How are REITs impacted by the Jobs Act?

by Hogan Lovells

Hogan Lovells

On December 15, 2017, the Conference Committee of the U.S. Congress approved the Tax Cuts and Jobs Act (the “Jobs Act”). The Jobs Act is expected to be approved by both Houses of Congress and signed by President Trump. The Jobs Act is generally favorable for real estate investment trusts (“REITs”). This article summarizes the impact of the Jobs Act on REITs, with commentary on whether the changes are positive or negative for REITs. This article does not address all changes in the Jobs Act that could impact REITs, including compensation-related changes and international changes.

Income tax rates

The Jobs Act significantly reduces the corporate income tax rate from the previous highest marginal rate of 35% to a flat 21% rate – a 40% reduction. The reduced corporate income tax rate is effective for taxable years beginning after December 31, 2017. The lower effective tax rate on the income of C corporations reduces some of the tax advantage of the REIT structure relative to C corporations, but REITs still enjoy an overall advantage because they generally can operate without incurring any federal or state corporate level tax on their income. To the extent REITs incur federal income tax (e.g., tax imposed on the net income of taxable REIT subsidiaries and C corporation “built-in gains” tax), REITs will benefit from the lower corporate income tax rate.

The Jobs Act also reduces the previous highest marginal income tax rate applicable to non-corporate taxpayers from 39.6% to 37% (excluding the 3.8% Medicare tax on net investment income) – a 6.6% reduction. In addition, under the Jobs Act, non-corporate taxpayers may deduct 20% of their dividends from REITs (excluding capital gain dividends and qualified dividend income, which continue to be subject to a 20% rate). The income tax rate changes applicable to non-corporate taxpayers are effective for taxable years beginning after December 31, 2017 and before January 1, 2026.

For a non-corporate taxpayer in the top marginal tax bracket of 37%, the deduction for REIT dividends yields an effective income tax rate of 29.6% on REIT dividends (excluding capital gain dividends and qualified dividend income), compared to the previous effective rate of 39.6% – a 25.3% reduction. This substantial reduction in the effective tax rate on REIT dividends for non-corporate taxpayers (i.e., individuals, trusts and estates) is a positive change at the shareholder level and substantially offsets, for these investors, the impact at the corporate level, where, as noted above, the tax advantage of REITs over C corporations is not as significant following the changes made by the Jobs Act.

Depreciation of real property

The Jobs Act reduces the recovery period under the modified accelerated cost recovery system (“MACRS”) for qualified improvement property (“QIP”).¹ The Jobs Act made no change to the MACRS recovery period for non-residential real property and residential real property. The Jobs Act also reduces the alternative depreciation system (“ADS”) lives of residential real property and QIP. The Jobs Act made no change to the ADS life of non-residential real property.

The changes made by the Jobs Act to depreciation on real property apply to property placed in service after December 31, 2017, except for real property trades or businesses electing to deduct 100% of their interest expense (see discussion below). The changes made by the Jobs Act to real property depreciation are summarized in the following chart:








Nonresidential real property

39 years

39 years

40 years

40 years

Residential real property

27.5 years

27.5 years

40 years

30 years


Same as underlying property*

15 years

Same as underlying property

20 years


* Exceptions for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.

The shortening of the MACRS recovery period for QIP, and the shortening of the ADS lives for residential real property and QIP, are favorable changes for REITs because of the increased depreciation deductions.

Limitation on deductibility of business interest

Before the changes made by the Jobs Act, interest paid or accrued by a business generally is deductible, subject to certain limitations. Under the Jobs Act, the deductibility of net interest expense for a business, other than certain small businesses, generally is limited to 30% of the “adjusted taxable income” of the business. Adjusted taxable income equals business taxable income, computed without regard to business interest income or deductions, NOL deductions and, in the case of taxable years beginning before January 1, 2022, deductions for depreciation or amortization. Disallowed interest can be carried forward indefinitely. However, a “real property trade or business” is permitted to elect to deduct 100% of its interest expense the (the “Interest Election”) but, by making the Interest Election, the taxpayer is required to use ADS to depreciate real property used in its trade or business, regardless of when the property was placed in service. For this purpose, a real property trade or business is any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. The limitations on deductibility of net interest expense for a business under the Jobs Act apply to taxable years beginning after December 31, 2017, including interest paid or accrued on indebtedness incurred prior to December 31, 2017.

