Market Insight June 2018

INVESTMENT Market Insight JUNE 2018

Should Real Estate Investments Change in Light of New Tax Laws?

Uncertainty regarding the influence of the Tax Cuts and Jobs Act (TCJA) on investment strategies has prolif- erated both before and after the bill took effect at the beginning of the year. That said, the consensus has generally been that this law will bolster investor opportunities in commercial real estate by offering incentives that further position real estate as an attractive alternative investment. Following Q1, many investors still have questions re- garding the impact of TCJA on their current real estate portfolios and how they should change their investment strategy going forward – if at all. Below, we’ve highlighted some key effects that the new bill has had on the real estate investing landscape, as well as factors and strategies to consider when advising clients regarding real estate investment in light of the changes: Reap the full benefits of the 20 percent deduction Although it is not the only potential benefit that the new act brings to real estate investors, the 20 percent tax deduction on income generated by pass-through enti- ties – which includes nearly all real estate private equity firms, crowdfunding endeavors, and REITs – is perhaps

the most talked-about due to its direct impact on higher returns for investors. For example, if an individual investor is paid out $1,000 in returns from a fund, they will only be taxed on $800. Essentially, qualifying investors will never pay more than 29.6 percent on pass-through income. That said, advisors must counsel clients to help them understand exactly how they will or could benefit from this deduction, as there are some limitations on those who make over a certain amount in income – more than $207,500 if single or $315,000 if married and filing jointly. As a general trend, we anticipate that we’ll see high-net- worth individuals working closely with advisors to identify which real estate investment strategies offer the most income-producing strength, which will depend on many factors including market, product type, and length of hold, among others. Be prepared for potential changes in investment man- ager habits and trends While commercial real estate is predicted to be boosted by recent regulatory changes, high-net-worth clients should be made aware that some investment managers may choose to change their strategy as a result, and certain sectors may not present the same investment opportunities they did previously. For example, for investment managers to qualify for carried interest – which allows them to make a profit that is more than simply the return on their contribution to a property investment – the subject property must now be held for three years, rather than the previous requirement of one year. Certain managers might have been bullish in the past on opportunities that would allow for a quick turnaround of 1-2 years, in order to maximize internal rates of return. These same management companies may reconsider this strategy now to avoid being taxed at their ordinary income tax level. The difference can be significant – carried interest tax is capped at 23.8 percent, while the highest income tax bracket pays a rate of nearly 37 percent. (continued...)

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