Tags: congress | gop | tax bill | reits | selloff | trump

Would the Proposed Tax Bill Cause a Sell-Off of REITs?

Would the Proposed Tax Bill Cause a Sell-Off of REITs?
House Ways and Means Committee Chairman Kevin Brady (R-TX) (R) and Speaker of the House Paul Ryan (R-WI) address a news conference to introduce the House Republicans' tax reform proposal June 24, 2016 in Washington, D.C. (Chip Somodevilla/Getty Images)

By    |   Wednesday, 15 March 2017 11:05 AM

Speaker Paul Ryan and House Ways and Means Committee Chairman Kevin Brady rightfully want to bring manufacturing jobs back to the United States.

Towards that end, they have included a provision in their tax proposal for immediate deduction of capital outlays or immediate expensing as it is colloquially known on Capitol Hill. Ryan believes immediate expensing will bring back the manufacturing jobs to the United States that have been lost in recent years because he believes this tax incentive will spur businessmen to build factories.

But is he right? Some labor experts argue the manufacturing jobs that have been lost are never coming back due to automation and robotics. A much heralded study by two professors at Indiana’s Ball State University found that 88 percent of the manufacturing job losses between the years 2000-2010 resulted from more efficiency in the factories due to automation and better technology. Additionally, the study found that trade only cost 13 percent of the job losses in the last decade.

The non-partisan Congressional Budget Office estimates that the adoption of immediate expensing will increase the federal deficit by $500 billion the first year alone at a time when the nation desperately needs money to fund the president’s top priorities such as infrastructure and the buildup of our military. The Speaker says that deficits will be temporary because the new factories built will stimulate the economy’s growth rate to 3-4 percent. What if the Speaker is mistaken and this growth doesn’t manifest as suggested by labor experts? The real legacy of immediate expensing will be increased federal deficits.

Along with the provision in the Ryan-Brady plan to disallow deductions for net interest expense, many real estate experts, including those at the Real Estate Roundtable, have concluded immediate expensing could destabilize the real estate industry, which is one of the greatest generators of individual wealth in the last century as well as a major economic driver of the U.S. economy. In 2016, real estate construction contributed $1.2 trillion to the nation's economic output or 6 percent of the U.S. gross domestic product (GDP). A destabilization of real estate values would lead to a decrease in the issuance and the amount of home equity loans that have fueled much of the recent consumer spending.

This change in the tax code for real estate could trigger a decline in real estate values for several reasons. The largest holders of real estate in the United States are Real Estate Investment Trusts (REITs). Investors buy them for the income, with a preference for tax sheltered income. The adoption of immediate expensing would mean that the income generated by properties in the REIT after the first year would be mostly taxable. An increase in taxable income would trigger a sell-off in REITs. If there is a sell-off in REITS, less will be issued which will reduce the demand for real estate and eventually its value.

Any decline in the value of real estate could precipitate a financial crisis similar to the one in 2008 since the overly leveraged balance sheets of mid-sized banks are comprised of real estate. Filed under the department of unintended consequences, a change in the tax code from multi-year deprecation to immediate expensing could lead to more foreclosures and bankruptcies in the real estate industry. The annual tax savings from deprecation is often the money that is used to pay down back loans. Without this annual forced savings, there would be more foreclosures and bankruptcies accelerating the decline in real estate prices.

The current proposal calls for most of the tax savings from the adoption of immediate expensing will be recaptured when the building is sold. Facing a large tax bill, many sellers will refrain from selling. This will have a ripple effect on the economy since the buyers of a new building often spend money to upgrade the building. Now that spending will be delayed or will never happen. Bankruptcies and foreclosures of the building’s owners, as well as clever lawyers, could further slash the tax revenues returned to the Treasury.

Arthur L. Bernstein is instrumental in new group/employee benefits development and individual life insurance planning at Richard S. Bernstein & Associates, Inc. He assists corporations to expand their current revenues while creatively exploring additional methods to reduce insurance costs. Visit www.rbernstein.com for more information.

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RichardSBernstein
The adoption of immediate expensing would mean that the income generated by properties in the REIT after the first year would be mostly taxable. An increase in taxable income would trigger a sell-off in REITs.
congress, gop, tax bill, reits, selloff, trump
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2017-05-15
Wednesday, 15 March 2017 11:05 AM
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