Q: What is the biggest tax reform change that will impact CRE analysis?
A: There is nothing in the 2017 Tax Cuts and Jobs Act (TCJA) that impacts the CRE analytical process. It remains untouched, in effect.
However, there are numerous provisions in the 2017 TCJA that dramatically impact, favorably, the personal tax liability of those taxpayers who own a pass-through entity engaged in real estate activity. Very briefly, there are adjustments to the Section 179 Deduction that increase the array of qualified assets to include some elements of real estate assets, such as improvements, while increasing the deduction amount from $500,000 to $1,000,000. In addition, there is a separate accelerated depreciation feature that can drive down taxable business income via 100% depreciation of certain assets if purchased after September 2017, and, therefore, reduce the pass-through taxpayer's personal tax obligation. Further, owners or partners of pass-throughs may deduct up to 20% of qualified business income from a pass-through, i.e., deduct it from taxable income reported by the pass-through and included as income on the taxpayer's personal income tax returns.
All these measures reduce the taxable income and income tax obligation of pass-through owners and partners. But CRE analysis remains CRE analysis. Property cash flow must still meet or exceed the debt service on the property's financing.
Q: Can you explain further your statement on Slides 61 and 62 that Fresno Properties’ debt service is scheduled to increase in 2015 since 2014 CMLTD of $107,491 are greater than 2013 CMLTD of $68,482? How do you come to that conclusion based on those numbers?
A: Slide 61 and 62 recap the “Likely 2015 Performance Changes” for Fresno Properties and Modesto Services respectively. The bullets for Fresno Properties – “debt service is scheduled to increase” – is followed by the supporting sub-bullet providing the year-end Current Maturities of Long term Debt (CMLTD) balances – “2014 CMLTD of $107,491 greater than 2013 CMLTD $68,482” – to support the conclusion that debt service is scheduled to increase.
The 2014 CMLTD balances are the balances that will have to be paid in 2015. In other words, prior year CMLTD balances will become current liabilities and represent the balance that has to be paid on term debt in the subsequent 12 month period. Therefore, in the Fresno Properties example on Slide 61, the 2013 CMLTD balance of $68,482 had to be paid in 2014. The $107,491 balance of 2014 CMLTD that has to be paid in 2015 is greater than the 2013 CMLTD balance of $68,482. Based on these balances, we can conclude that it is “likely” to expect debt service in 2015 to be greater. Debt service would be less in 2015 only if interest expense – the other component in a company’s debt service – were less than 2014 interest expense of $193,564 by more than $39,009, or ($107,491 – $68,482) = $39,009. It seems highly unlikely that the company’s 2015 interest expense would decrease by that amount.
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