House-Senate Conferees Approve Tax Reform Bill

Vote expected this week; Trump to sign

On Dec. 15, the House and Senate Conference Committee released the conference report including statutory language (Conference Agreement) and a “Joint Explanatory Statement of the Committee on Conference” (Conference Explanation) of H.R. 1, the Tax Cuts and Jobs Act (TCJA). The Conference Agreement reconciles the differences between the Nov. 16, 2017 House-approved version of the TCJA (House-approved bill), and the Dec. 2, 2017, Senate-approved bill (Senate-approved bill). For additional background, please visit Nareit’s tax reform webpage.

The House is expected to approve the Conference Agreement on Dec. 19, and the Senate is expected to vote on the Conference Agreement Dec. 19 or 20. Because tax reform is being considered under expedited reconciliation procedures, no cloture vote is required in the Senate (which requires 60 voting in the affirmative), and only a majority vote is needed to pass the bill. Although all 48 Senate Democrats are expected to vote against the bill, Senate Republicans are expected to vote for it without exception, and President Trump has expressed his desire to sign the bill on or prior to Dec. 22.

The Conference Agreement contains the following provisions of interest to REITs and real estate investment:

Individual Income Tax Rates and Thresholds Lowered. Effective Jan. 1, 2018, the Conference Agreement proposes retaining seven tax rate brackets in combination with tax cuts that would expire on Dec. 31, 2025. The highest tax bracket would be reduced from a maximum 39.6 percent (43.4 percent with the ACA surtax) under current law to a maximum of 37 percent (40.8 percent with the ACA surtax). As described below, certain pass-through business income, including REIT dividends, will be subject to a maximum tax rate of 29.6 percent (33.4 percent with the ACA surtax).

Maximum Corporate Tax Rate Lowered from 35 Percent to 21 Percent. The Conference Agreement would reduce permanently the 35 percent maximum corporate tax rate to a maximum 21 percent corporate rate, effective in 2018.

Pass-Through Business Rate Lowered through Deduction of 20 Percent of “Combined Qualified Business Income Amount” – Including REIT Dividends. The Conference Agreement would create a new deduction for individuals, estates, and trusts of generally the lesser of 20 percent of their combined qualified income amount (CQBIA) or 20 percent of the taxpayer's income (reduced by any net capital gain). CQBIA is defined as the sum of qualified REIT dividends (QRDs), qualified publicly traded partnership income (QPTPI), and qualified business income with respect to a qualified trade or business of a partnership, S corporation or sole proprietorship (QBI).

For taxpayers above certain income thresholds ($157,500 for single taxpayers/$315,000 for married filing jointly), income from specified service business would be ineligible for inclusion in QBI. Similarly, for taxpayers with taxable income above these thresholds, the QBI calculation would be subject to a limit of the greater of: a) 50 percent of the taxpayer’s allocable share of the pass-through entity’s W-2 wages, or, b) 25 percent of the taxpayer’s allocable share of the pass-through entity’s W-2 wages, plus 2.5 percent of the unadjusted basis (for real property structures, but not land), immediately after acquisition, of all depreciable property used for the production of qualified business income by the qualified trade or business. REIT dividends are not subject to either of these limits.

In sum, a taxpayer qualifying for the full deduction would be subject to a maximum tax rate of 29.6 percent (33.4 percent with the ACA surtax).

This deduction would be applicable for taxable years beginning after Dec. 31, 2017, but would expire after 2025.

Real Property Trades or Businesses May Elect Out of Limits on Business Interest Deductions. The Conference Agreement generally would limit the deductibility of business interest for every business, regardless of its form, to 30 percent of its adjusted taxable income, effective in 2018. For 2018-21, “adjusted taxable income” would be defined similarly to “EBITDA,” or earnings before interest, taxes, depreciation and amortization. Beginning in 2022, “adjusted taxable income” would be defined without reference to depreciation and amortization (i.e., “EBIT”).

This limitation would not apply to real property trades or businesses and regulated utilities since they do not benefit from full expensing provided to tangible personal property. The Conference Agreement follows the Senate provision. The Conference Explanation notes that under the Senate provision any real property trade or business, including ones conducted by widely-held corporations and REITs, may be considered real property trades or businesses. The Conference Explanation of the Senate provision further provides that it is “intended that a real property operation or a real property management trade or business includes the operation or management of a lodging facility.”

Taxpayers electing to use the real property trade or business exception to the interest would be required to use ADS periods for depreciation.

Expensing for Equipment; No Change in Cost Recovery Periods for Structures Unless Taxpayers Elect Out of Interest Limitation. Under the Conference Agreement, tangible personal property placed in service from Sept. 27, 2017 and before Jan. 1, 2023 could be expensed. However, cost recovery for structures, including buildings, would remain under the current law approach: 27.5-year straight line depreciation for residential buildings and 39-year straight line depreciation for nonresidential buildings. Expenses for qualified leasehold improvements would be consolidated with similar retail and restaurant improvements under a new category called “qualified improvement property” with a recovery period of 15 years and also would be eligible for 100 percent bonus depreciation.

The Conference Agreement would retain the existing 40-year alternative depreciation system (ADS) cost recovery period (used, among other purposes, to measure a company’s earnings and profits) for nonresidential real property, but would apply a reduced 30-year ADS period for nonresidential real property and a 20-year ADS period for qualified improvement property.

