Proposed Changes to the Tax Code and Other Regulations Affecting Real Estate - by Norm Miller

Thursday, June 1, 2017

There are a number of proposed changes to the Federal Tax Code that will affect real estate. Among these are the proposals to reduce corporate income taxes, capital gains taxes, eliminate the estate tax, and eliminate the alternative minimum tax and lower the top tax rates on individuals. Most of these are well known and most people would support the reduction of corporate income taxes, capital gains taxes and a simplification of the tax code. What might be less known is the proposal to double the standard exemption from $15,000 to $30,000. This will lower the tax burden on most households and eliminate the need to itemize unless you have income in the top tier of all households. As of 2017, the average U.S. household income is only about $60,000.

What might be less obvious is the impact of doubling the standard exemption on home ownership. Current deductions for mortgage interest and property taxes lower the after tax cost of owning for many households. If rent paid is close to the sum of mortgage payments, property taxes and insurance, then there is an incentive to buy a home rather than rent, aside from investment considerations. By increasing the standard deduction, the marginal renter might stick with renting and maintain more mobility, so the impact would be to decrease the long term home ownership rate, something that has been declining for the last 10 years anyway.

The lower corporate tax rates are generally welcome to all businesses with the exception of Low Income Housing Tax Credit Affordable housing programs that depend on tax credit purchases for the equity in these projects. The lower tax rates expected are reducing the value of the equity purchase by 10 percent to 20 percent, thus becoming harder to finance.

The EB-5 program is under review. It is a program that essentially sells US citizenship in exchange for cheap money often funneled into real estate projects as mortgages. Some 90 percent of all EB-5 buyers are wealthy Chinese, but others can also participate. Intended to supply capital to underserved markets, this program mostly results in financing large urban projects that could be financed with more traditional capital. 

Dodd-Frank is under review with a proposed program called CECL, Current Expected Credit Loss accounting. One proposal would eliminate Dodd Frank for small to medium sized banks in exchange for higher reserve capital. This would be welcome news. Other proposals suggest higher capital reserves and skin in the game as a replacement for Dodd Frank. 

Progress will be slow on all fronts because of numerous unfilled government positions, yet if the Dodd Frank regulations are not reformed relatively soon, expect the bank stock investors to lose patience. A crash in bank stocks will signal a breakdown in negotiations on many regulatory reforms and that could trigger a general stock reset. Lots to watch right now and perhaps a good time to be cautious and defensive.

Norm Miller is the Hahn Chair of Real Estate Finance at the University of San Diego School of Business and is affiliated with the Burnham-Moores Center for Real Estate.