CoStar Insights

CRE Industry Turns Up Heat on Congress to Retain Like-Kind Exchanges, Interest Deductibility

by Randyl Drummer | Jul 17, 2017
While health-care reform and the investigation into Russian meddling in the U.S. election took center stage as Congress returned this week from the July 4th recess, Republican lawmakers are also quietly trying to jumpstart discussions on tax reform, including the proposed elimination of the deduction for business interest expenses and the tax incentive for 1031 like-kind exchanges, which is used in as much as one in every five U.S. commercial real estate sales transactions. 

Senate Finance Committee Chairman Orrin Hatch (R-Utah) today announced a July 18 hearing on tax reform in which the committee will hear from several former assistant secretaries for tax policy who served during the Bush and Obama administrations. The hearing will come in the middle of a three-week session by Congress before lawmakers adjoin for their annual August hiatus. 

Reducing corporate tax rates would allow American companies to better compete with their international counterparts, result in fewer U.S. businesses moving offshore, and incentivize more new companies to set up shop, invest capital and hire workers here, Hatch said in remarks on the Senate floor Wednesday. 

One of several issues that have emerged as polarizing factors for Republicans is business interest deductibility, which allows companies to subtract interest payments from their taxable income. The Trump Administration has called for preserving interest deductibility, putting it at odds with the tax reform Blueprint plan championed by House Speaker Paul Ryan. 

Ryan has said eliminating the deduction in favor of allowing corporations to immediately write off capital spending costs would raise an estimated $1.2 trillion over 10 years to pay for cuts in the tax rate and other measures favored by Trump and the GOP. 

However, before last week's Fourth of July recess, House Ways and Means Committee Chairman and GOP tax plan author Kevin Brady, R-TX, expressed optimism that language grandfathering existing debt and financial arrangements, carving out exemptions for financial companies and small business, and allowing deductions on land purchases by farmers will be included in any eventual tax reform bill. 

GOP lawmakers and Treasury Secretary Steven Mnuchin had targeted September for introduction of a tax reform package, but Speaker Ryan is now hinting the legislation will be introduced by "the end of the year." 

Proposal to Scrap Write Offs Riles CRE Industry

Rallying support to preserve the tax status of interest deductibility, a broad coalition of real estate, financial, agriculture, manufacturing and telecommunications industry groups, including special interest group the Real Estate Roundtable, last week registered their strong opposition to scrapping the deduction. 

In a July 6 letter to the Senate Finance Committee, the various interest groups acting as the Businesses United for Interest and Loan Deductibility (BUILD) Coalition, urged Congress to fully preserve interest deductibility in order to simplify the tax code and promote economic growth. The coalition cited a recent Goldman Sachs analysis predicting that eliminating interest write offs in favor of full immediate expensing by companies "would raise the user cost of capital and reduce investment in the longer run." 

Further, Goldman Sachs posited that, contrary to conventional wisdom, eliminating the deductibility would result in higher risk, as well as an increase in defaults and average credit spreads since the policy change would likely make external financing more costly for corporations. 

BUILD also said "numerous policy proposals," including President Trump's call for $1 billion in infrastructure spending largely through public-private partnerships, could be hurt by such a move. 

Pitching hard to retain the valuable deduction, Jeffrey DeBoer, president and CEO of Real Estate Roundtable said in the group's letter, "Deducting the interest on commercial real estate debt has always been an appropriate way to measure income from an investment. The deduction has been an essential tool in helping spur real estate development activities, which leads to job creation and economic growth for communities throughout the country." 

Is 1031 Exchange Also On Chopping Block?

Conservative lawmakers seeking revenue to offset the cost of cutting tax rates are also taking a hard look at the so-called 1031 exchange, which allows businesses and individuals to defer taxes owed on the sale of investment property if sale proceeds are used to purchase other “like-kind" property as part of an exchange. 

In a June letter to the House Ways and Means Committee outlining the industry's tax reform positions signed by 21 national real estate groups and organizations, including the Roundtable, the groups lobbied hard to keep the 1031 exchange option, citing research analyzing 18 years of transactions that found exchanges result in greater investment and tax revenue while reducing the use of leverage and improving market liquidity. 

Ernst & Young also weighed in on the impact of eliminating tax-free exchanges, claiming such a move would subject many small businesses to higher taxes, result in longer asset-hold periods and creating a "lock-in" effect on property values and liquidity. Investors would also be forced to rely more on debt financing at higher capital costs, according to the EY research. 

While like-kind exchanges may sound like an unwarranted tax giveaway that doesn't benefit average people, "that simply isn’t the case," noted Rep. Steve Stivers, an Ohio Republican member of the House Financial Services Committee. Stivers added that the provision is available to small business and individuals as well as major investors. 

"In the vast majority of circumstances, those capital gains taxes will eventually be paid," Stivers said. "A 1031 exchange simply allows someone to defer the tax while they continue making valuable investments for themselves and the broader economy. What that means is people can choose for themselves to reinvest in their business and community rather than worry about getting sideswiped by a tax bill at the end of the year." 

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