What do Republican tax cuts mean for those who rent housing? A recent opinion piece in the NY Post suggests some good news: ‘New tax law is a huge win for renters’ reads the headline. But don’t be fooled: the American Apartment Owners Association is calling it a “gift to landlords.” Headlines like ‘GOP Tax Bill Rewards Real Estate’ and ‘GOP Tax Plan Holds Benefits for Landlords’ suggest the real beneficiaries. Let’s have a look at this gift from Republicans to landlords called the Tax Cuts and Jobs Act.
Last year congressional Republicans pushed through the Tax Cuts and Jobs Act of 2017, a smorgasbord of tax breaks and slashed tax rates to accelerate the concentration of wealth at the top of the economic ladder. The new tax law continues to greatly favor investment income over earned income but goes farther by disproportionately rewarding real property investors relative to other investors, the New York Times reported.
These new gifts come on top of all manner of existing benefits for real estate investors up-and-down the ladder. There are deductions for operations expenses and business losses; depreciation of tangible property (including major improvements); the capacity to shift losses from one rental property to offset taxable gains generated by another. All of that’s represents money in the landlord’s pocket.
Even a ‘mom-and-pop’ owner-operator will benefit if he reorganizes as a pass-through entity, such as an LLC. He can now take advantage of the 20% deduction on taxable income when he files his individual income tax return. But he will benefit even more if he simply sells out to an real estate investor or investment trust. Rental property investors under a corporation structure get the biggest tax cut: their tax rate is now just 21% period. And ‘passive’ investors, relative to active owner-operators, get a bigger break than mom-and-pop owners.
What does that mean for you and me living in Beverly Hills? It means change. Corporate real estate investors will be shopping for multifamily properties, even the smaller older ones that predominate in the Beverly Hills rental housing stock. Our relationship with our landlords will change accordingly. It already is changing.
The Tax Law Will Add to the Middle-Class Squeeze
Last Friday’s New York Times front-page headline said it plain: “Under Tax Law, Affordable Rents May Take a Hit.” There is no ‘may’ about it. We who rent housing in Beverly Hills will pay more on average. There will be increased competition for existing rental housing and households at the bottom of the economic ladder will be unable to compete for the scarce rental housing available.
The Times article focused on a provision in the tax code that will reduce the production of affordable housing. Those developers rely on a tax credit that corporations purchase in order to reduce their own tax liability. The sales of the credits goes into financing affordable housing that would not otherwise “pencil out,” as they say in the business.
The $9 billion tax credit program is itself the product of an earlier tax deal, and it depended on a high corporate tax rate to give those credits value in the marketplace (a higher tax obligation makes a credit more valuable). But the new tax law slashes the corporate tax rate to 21%, so the value of those credits that offset taxable income is reduced too. When the market price of those credits declines there is less money available for constructing affordable housing.
Experts foresee a significant reduction in the production of housing affordable to the working-class due to the tax law. Of course we never got a start on that here in Beverly Hills.
The New Tax Code Will Not Help Tenants
An analysis from the Tax Policy Center shows that ‘tax reform’ will add little to the average after-tax income for household on most rungs of the economic ladder (about $110 a month for households under $100,000). Instead Congress pushed gains up the ladder. Even ten years down the line, the tax law is expected to flatten benefits for lower rungs on the ladder except that the top rung will continue to gain.
But the Tax Cuts and Jobs Act of 2017 does just fine by property owners. Consider these giveaways the next time you hear a landlord cry poverty about a 3% cap on annual increases.
Owner-operators of residential rental property now receive a 20% deduction on taxable income generated by a pass-through entity. The majority of rental properties in Beverly Hills are operated by owners as a personal housing investment. Think duplex or triplex bought with a conventional mortgage. The expenses were deductible and the income went on the personal return. The next biggest category of owner is the pass-through structure: partnerships, limited liability companies, family trusts or real estate investment trusts (REIT). The new tax law now privileges them for tax purposes with the flat 20% deduction. Individuals can only dream of that off-the-top deduction.
This particular break tilts the advantage toward larger real estate firms. While the deduction is capped for at $157,500 in taxable income (or $315,000 for a couple filing jointly), the cap’s complex formula allows a pass-through entity to claim a deduction equivalent to 50% of all employee wage income for the entity. The larger the payroll, the higher the allowed deduction. Alternately, pass-through income can be deducted at a rate that equals 25% of paid wages PLUS 2.5% of the value of “tangible depreciable property.” The larger the property portfolio, generally speaking, the greater would be the allowed deduction.
The National Apartment Association with some understatement has called it a “significant benefit to the multifamily industry.” (Read the Association’s statement.)
Pass-through entities have it good, but corporations that own multiple LLCs (each formed for an individual building) have it even better. The corporate rate under the new tax law is just 21% – down from 35%, a big windfall! Corporations may be people, but no individual sees such a whopping tax break under the new law as do corporations. HUGE win for shareholders in real estate ventures.
The tax code also includes a little Easter egg: a new accelerated depreciation schedule for residential real property. Property owners can realize the benefit of depreciation (exclusive of land value) over a period of only 25 years (down from the prior 27.5 years). That itself is a big win over the Senate’s version of the tax bill: it proposed a 40 year schedule because this tax giveaway costs other taxpayers lots of money. Landlords can thank their regional, state and national industry associations for lobbying successfully for the change.
Moreover, the tax code now rewards capital investment by front-loading the deduction for depreciation. Why spread the deduction over several years when the law lets a property owner now take it all in the first year? Shortening the depreciation period effectively reduces the landlord’s tax burden. Read more about tax benefits for property owners. It will blow your mind.
The continued ‘like-kind’ (1031) exchange allows a property investor to reinvest profits from the sale of a property in the next venture without having to pay a dollar of tax on the capital gains. If residential rental real estate is the gateway to commercial property ownership, then the like-kind exchange is a friend to the ambitious property owner. He can buy, hold, and sell, all while realizing asset appreciation yet without having to pay any tax as long as he plows the gains into the next investment.
The National Multifamily Housing Council and the National Apartment Association in a news release called keeping like-kind intact in the final reconciliation tax bill “a critical win for the industry.” Republicans, you may recall, were digging behind the sofa cushions for spare change in a bid to keep the total bill’s contribution to the debt under $1.5 trillion as required under the budget reconciliation rules, but that didn’t keep them from keeping the 1031 exchange on the books.
And finally – and I mean finally as in when the end of the road is approaching – property owners now enjoy a doubled exemption from the estate tax. Now it is a whopping $11M for individuals and $22M for couples filing jointly. It will touch even fewer estates than ever and very few residential rental properties in Beverly Hills.
Not surprisingly, apartment rental industry associations were pleased with the outcome of ‘tax reform.’
“Your voice mattered on #TaxReform,” tweeted the National Apartment Association on the day the Senate passed the Tax Cuts and Jobs Act. “When the stakes were high for the apt housing industry, you spoke up & Congress listened.”
Indeed! Bloomberg weighed in on the value of the tax plan to the real estate sector with a headline said it all: ‘Big Winner in a Pass-Through Tax Cut? Real Estate.’
So keep all of this in mind when you hear a landlord whine about his 3% rent increase. Point out the many favorable tax benefits he already enjoys and remind him that the $1.5 trillion tax giveaway holds plenty more gifts for him – especially if he sells out. That should put a smile back on his face!