Summary

As part of the budget reconciliation process and in order to finance a growing list of tax priorities, members of Congress have considered limitations on the federal tax deduction for state and local taxes paid by businesses (“Business SALT”) as a source of new revenue. These restrictions could take several forms. A cap on the deductibility of business-related property taxes would have devastating consequences for commercial real estate values, rents, and the entire economy and financial system. The tax legislation passed by the House Ways and Means Committee in May does not limit the deductibility of state and local business-related property taxes.

RER has strongly urged Congress to preserve the deductibility of state and local business property taxes to avoid the detrimental impacts that would result from changing this policy.

Key Takeaways

Analysis by the Tax Foundation indicates that disallowing corporate SALT deductions for corporate income and property taxes would reduce GDP and American incomes by 0.6 percent and reduce hours worked by 147,000 full-time equivalent jobs.

State and local property taxes represent, on average, 40 percent of the operating costs of U.S. commercial real estate, a greater expense than utilities, maintenance, and insurance costs combined.

Business-related property taxes are different from state and local income taxes. Property taxes are an unavoidable expense, an inescapable cost of operating any business. They are a cash outlay that is owed regardless of whether the business has any income at all.

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Summary

Real estate generally is owned and operated through “pass-through” entities that allow income to pass through to individual owners rather than taxing the income at the entity level. Pass-through entities such as partnerships, limited liability companies (LLCs), S corporations, and REITs are ideal for real estate because they give investors flexibility in how they structure the risks and rewards of these capital-intensive and relatively illiquid businesses. 

The 20 percent deduction for pass-through business income enacted in 2017, Section 199A of the tax code, expires at the end of 2025. At that time, the effective marginal rate on pass-through business income would rise by over one-third. Tax legislation passed by the House Ways and Means Committee in May would permanently extend Section 199A and increase the deduction to 23 percent, lowering the top effective tax rate on qualifying income to 28.49 percent.

Key Takeaways

Our pass-through regime is a competitive strength of the U.S. tax system. Most countries rely on inflexible corporate regimes that provide little ability for an entrepreneur to tailor the capital and ownership structure to meet the needs of the business and its investors.

Half of the 4 million partnerships in the U.S. are real estate partnerships, and real estate activity constitutes a large share of pass-through business activity.

Listed REITs allow small investors to invest in diversified, commercial real estate using the same single tax system available to partners and partnerships. 

Small and closely-held businesses drive job growth and entrepreneurial activity in the United States. Entity choice is a differentiator that contributes to our entrepreneurial culture.

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Summary

A “carried” interest is the interest in partnership profits that a general partner receives from the investing partners for managing the investment and taking on the entrepreneurial risks of the venture, such as funding pre-development costs, guaranteeing construction budgets, and potential litigation. Carried interest is also granted for the value the general partner adds beyond routine services, such as business acumen, experience, and relationships. Carried interest may be taxed as ordinary income or capital gain depending on the character of the income generated by the partnership. 

This year, both Republican and Democratic leaders have proposed making policy changes that would increase the tax burden on carried interest. President Trump has urged Republican lawmakers to include a tax increase on carried interest as part of budget reconciliation legislation.

Since carried interest and its tax treatment first emerged as a controversial political issue in 2007, RER has consistently opposed legislative proposals to tax all carried interest at ordinary income rates.

Key Takeaways

Unfair retroactive application of carried interest legislation to existing partnerships would distort the economics of private-sector agreements with unknown and potentially damaging consequences for real estate markets and the overall economy.

Carried interest is essential to real estate investment, supporting housing development, economic growth, and the modernization of U.S. infrastructure.

Carried interest is not compensation for services. General partners receive fees for routine services (leasing, property management). Those fees are taxed at ordinary tax rates.

Proposals to tax all carried interest as ordinary income would result in an enormous tax hike on the 2.2 million real estate partnerships and 9.7 million real estate partners across the country who develop, own, and operate income-producing real estate. 

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Summary

Created in 2017, Opportunity Zones (OZs) are designated, low-income census tracts where qualifying investments are eligible for reduced capital gains taxes. By channeling investment where it is needed, OZs help stimulate jobs, generate economic opportunity, and improve the built environment in low-income communities. The decentralized design of OZs allows more investors and stakeholders to participate in the market and invest in these projects.

This year, the renewal and reform of the OZ tax incentives is expected to be a major topic of discussion as Congress considers the extension of the Tax Cuts and Jobs Act of 2017. RER has advocated for a long-term extension of the OZ incentives, as well as additional reforms to scale their impact and improve their effectiveness.

Tax legislation passed by the House Ways and Means Committee in May would extend OZ incentives through 2033, create new benefits for rural OZs, call for a new round of OZ census tract designations, and make other reforms to the provisions.

Key Takeaways

In their short tenure, OZs have created jobs and spurred billions of dollars of new investment in economically struggling communities across the country.

Opportunity Funds finance affordable, workforce, and senior housing; grocery-anchored retail centers; and commercial buildings that create spaces for new businesses and jobs. 

In 2020, the White House Council of Economic Advisers estimated that the Opportunity Funds had raised $75 billion in private capital in the first two years following the incentives’ enactment, including $52 billion that otherwise would not have been raised. The council projected this capital could lift one million people out of poverty in OZs by 11 percent.

