A Taxing Process – Real Estate Investment in the Crosshairs

Reposted by an article written by Net Lease Capital Advisors.

We recently attended the Federal Exchange Accommodators (FEA) Capital Hill Conference held in Washington DC. It was an excellent program that was highlighted by an informed group of speakers including Congressman Peter Roskam (R-IL), Congressman Mike Thompson (D-CA), Andrew Prior of PwC National Tax Services Group and David Franasiak from Williams & Jensen.

The program was highlighted by the following major takeaways:

1. Tax Reform is key to Republican economic growth plans
2. Bipartisanship remains dead
3. Traditional real estate investment tax policy is in the crosshairs

First, the Republicans have a stated objective to see the economy grow by 4% annually. This was clearly articulated by Roskam, who currently serves as Chairman of the House Ways and Mean Committee. Tax reform is identified as a crucial component in seeing these growth projections come to fruition. They have begun a significant marketing effort with their “A Better Way Forward” [https://waysandmeans.house.gov/taxreform/] campaign, highlighting job growth, simplified tax reporting and a service first IRS.

Second, bipartisanship remains a vestige of the past. For those unfamiliar with the concept, bipartisanship is defined as “an archaic political construct whereby two or more political parties work together for public and tax policy beneficial to all Americans.” Thompson stated that the process thus far has been a closed-door endeavor driven by Republicans Paul Ryan and Kevin Brady, with few details being shared with their fellow congressmen from across the aisle.

Third, real estate investment tax policy is in the crosshairs of the tax reform conversation. The Republican Plan targets real estate investment particularly hard, with 100% expensing of real estate (excluding land) in year one, eliminating the mortgage interest deduction, the elimination of 1031 exchanges, and modifying the capital gains tax rate (using a tiered structure) to broaden the base of tax revenues. All of these proposals will have to be considered in the context of a promised but yet to be seen Trump Tax Plan.

What seems to be missing in the current proposals is the understanding of efficient markets that real estate investment in general and 1031 exchanges in particular have facilitated for real estate transactions. 1031 exchanges remove friction and add liquidity to the commercial real estate marketplace. It’s elimination would have a negative impact on growth by decreasing incentives to sell, leading to longer term hold periods and a reduction in property valuations, transaction fees, and economic activity.

Ultimately, whatever survives the tax reform process will require the support of the White House. Sausage-making Washington style is always interesting and typically unpleasant. Stay tuned.