In this article, we will sort through the impact of the new law as it applies, or may apply, to developers and home builders based on what we know today. We answer the question of how tax reform will impact home builders and developers earn income and pay taxes? How does proper planning establish a tax benefit as a result of tax reform?

We are all aware that the President has signed the Tax Cuts and Jobs Act (TCJA) into law. No one is certain of what that means whether as individuals, business, developers or home builders. The answer won't be the same for any of us.

Tax reform has many impacts on the residential home building community. Some are favorable and some are not, and this is not a simplification. The TCJA is complex. The job of sorting through the maze of new laws without having the full details available is daunting. To add further complication, look at the state tax implications of the TCJA. The states are beginning to interpret the new law. It'll take time to decide how they will deal with the changes. The states can conform, disconnect entirely, or disconnect in part from the new law. By working with the TCJA, the states will determine if the language in state tax law, produces the intended result.

The Most Discussed Tax Reform Impacts on Home Builders:

  • The reduced top corporate tax rate of 21% applies to C Corporations and should benefit large developers and home builders but few smaller local builders.
  • The taxable income reduction of 20% for many pass-through entity owners appears to benefit to the local guy and intended to allow the pass-through to play on a level playing field with the "Big Boys." There are limitations! The benefit is limited to the greater of: (a) 50% of the wages paid by the qualified business or (b) the sum of 25% of the qualified wages of the qualified business plus 2.5% of the unadjusted basis of the "qualified property." The definition of "qualified property" remains complicated. Be careful to make sure that you have properly valued the basis such qualified property.
  • The mortgage interest deduction cap has been reduced from $1,000,000 to $750,000 of new mortgage financing. This should not have a huge impact on the local tract developer or builder, as the target buyer typically does not spend at this level. However, the custom high-end builder could see an impact.
  • The allowed deduction for a home equity line of credit interest has been wiped out.
  • The deduction for state and property taxes is limited to a total of $10,000. This is purportedly largely offset by the increased standard deduction but will need to analysis on a case-by-case basis. Note that the limitation is applicable to the individual residence and NOT properties used in a trade or business.

Lesser Known Changes to Home Builders from Tax Reform:

Let's turn our attention to the other, less publicized changes that may affect home builders and developers in our community.

Fixed Asset Changes

  • First-year bonus depreciation is increased to 100% deductible for qualified assets placed in service after September 27, 2017. Used assets were added to the definition of qualified property. The amount phases out over time through 2027, when it will be eliminated entirely. There are no income limitations for the amount of bonus depreciation that can be taken annually.
  • Section 179 – The maximum amount available has been increased to $1 million and will phase out at $2.5 million of purchases. The definition of qualified improvement property is currently being dissected, as there is strong belief that there was an error in the drafting of the TCJA.

The treatment for like-kind exchanges has been modified to limit the benefit to real property, thereby retaining the benefit for the developer and home builder community.

The cash method of accounting is available for taxpayers who have up to $25 million in average annual gross receipts. The holding of inventory is allowed, and the percentage of completion method is no longer required for construction contracts that are expected to be completed within two years.

Domestic Production Activities Deduction was repealed as of January 1, 2018.

Private activity bonds have been retained allowing the "Low Income Housing Credit" to retain its effectiveness and allow the continued production of affordable housing.

The business interest deduction is now limited. However, "small taxpayers" may be excluded from the limitation if they meet the "small taxpayer" definition. "Small taxpayer" is defined as having less than $25 million of gross receipts based on a prior 3-year average. The gross receipts test is aggregated for entities under common control (i.e., group common controlled entities together, and count the gross receipts as if these entities were a single entity when determining if under or over the $25 million gross receipts test).

For larger taxpayers, there is an exemption from this limitation for electing real property trades or businesses. A real property trade or business defined for this purpose is a trade or business described in Sec. 469(c)(7)(C) that is a real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. The business interest limitation does not apply to such trades or businesses if the taxpayer makes this election. Guidance has not yet been provided as to the timing and manner of making this election. If made, the election will be irrevocable.

The deduction for net interest expenses related to and incurred by the business is limited to the sum of:

Business interest income plus 30% of the business's adjusted taxable income calculated without regard to depreciation, amortization, or depletion, plus floor plan financing interest amounts not allowed in the current year may be carried forward until used.

Net operating losses (NOLs) are no longer eligible to be carried back and may only offset up to 80% of the taxable income of the taxpayer. The 80% limitation does not apply to NOLs generated prior to 2018.

Meals and entertainment (including travel) – There are no longer deductions allowed for entertainment, amusement or entertaining, club memberships, or qualified transportation benefits paid to employees. Certain meals will still be 50% deductible, but the requirements are complex, and the law is unclear. We anticipate some housekeeping changes to the law will be made before we can provide concrete answers in this area.

The alternative minimum tax (AMT) has been eliminated for corporations, and the thresholds have been raised for individuals. This reduces the likelihood that you will be subject to an increased tax liability under AMT.

Certain state and local tax incentives may now be taxable:

  • Incentives such as cash grants, no cost land, equipment, public infrastructure, reimbursements, refunds, and reductions of tax (often referred to as "Economic Development Incentives") appear to be taxable under the JCTA.
  • State tax credits have been considered a reduction of tax in the past and not subject to federal tax; however, under the JCTA, the Internal Revenue Service is looking at the possibility that refundable tax credits and transferable tax credits may be taxable.

Even though we have addressed many elements of the JCTA in this article, it does not even scratch the surface of the depth of changes. States are scrambling to attempt to preserve the tax benefit to individuals of the state tax deduction and the Internal Revenue Service is working just as hard to invalidate those attempts such as replacing taxes with a charitable contribution deduction when the taxes are prepaid. We are hopeful that we will have much more concrete information on all aspects of the JCTA by the time we present at the BuildRight Conference on April 25th. Please join our discussion on the impact of tax reform on home builders and if we can be of further assistance please contact us directly at 503-697-4118. We hope to see you there.

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