The Tax Cuts and Jobs Act of 2017 (“TCJA”) was passed by Congress and signed by President Trump. The new law includes changes that will impact REIT investors and REIT corporations. Commentators believe the law changes will also have indirect impacts that may economically benefit REIT investors and REITs. The post below provides REIT investors with some of the details of the TCJA provisions applicable to corporations and their investors.
A) Potential Impact of TCJA on REIT Investors:
Primary changes relate to how taxes are charged to the recipient of REIT dividends. As a result of the TCJA, investors in the highest tax bracket may see the effective tax rate charged on REIT dividends received (after application of certain new deductions permitted under TCJA) reduced from the previous 39.6% to 29.6%. The chart below summarizes these changes.
|REIT Dividend Treatment||Pre-TCJA||Post-TCJA|
|Dividend Character – Taxable (income)||Ordinary Income||Qualified REIT Dividends (“QRD”)|
|Dividend Character – Tax Deferred (Return of Capital)||Reduction of Tax Basis of Investment||Reduction of Tax Basis of Investment|
|Highest Applicable Tax Rate||39.6%||37%*|
|Combined Quallified Business Income Deduction (“CQBID”)||N/A||20%|
|Effective Tax Rate on QRD’s (including CQBID)||39.6%||29.6%**|
*This rate is prior to the effect of the CQBID, as applicable. If the investor is unable to use the CQBID deduction, this will be the highest tax rate.
**This represents the highest tax rate of 37%, net of the benefit of the CQBID 20% deduction from income.
B) Potential Impact of TCJA on REIT Corporations
Material changes affecting REITs, as a result of the TCJA include the following:
- Interest Expense will be a limited deduction unless the taxpayer meets certain criteria or is eligible to make (and does make) certain elections.
- Deductible Interest Expense is limited to 30% of Adjusted Taxable Income.
- The limitation does not apply to businesses with less than $25 million of gross receipts.
- The limitation does not apply to real property trades or businesses that are eligible to elect out of this provision (forcing such businesses to then use the Alternative Depreciation System (ADS) requiring longer depreciable lives). REITs are considered to be a real property trades or business.
- Depreciation Expense changes now allow for full expensing of certain property.
- 100% bonus depreciation is permitted for certain property in the year placed in service.
- New (property where its original use began with the taxpayer) and used property qualify.
- This is applicable to short-lived assets with lives of 20 years or less.
- This could further reduce the taxable income portion of a REIT Corporation’s dividends
- The Qualified Business Income Deduction may be available to the members of REIT Corporation’s operating partnership, as applicable.
- Members who are allocated income from the operating partnership are eligible for the 20% deduction, as applicable.
- An attractive incentive for potential future UPREIT partners who may be able to claim the CQBID.
In general, REITs are often desired by investors looking for a stable investment with fixed income characteristics. The after-tax yield of an investment in REIT stock is often a significant factor for investors comparing alternative investment opportunities. REIT investors may want to take the anticipated tax deferred (return of capital) portion of the targeted annual dividend into consideration as an important aspect of their investment analysis. In this analysis, they would have considered that the taxable portion of the annual dividend could have been taxed at a federal tax rate as high as 39.6% prior to passage of the TCJA. With the TCJA tax benefits attributable to the CQBI deduction, investors may now be able to realize reductions in marginal federal tax rates by as much as 10%, providing an immediate increase to the after-tax yield on their investment.
In addition, REIT corporations may benefit from increased depreciation expense deductions with the potential to further reduce the taxable portion of the dividends received (reported on the annual form 1099).
These and other new provisions under the TCJA are in many cases quite onerous. Each REIT or owner could end up with vastly different results depending on their income, gross receipts, type of business model, tax rate structure, entity structure, etc. Careful, thoughtful, customized analysis is going to be the right policy to apply these all of these new principles.