As we have seen in the news, tax reform is the focus of the House and Senate; the House passed its version of tax reform, “Tax Cuts and Jobs Act” (“H.R. 1”) by a vote of 227-205. The Senate Finance Committee (SFC) finalized its work on its tax reform legislation by passing its tax bill in a party-line vote. This SFC tax bill now moves to the Senate floor for action this week. Based on the proposed tax overhaul, here are some highlights of how construction and real estate businesses could be impacted.
Tax Reform Highlights for Construction and Real Estate Businesses, House vs. Senate Proposals
The tax reform framework offered several major provisions for businesses. One of which was a drop in the corporate tax rate from 35 percent down to 20 percent. Another major provision was to establish 100 percent expensing of capital expenditures. The framework, however, indicated that many other deductions and incentives may be repealed or curtailed. Selected business provisions impacting construction and real estate included in the SFC’s tax proposal compared with proposals in the House’s version are highlighted in the chart below.
HOUSE vs. SENATE
SELECTED HIGHLIGHTS FOR CONSTRUCTION & REAL ESTATE BUSINESSES
HOUSE (as Amended)
|Corporate Tax Rates||20% for C Corporations beginning in 2018.
A Personal Service Corporation (PSC) would be taxed at 25%.
|Same tax rate, but delays the effective date to 2019.
PSC rate at 20%.
|DPAD (Section 199) Deduction||As part of lowering the tax rates, the 9% DPAD deduction would be eliminated. Effective in 2018.||Senate bill would also repeal the DPAD; effective in 2018. New 17.4% business deduction replaces DPAD (for pass-through businesses).|
Pass-Through Tax Rates
|25% tax rate for “pass-through businesses” (S Corporations and Partnerships/LLCs). “Passive” owners would receive this 25% rate, but active owners would be subject to a more complicated analysis that will likely result in the tax rate being higher than 25%. Effective in 2018.||Adds a new business deduction of 17.4% for pass-through businesses to achieve tax savings. Effective in 2018.|
|Interest Deduction for Larger Companies (those with over $25 million/$15 million in revenue)||Applies to businesses with revenue over $25 million. Limits interest deduction based on 30% of adjusted taxable income. Any unused interest expense above 30% threshold would be disallowed, and would carry forward for five years. An exception to this limitation applies to a “real property trade or business.” This limitation would first apply in 2018.
Businesses with revenue under $25 million are not subject to the limitation.
|Similar provision for the 30% of adjusted taxable income except the revenue threshold is $15 million. An exception applies for a “real estate trade or business,” but this treatment is elective by the taxpayer.
Also, unlimited excess interest carryforward period.
|CapEx Additions||100% bonus depreciation for additions placed in service after September 27, 2017. Applies to property new to the buyer, thus could be “used.”
The proposal, however, excludes from the definition of qualified property any property “used in a real property trade or business, i.e., any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.” This is the same definition as used for the limitation on the deduction for interest expense and the exception for “real property trade or business.”
|Similar provision, and effective date. Unsure if “used” property definition applies to Senate bill.
Exclusion in the definition of qualified property for any property used in a “real property trade or business” in the House bill is not in the Senate bill.
Also, enhanced depreciation for property used in farming.
Also, depreciable life of a commercial or residential building reduced to 25 years. Also, changes to qualified improvement property to 10 years. Applies to property placed in service after 12/31/2017.
|Section 179 Expensing||
No provision for lodging in House bill.
The proposal also expands the definition of qualified real property qualifying for Section 179 to include qualified energy efficient heating and air-conditioning property acquired and placed in service by the taxpayer after November 2, 2017.
|Similar provision, but increases are smaller. Expensing would be raised to $1,000,000 and phase-out at $2,500,000.
Section 179 property expanded to include certain depreciable tangible personal property used to furnish lodging or in connection with furnishing lodging.
Also, Section 179 property covers improvements to nonresidential real property for roofs (heating, ventilation, and air-conditioning property); fire protection and alarm systems; and security systems.
|Accounting Method Reforms for Small Businesses||
||Similar small business provisions (small business up to $15 million in revenue).|
|Net Operating Losses (NOLs)||
||Similar NOL provision with 90% income limitation, and moving to 80% after 2022. NOLs can only be carried forward indefinitely. No interest factor listed with NOL carryforwards.|
|New Markets Tax Credit (NMTC) and Rehabilitation Tax Credit (RTC), including Certified Historic Structures||NMTC and RTC eliminated in 2018.||No proposed changes to NMTC.
RTC repealed in 2018, but credit for certified historic structures retained with some modifications.
|Like-Kind Exchanges (Section 1031 Exchanges)||Limited. Only applies to real property beginning in 2018. Does not apply to personal property.||Similar provision as House bill.|
Next Steps and Outlook
Please keep in mind – tax reform legislation is not final. These two bills will continue to be worked out almost side-by-side in the House and Senate, and the differences between these two tax plans will need to be reconciled.
Please consult your local Sikich tax professional with any questions you may have or visit www.sikich.com to stay up-to-date on all tax reform changes or for more information.