As noted above, taxpayers electing to use the real property trade or business exception to the interest limitation would be required to use the longer ADS periods noted above for depreciation. Additionally, if property is depreciated under ADS, it is not eligible for bonus depreciation.

Like Kind Exchanges Retained for Real Property; Eliminated for Personal Property. The Conference Agreement generally would eliminate the use of section 1031 like kind exchanges after 2017 for all assets other than real estate.

Limit on Net Operating Losses; Improved Ordering Rule for REIT Dividends Paid Deduction. Effective for taxable years beginning after Dec. 31, 2017, the Conference Agreement would limit net operating losses (NOLs) to offset only 80 percent of taxable income. Absent a conforming change to current law, REITs would calculate taxable income for this purpose after reduction by the dividends paid deduction (DPD). The Conference Agreement would reverse the calculation of this limitation for REITs so that the calculation of REIT taxable income to which the NOL limitation applies would be made before reduction by the DPD.

International Provisions. Under the Conference Agreement, the United States would move from a worldwide to a territorial tax system. Nonetheless, non-U.S. activities by U.S. taxpayers would be subject to certain base erosion tax provisions. In addition, deferred foreign income of controlled foreign corporations would be taxed at a 15.5 percent rate for earnings and profits (E&P) comprising cash or cash equivalents and at an eight percent rate for remaining E&P.

Any income deemed repatriated would be excluded from the REIT gross income tests. Furthermore, a REIT could make an irrevocable election to defer the inclusion in taxable income of the deemed repatriated income over the same eight-year period applicable to non-REIT C corporations that elect to pay taxes on the deemed repatriated amounts over eight years.

One of the Conference Agreement‘s base erosion provisions (referred to as global intangible low-taxed income, or GILTI) would require deemed inclusion in income of new types of foreign income (similar to current law’s deemed inclusion of controlled foreign corporation’s passive under Subpart F). While non-REITs would be permitted a deduction of a portion of this type of income in order that this income be subject to a lower tax rate than that otherwise applicable, this deduction would not be available to mutual funds or REITs since REITs and mutual funds cannot claim a dividends received deduction. The Conference Explanation notes that although these types of inclusions do not constitute Subpart F income, they are generally treated similarly to Subpart F income.

The Conference Agreement also would require “applicable taxpayers” to be liable for a “base erosion minimum” tax. REITs are specifically excepted from the application of this tax.

The House-approved bill had included a provision that would have disallowed the deduction of certain interest payments made to related foreign parties. The Senate-approved bill included a related provision, but it was only applicable to includible corporations of an affiliated group under section 1504. The Conference Agreement did not include either provision.

Reduced FIRPTA Withholding Tax Rate Applicable to REIT Capital Gain Distributions. Under current law, REIT distributions to non-U.S. shareholders that are attributable to the sale or exchange of U.S. real property interests are subject to a 35 percent withholding tax. The Conference Agreement would reduce this withholding tax rate to the highest corporate tax rate in effect for the taxable year (21 percent starting in 2018).

Certain Limited Items of Income Required to Be Included in Income No Later than When Included in Financial Statements. The Conference Agreement includes a provision that had been included in the Senate-approved bill to require an accrual method taxpayer subject to the all events test for an item of gross income to recognize such income no later than the taxable year in which such income is reflected as revenue in an applicable financial statement. While this provision appeared to be limited to inclusion of income in connected with original issue discount and related items, some commentators had speculated whether the provision could be interpreted more broadly, for example, to require mark-to-market of items for tax purposes if required under generally accepted accounting principles.

The Conference Agreement clarifies that:

[This] provision does not revise the rules associated with when an item is realized for Federal income tax purposes, and accordingly, does not require the recognition of income in situations where the Federal income tax realization event has not yet occurred. For example, the provision does not require the recharacterization of a transaction from sale to lease, or vice versa, to conform to how the transaction is reported in the taxpayer’s applicable financial statement. Similarly, the provision does not require the recognition of gain or loss from securities that are marked to market for financial reporting purposes if the gain or loss from such investments is not realized for Federal income tax purposes until such time that the taxpayer sells or otherwise disposes of the investment.

Limitation on Use of Active Losses. The Conference Agreement would prohibit taxpayers from using net losses incurred in active trades or businesses to offset their wage income or investment income, effective beginning in 2018.

Other Provisions. The Conference Agreement would make many other significant changes to the tax code, such as doubling the estate tax exemption beginning in 2018; eliminating the exception to the $1 million limit on the deduction of certain executive compensation paid by publicly held corporations; repealing the corporate alternative minimum tax while increasing the income threshold for the individual alternative minimum tax; approximately doubling an individual taxpayer’s standard deduction, while repealing all other itemized deductions, other than charitable contributions and medical expenses; limiting the interest deduction on a mortgage for a newly acquired principal residence to $750,000 of debt and ending the deduction of home equity interest starting in 2018; and, limiting an individual’s annual itemized state and local tax deduction to a total of $10,000, comprised of any combination of the amount of an individual’s total state and local income, property and sales tax expenses.

Nareit has been and will be actively engaged in this process and it will continue to keep you up-to-date on significant tax reform developments, including the development of regulations next year assuming the tax bill passes this week.

For more information, please contact: Nareit's EVP and General Counsel Tony Edwards; SVP, Policy & Politics Cathy Barré; or SVP and Tax Counsel Dara Bernstein.