Well, we’ve had the big reveal and the administration’s new tax plan is out. This plan, announced with a great deal of fanfare, feels more like a campaign promise than an actual executable plan. At two hundred forty-six words from end to end (four different typesets, three different fonts, three colors, weird spacing and a sad little dash at the top), anyone who was hoping for clarity and a plan to go to the bank on, is either disappointed… or perhaps relieved.
The big stuff is, of course, the reduction of the corporate rate to 15%, the reduction of the individual rates, simplification of brackets, trimming deductions (sorry Blue State high state tax paying friends), reduction of the pass-through entities tax to 15% (Just a personal comment: you have got to be kidding, Mr. President, but if this happens, I will take it and run!), a get out of jail free (or mostly free) card to repatriate corporate earnings to the United States and conversion to a territorial tax system.
The Dow got all atwitter in the run up to the big announcement, took a look and then, like the groundhog seeing its shadow, slid 21 points. The 10-year crept up, currency and commodity markets barely moved. In other words, it was largely, for the markets, a non-event.
We were riveted here at CrunchedCredit about the possible impact of a truly major tax overhaul on commercial real estate. Would it change the deductibility of business interest? Eliminate 1031 exchanges? Change accelerated depreciation, maybe even – we can dream can’t we – simplifying things like the REMIC tax rules, or the Taxable Mortgage Pool Rules? Nada.
Remember, this plan was released against the backdrop of what is a very detailed tax plan proposed by Speaker Ryan and the House Republicans. This “A Better Way” plan, developed when they had no real ability to implement legislation (which of course makes proposing something way easier), was considerably more detailed than the President’s plan. Some of the key takeaways of that plan, apart from the wacky border adjustment proposal (wacky is a legal term), was that it provided for 100% immediate deductibility of capital expenditures, and limited the deductibility of interest to the amount of interest income. Beyond that, even in this “blueprint,” the details of how the tax plan would impact the commercial real estate space was fuzzy at best. There was a hint that 1031s might go away – but again, nada about REITs, FIRPTA, REMICs, or TMPs.
So what do we have? Not a lot, and I’m not sure that’s good news or bad news. Maybe there’s a core deal here to be had around corporate tax rates and repatriation, but the toxic political environment and the broken mechanics of reconciliation, puts even what economists from both left and right agree is important, in doubt.
What do we care about the most in CRE finance? Let’s start with interest deductibility. Interest deductibility has been a part of the Code since 1913 and while a number of academic economists have long held that it distorts economic activity, it’s really hard to see it going away. My brain skitters away from even trying to contemplate what might happen across the CRE spaces which are entirely dependent (perhaps more so than they should be) on debt if a dollar of equity and a dollar of debt had the same tax consequences.
So, for the moment, I’m going back to worrying about other things. Tax reform looms over all other issues with its potential to transform the legal environment for CRE capital formation and could be the biggest driver of change in our industry, certainly since the 80s and perhaps since the invention of the mortgage banker (blue blazer, khaki pants, vacuous smile and southern accent). But like the crazy North Korean dictator’s childlike fascination with threats of obliteration, further Russian aggression, a zombie apocalypse and the return of Elvis, while the magnitude of resulting change is enormous, the likelihood of occurrence seems low. So we’ll keep monitoring all that, but in the more mundane world where Basel (Steps in Risk is alive and well), Dodd-Frank, Volcker, Risk Retention, shrinking liquidity, shrinking investor bases and grumpy borrowers are real, everyday problems, we have more than enough to worry about.