Despite major hurdles such as COVID-19 and high interest rates, more recent estimates suggest OZs have attracted over $120 billion in capital.

Today, 72 percent of U.S. counties contain at least one OZ, and 32 million people live in the 8,764 OZ-designated census tracts.

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Summary

It has become standard practice in the United States to tax long-term capital gain at a lower rate than ordinary income. The previous Biden administration proposed raising the capital gains rate to be on-par with the top rate on ordinary income. Former President Biden also proposed increasing the tax rate on net investment income and applying it to active business owners, including real estate professionals.   

RER encourages Congress to continue to support investment and job creation with a meaningful capital gains incentive.

Key Takeaways

A tax on unrealized gains would require the IRS to police households as they identify, tabulate, and value all their worldly possessions. The tax would thrust the IRS into a new and unwelcome role. The agency would become a permanent, live-in accountant and watchdog over every aspect of household finances, consumer activity and economic life.

Unlike other tax policies, such as immediate expensing, the capital gains preference only rewards smart, productive investments that generate profits.  

The reduced capital gains rate partially offsets the higher risk that comes with illiquid, capital-intensive real estate projects, as well as the economic effects of inflation.

High taxes on capital income make it harder to attract the investment needed to rebuild our urban centers. Opportunity Zone capital gains incentives facilitated $75 billion in new investment in low-income communities in the first two years after enactment. 

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Summary

Currently, the tax code allows taxpayers to defer capital gain when exchanging real property used in a trade or business for a property of a like-kind. The prior Biden administration proposed restrictions on gains deferred through like-kind exchanges. RER advocates for preserving the current tax treatment of like-kind exchanges.

Key Takeaways

Land conservation organizations rely on exchanges to preserve open spaces for public use or environmental protection.

15-20 percent of commercial transactions involve a like-kind exchange. Exchanges get languishing properties into the hands of new owners who improve them and put them to their best use.  

Academic and outside research has found that exchanges spur capital expenditures, increase investment, create jobs for skilled tradesmen and others, reduce unnecessary economic risk, lower rents, and support property values.

Like-kind exchanges allow businesses to grow organically with less unsustainable debt, creating a ladder of economic opportunity for minority-, veteran- and women-owned businesses and cash-poor entrepreneurs that lack access to traditional financing. 

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Summary

The 2017 tax bill included strict new limits on the deductibility of business interest, generally restricting this to 30 percent of the taxpayer’s EBITDA (earnings before interest, tax, depreciation, and amortization). However, the bill also included a key provision that allows commercial real estate (a real property trade or business) to opt out of the interest limitation.  

Since 2022, the general 30 percent business interest limitation has applied a less favorable rule that uses the taxpayer’s EBIT (earnings before interest and tax) rather than EBITDA as the base for measuring the amount of deductible interest. In 2025, extension of EBITDA rule, which was in effect from 2018-2021, is under review as Congress considers extension of the 2017 tax bill.

Tax legislation passed by the House Ways and Means Committee in May would reinstate the EBITDA tax rule for business interest deductibility for five years: 2025-2029.

Key Takeaways

Debt is a fundamental part of a real estate entity's capital structure and, in addition to property acquisition costs, is used to finance day-to-day operations like meeting payroll, buying raw materials, making capital expenditures and building new facilities.

The ability to finance investment and entrepreneurial activity with borrowed capital has driven jobs and growth in the United States for generations. America’s capital markets are the deepest in the world and provide our economy with a valuable competitive advantage.

Commercial banks are the dominant source of financing for commercial real estate investment. Like other entrepreneurs, small and medium-sized real estate developers and investors lack access to equity markets and rely on traditional lending to grow and expand.

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Summary

Under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), foreign investors are generally subject to U.S. capital gains tax on sales of U.S. real estate and most REIT shares—unlike gains on other U.S. investments. However, an exemption exists for domestically controlled REITs, where less than 50 percent of the shares are held “directly or indirectly” by foreign persons.

In April 2024, the Treasury Department issued final regulations under FIRPTA that changed the previous interpretation of the phrase “directly or indirectly” and introduced a sweeping new “look-through” rule. Though these changes aim to safeguard national security, they risk discouraging essential foreign capital crucial for refinancing and sustaining U.S. commercial real estate markets, particularly given upcoming debt maturities.

At the state level, 20 states have enacted restrictions on foreign investors in real estate and agricultural land, and eight states have considered similar measures. 

RER has advocated for the withdrawal of the “look-through” rule and the restoration of a stable, predictable framework for foreign investment in U.S. real estate.

Key Takeaways

The FIRPTA look-through rule is legally unsound, economically harmful, and inconsistent with congressional intent.

Foreign investment is a major source of capital for U.S. commercial real estate, leading to job creation and economic growth for communities throughout our nation.

Many investment funds that are controlled or advised by regulated U.S. asset managers source investment capital in global capital markets.

With approximately $1.5 trillion of U.S. commercial real estate debt coming due in the next three years, foreign equity investments in U.S. assets are often an important source of capital as commercial real estate owners seek to restructure, refinance, or sell their properties.

Discouraging foreign investment weakens U.S. competitiveness, raises the cost of capital for U.S. developers and undermines efforts to revitalize urban cores, modernize infrastructure, and expand the housing supply.

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