After years of tax policy and planning discussions, and following debates within committee during the last few months, the U.S. House of Representatives’ Ways and Means Committee yesterday released the first draft of the “Tax Cuts & Jobs Act” or H.R. 1 of the 115th Congress. The tax proposals have implications for those in the real estate industry. Here are some brief highlights:
- The carried interest provisions under the Internal Revenue Code would be preserved. This will allow a portion of a real estate fund’s earnings paid to investors do be subject to capital gains rates instead of ordinary income when investors file their returns.
- Under the bill, a new tax rate and income category has been created for business income earned through pass-through entities like S corporations, partnerships and LLCs. This business income would be subject to a maximum tax rate of 25 percent. However, the bill also includes safeguards to prevent taxpayers from using pass-through entities to receive a lower tax rate on labor or compensation income which would be subject to ordinary income rates. In general, pass-through owners who actively participate in their businesses would be subject to ordinary income tax rates on 70% of their income, while 30% of the pass-through income would be subject to the 25 percent rate. Professional service firms, on the other hand, would treat 100 percent of the owner’s income as salary. There are exceptions to these general rules if one can show a substantial capital investment was made in the business so more income should be treated as non-salary business income.
- The bill also preserves Code section 1031 which provides for like-kind exchanges to defer recognizing taxable income where a replacement property is identified in an exchange of properties.
- The controversial state and local tax (SALT) deduction is maintained for trade or businesses, but individuals who itemize deductions will be limited to a $10,000 maximum deduction for SALT paid. A downside to this proposal is that owners or partners in pass-through entities will be limited in their SALT deductions, while the entities they own do not generally pay income tax.
- No limits on interest deductions for businesses with $25 million or less in gross receipts
- Preservation of the Low-Income Housing Tax Credit as well as the Research and Development Tax Credit.
It bears mentioning that this is a first draft of the committee’s bill. The legislation will likely see additional changes as interests from all sides still have problems with the bill, especially the cap on the SALT deduction, the provision for carried interest, as well as the pass-through income rate. We will continue to monitor the progress of the legislation and keep you apprised of major developments.