then the depreciation timeline of their asset gets extended,” he says.
However, he adds, the rule is not clear as written, making it open to
interpretation on exactly how the depreciation and mortgage interest
deductions on investment property will play out. “Until we have guidelines,
we don’t know how it will go. That makes it difficult for investors as they
underwrite possible acquisitions in terms of deductions and depreciation.”
THE LAW OF UNINTENDED CONSEQUENCES
It’s clear that there’s much to be settled with the tax law. And even once
these minute details are straightened out by the Treasury Department,
there will still be more unknowns.
“This new law will affect behavior on a massive scale, especially as
people better understand the nuances of the law,” Chang says. For
example, he says, there is the assumption that fewer people will be buying
homes going forward because of the law. That means apartment demand
will increase. Or this: The new law may lead to increased consumption,
which should boost demand for retail and retail real estate as well as
industrial real estate. “The elimination of the individual mandate of the
Affordable Care Act will influence insurance behavior, which affects
healthcare real estate,” Chang says.
He also theorizes that—despite the many unknowns in the law at present—the new tax law will ultimately boost the performance of real estate
assets. “That’s something that we’re going to see happen over the course of
the next year,” he predicts.
Because of the reduced taxes on pass-through entities and C-Corps (see
sidebar, this page), the after-tax yields on commercial real estate investments will increase, Chang explains. “And so there will be a larger pool
of investors considering the yields of different assets and investment
structures, making real estate all that more compelling.” ◆
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C-CORP VS. PASS-THROUGH ENTITY
Another question real estate firms will be grappling with is whether
to structure as a C-Corp to take advantage of the new 21% corporate tax rate or to continue to operate as pass-through entities.
The lower rate notwithstanding, this can be a surprisingly com-
plex decision to make, says Montgomery McCracken senior tax law
partner Gary M. Edelson. There is still the accumulated earnings tax
and the personal holding company tax. As such, a C-Corp can’t be
used to to hold a large portfolio of stocks and bonds. But it’s a great
option, he explains, for “business entities that need every nickel,
and have no intention of distributing anything to the equity owners
for as long as they can.”
There are other considerations. For instance, the bonus deprecia-
tion rule now applies to both used and new equipment, as long as it’s
bought from an unrelated person. “Many transactions that might have
been stock purchases may be recast as asset purchases because the
buyer is able to immediately deduct a very substantial portion of the
price if that business happens to use a lot of equipment,” Edelson says.
In short, he explains that pass-through entities only get taxed
once, compared to C-Corps, which are subject to double taxation
when selling assets and liquidating. All of this makes that decision
of whether to opt for C-Corp or pass-through entity that much
more difficult, Edelson says, because to make the best decision
you have to know what is going to happen down the road.
Given all of the uncertainty, a knee-jerk decision to change an
entity’s structure to a C-Corp is foolhardy. “My guess,” he says. “is
that it’s going to be midyear before anyone is able to fully think
through all of the ramifications of making the choice.”