they heard that the House bill raised and capped the interest deduction amount on the mortgage to $750,000. Before this provision, anyone who purchased a new home was only able to deduct the first $500,000 of their total mortgage loan value. Also, under the new bill, the mortgage interest deduction cap is lowered to $750,000 from $1 million. This is likely to affect people looking for homes in more expensive coastal regions.

Moreover, the additional standard deduction, which the House bill has repealed, won't be influenced. The inflation gauge used to accurately predict and catalog the standard deduction will be changed in a way that is probably going to accelerate the frequency of bracket creep at the starting of 2019. That’s why many economists consider that potential homeowners will widen the net of their renter base and allow realtors to find tenants.

1031 Exchange

It is no denying fact that the 1031 tax-free exchange program is a gift to commercial real estate investment sector. Advocates of 1031 program believe that it will close certain loopholes in the tax code and promote liquidity in the marketplace.

Here are some key benefits of 1031 exchange program:

  • Property owners can defer any capital gains tax from the sale by shifting these advances from one property to another.
  • The law allows an owner of “investment property” to sell it and purchase another “same kind” real estate of equal or lesser amount.
  • Proprietors can use the sales proceeds for diversifying the assets or exchanging old property for a new one.

With around 10 to 18 percent of all commercial transactions in states such as California, Colorado, and Oregon, the 1031 law will help and empower the real estate industry in many ways.

If you’re looking for a multifamily properties loan or have any query associated with 1031 exchange program, contact us for a free quote. Call us at +1 (951) 634-2477 or drop a message on bb@arrowfinancialco.com

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