7 Reasons Why NYC RE Investors Will Like the New Tax Law

7 Reasons Why NYC RE Investors Will Like the New Tax Law

1/17/2018

December 20th, 2017 marked the passage of the first major overhaul of the tax code in decades. This event ends a year of uncertainty. It will have wide-reaching effects on the economy.

Although not everyone is happy with the new tax code, real estate investors will find that it provides them with favorable tax treatment with large tax cuts for corporations and pass-throughs such as LLCs.

Heading Into 2018

Current real estate investors will be happy to note that their current investment strategies will work surprisingly well with the new tax law. Although some shifts will occur, most investors will move forward smoothly from the old to the new. The law will go into effect immediately, affecting 2018 income.

Law Provisions To Understand

Although the new tax bill is long and complex, there are a few specific changes that will directly affect those investing in NYC real estate.

  1. 1031 Exchange: Although there had been talk of removing the 1031 Exchange, no changes were made to this provision.
  2. Depreciation: The depreciation timeline stays ‘as is’ for those who do not elect to take the mortgage interest deduction. For those that do take the deduction:
    • Commercial property depreciation timeline increases one year, from 39 to 40 years
    • Residential property depreciation timeline increases 2.5 years, from 27.5 to 30 years
  3. Capital Gains: In order to avoid capital gains tax, a homeowner must hold the property for three years, up from a year. The gain still needs to be less than $250,000 for a single filer and $500,000 for joint filers.
  4. Pass-Through Income: Pass-through entities can now take a 20% deduction for qualified income, which includes depreciable property. For filers making over $157,500 single file or $315,000 joint filer, the deduction is no more than 50% of their W-2 employee wages OR 25% of employee wages and 2.5% of the purchase price of depreciable property, whichever is greater.
  5. Corporate Tax Rate: The tax rate has been cut for C Corporations from 35% to 21%. Additionally, provisions have been added that allow for generous depreciation schedules and rules on capital expenditures.
  6. Individual Tax Rate: Although the new tax law kept seven individual tax brackets, the income levels in each has changed, with most marginal rates lowering. Although several deductions have been eliminated or reduced, the standard deduction was increased significantly.
  7. Estate Tax: Estate tax exclusions were doubled for both single and joint filers to $11 million and $22 million respectively.

What This Means To the Economy at Large

In addition to looking at investment strategies, the new tax law may have several effects on the economy at large and real estate investing in particular.

In terms of the economy, 2018 starts with a bang due to strong job growth, low unemployment, high consumer and business confidence, high retail sales growth, and strong corporate investment into infrastructure. With tax incentives created by the new tax law, economists suggest that these trends will continue.

The reduction of the corporate tax is also likely to keep the economy strong as well. The favorable depreciation and expensing rules will encourage corporations to invest in infrastructure and equipment. Plus, with rules that help companies bring back holdings from overseas without crippling taxes, more capital should come back into the US. As corporations become more liquid, we should see more consumption and economic growth, though inflation is a risk with such a scenario.

Lower personal taxes should also boost the economy by creating greater consumption. Since economic growth moves with consumption, even a modest change in a worker’s paycheck can increase discretionary income and, therefore, consumption.

What This Means to the Real Estate Market

Other provisions speak directly to the real estate market. As abundant capital increases, real estate investors are likely to see buyer demand increasing for NYC multifamily.

Rental apartments are also likely to be in higher demand. For couples owning a $200,000 home prior to the new tax law, it made sense to itemize deductions and take the mortgage interest deduction. With the new provisions, most homeowners will need a $400,000 house to take advantage of homeowner’s deductions. Therefore, the incentive to buy a home will decrease, thus increasing the need for apartments.

Finally, net-leased properties are also likely to be stronger investments, particularly for passive investors. Since these properties often come with good tenants with long leases, the yields will be good for passive investors looking to take advantage of the pass-through tax rules.

Bringing it Together

As investors realize the favorable circumstances for those investing in commercial real estate, many investors are likely to focus on after-tax yields. In comparison to stocks and bonds, commercial real estate may offer an even stronger return than before.

While the new tax law unlocks capital in the economy at large, New York City multifamily investors are also viewing market headwinds in the rental market, political and regulator arena, and the trend of interest rates. Further, will consistently low unemployment levels + tax reform + time = future wage growth? If so, is this inflationary enough that interest rates rise, therefore putting downward pressure on values?   These are the topics Multifamily investors will be watching as we begin this year. That said, real estate investors have reason to celebrate the tax overhaul.   

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