As the Tax Cuts and Jobs Act approaches its one-year anniversary since becoming law, there are still a number of provisions the IRS must clarify. But one thing is clear: The commercial real estate industry stands to benefit in two big ways, both of which were the primary focus of the Commercial Legislation & Regulatory Advisory Board’s meeting at the REALTORS® Conference & Expo in Boston.
One is the creation of “opportunity zones.” These are Census tracts that have been designated as areas lacking investment. Individuals, corporations, businesses, REITs, estates, and trusts can all get sizable tax incentives for investing in opportunity zone funds that support development in such tracts. They could avoid paying taxes entirely on capital gains as long as the investment is held for at least 10 years.
Treasury Secretary Steve Mnuchin recently predicted that the newly designated zones could spur up to $100 billion in investment.
The board has been examining the way opportunity zones are being rolled out across the country all year, and invited Mike Kennealy, Assistant Secretary for Business Growth for the Commonwealth of Massachusetts, to offer an inside look at how the state helped local governments secure the zones and begin promoting the availability of such investment options.
Targeting Smaller Urban Centers
Kennealy told the committee that all 138 Census tracts nominated were eventually approved. They tried to target so-called “gateway cities”—smaller urban centers that haven’t seen the runaway development success making headlines in Boston and Worcester, Mass. But the state also called out 16 high-need communities in the Boston metro area, and 18 percent of the tracts are rural.
Kennealy noted that the government sees these special investment districts as a tool to address some of the challenges facing the state. While Massachusetts has seen low unemployment and robust economic growth, those market fundamentals have put downward pressure on affordable housing. “Housing is one opportunity within the opportunity zones,” he said. Outside of local interest in adding to a tight residential inventory, many communities also cited interest in mixed-use and transit-oriented development.
While the program is strictly a federal one, it may change how states spend their money. Kennealy says Massachusetts is looking at ways to increase spending to augment projects within opportunity zones. They plan to look at ways to expedite permitting, clean up brownfields, and deploy workforce housing programs in strategic ways around the selected tracts. Kennealy says the state spends around $80 million a year through their MassWorks Infrastructure Program, which invests in publicly owned infrastructure to support private developments.
Will Rental Income Qualify?
In addition, changes to the tax code known as Section 199A—which allows qualified businesses to take a 20 percent deduction on certain net income—could also be a boon for commercial real estate. But there’s still some ambiguity about whether rental income from real property will qualify for it. Evan Liddiard, the NAR’s director of federal tax policy, told the advisory board that some read the new law as allowing any entity that collects rental income to qualify, but the court cases and IRS positions vary on the details.
NAR has suggested to both the Treasury Department and the IRS that the rules be clarified and that all rental income be eligible for this deduction. The association hopes the regulations will be finalized by the end of the year.
The advisory board voted unanimously to recommend that the Federal Taxation Committee pass draft motions expressing NAR’s support for opportunity zones, as well as to support the idea of indexing capital gains. Liddiard said there have been indications recently that the current administration might grant the Treasury Department the authority to change the way capital gains are computed, especially since the election has shifted the House of Representatives to Democratic control.
Potential for Market
He explained that the move to index capital gains for inflation could make the market more fluid by lowering the lock-in effect that causes property owners to hold onto property to avoid paying taxes on these gains.
“It would be a very positive thing for real estate,” Liddiard said. “It has the potential to do a lot” for the commercial market.
And as if to underscore the outsized impact of federal policies on commercial real estate, changes are also on the docket for the advisory board itself. This year will be the final one for the Commercial Legislation & Regulatory Advisory Board; a full-fledged committee, to be known as the Commercial Federal Policy Committee, will take its place in 2019.