Mortgage REITs should not be impacted by the 30% limitation on the deductibility of interest imposed by the Jobs Act because interest expense can be fully deducted to the extent of interest income. Equity REITs, on the other hand, will need to determine whether their net interest deductions exceed the 30% limit imposed by the Jobs Act. The ability to add back depreciation and amortization deductions in computing adjusted taxable income for the next four years may allow many equity REITs to avoid the 30% limit on net interest deductions through 2021. When an equity REIT makes the Interest Election to avoid the limitations on interest deductions, it will need to analyze whether using ADS, based on the new recovery periods after the Jobs Act, will increase or decrease the depreciation deductions for purposes of computing REIT taxable income. Each REIT’s circumstances will be different, but many publicly-traded equity REITs already use ADS to compute taxable income and, thus, making the Interest Election should not be a negative and, in some cases, could be a positive if the Interest Election results in increased depreciation deductions.

Like-kind exchanges

Before the changes made by the Jobs Act, like-kind exchanges apply to both real and personal property. The Jobs Act restricts like-kind exchanges to exchanges of real property not held primarily for sale. The change applies to exchanges completed after December 31, 2017. However, if property is disposed of (or received) in a deferred like-kind exchange on or before December 31, 2017, the exchange (if otherwise qualified) may be completed after December 31, 2017. In general, built-in gain in a REIT’s properties is attributable to real property, not personal property. Thus, the limitation of like-kind exchanges to real property not held primarily for sale should not adversely impact most REITs.

Technical terminations of partnerships

The Jobs Act repeals the technical termination rule for partnerships. The technical termination rule provides that a partnership (or LLC taxed as a partnership) terminates for tax purposes (and a new partnership is deemed to be created) if there is a sale or exchange of 50% or more of the total interest in the partnership (or LLC) capital and profits in a 12-month period. The most significant adverse tax impact of a technical termination is the “resetting” of depreciation at the partnership level (i.e., treating the existing tax basis of the partnership’s property as if it were placed in service at the time of the technical termination, thus extending the recovery period, and decreasing the annual amount of depreciation, for such property). Many publicly-traded REITs hold substantially all of their properties in an operating partnership subsidiary (an “Operating Partnership”). The repeal of the technical termination rule is a favorable change for REITs with Operating Partnerships and subsidiary partnerships, particularly when those Operating Partnerships and subsidiary partnerships undergo change of control transactions.

Contributions to capital of corporations

Prior to the changes made by the Jobs Act, the gross income of a corporation generally does not include any contribution to its capital. However, for purposes of this rule, a contribution to the capital of a corporation, other than certain regulated public utilities, does not include any contribution in aid of construction or any other contribution from a customer or potential customer. Under the Jobs Act, contributions to capital after the date of enactment of the Jobs Act also exclude a contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such). A transition rule provides that the changes made by the Jobs Act do not apply to any contribution by a governmental entity after the date of enactment of the Jobs Act pursuant to a master development plan that has been approved prior to such date by a governmental entity. The change to the rule for contributions to capital is adverse to a REIT that receives contributions from a governmental entity or civic group that is not a shareholder of the REIT.

Partnership interests held in connection with performance of services

Some Operating Partnerships have issued long-term incentive units or performance units (“LTIP Units”) to employees and other service providers. Before the changes made by the Jobs Act, the sale of an LTIP Unit held for more than one year generally is eligible for long-term capital gain. Under the Jobs Act, if an “applicable partnership interest” is sold after December 31, 2017 and the holding period for the applicable partnership interest is three years or less, the gain from the sale of the applicable partnership interest is treated as short-term capital gain. An “applicable partnership interest” is an interest in a partnership which, directly or indirectly, is transferred to (or is held by) the taxpayer in connection with the performance of substantial services by the taxpayer in an “applicable trade or business.” An applicable trade or business includes any activity conducted on a regular, continuous, and substantial basis which consists, in whole or in part, of raising or returning capital and either investing in (or disposing of) or developing, specified assets, which include, among other assets, real estate held for rental or investment. Accordingly, under the Jobs Act, the transfer of LTIP Units is eligible for long-term capital gain only if the LTIP Units are held for more than three years.


1 QIP is any improvement to the interior portion of a building which is non-residential real property if such improvement is placed in service after the date the building was first placed in service (excluding any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building). The Jobs Act eliminated the special rules for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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