Real estate and construction companies can prepare for tax changes under Trump

Authored by RSM US LLP

Real estate and construction companies have more clarity about the direction of tax policy in 2025 now that Donald Trump has been elected president and Republicans have flipped control of the Senate while retaining control of the House of Representatives.

The unified Republican Congress will be able to quickly pursue broad legislation that remakes the U.S. tax landscape before dozens of provisions in the Tax Cuts and Jobs Act (TCJA) are scheduled to expire at the end of 2025. With nonexpiring provisions and provisions that were not part of TCJA also subject to change, new legislation could significantly alter businesses’ cash flows and tax obligations.

Ahead of any tax changes in 2025, real estate and construction companies can equip themselves to make smart, timely decisions by understanding how different tax policy scenarios could affect their tax profile, cash flow projections, valuation and net income.

Here, we examine how potential tax changes could affect real estate and construction companies in their efforts to raise, deploy and earn returns on capital.

Raising capital

Interest rates have risen and leveled out, but the increased borrowing rates and limitations on deductions for business interest have made purchasing or constructing real estate more costly.

To address the cost of capital and reduce taxes on gains from sales, we anticipate Republicans will push to reinstate real-estate-friendly provisions in TCJA that have either recently expired or changed. Those initiatives could attract investment by stabilizing returns and lowering project costs, as well as freeing a larger portion of gains from tax.

Trump has also discussed affordability as an important issue, so one might expect to see provisions aimed at bringing down the cost of construction or acquisition.

The tax policy crossroads

• The business interest expense limitation: The business interest expense limitation under section 163(j) is one of the biggest balancing factors when considering investment in new projects. The limitation became less favorable in 2022, as required by the TCJA, but there is some bipartisan support for implementing a more favorable limit. Real estate businesses often elect out of section 163(j), but some—especially commercial lessors—will find that a more favorable limitation favors accelerated depreciation methods.
• Relaxed limits on deducting interest: Easing the 30% cap on interest expenses may help offset the extra interest paid for the same loan taxpayers may have acquired in 2017. The typical debt cycle means many taxpayers are newly exposed to higher rates (or will be imminently), and the commercial real estate industry is feeling the heat.
• Tax rates on capital and ordinary income: Lower corporate and, potentially, capital gains rates are part of the strategy to spur more commercial activity and free up more capital for reinvestment.
• Credits for residential property conversions: The Trump administration may push to advance the Revitalizing Downtowns and Main Streets Act, which would offer tax credits for taxpayers that convert older or underused office property to new residential. This is a bipartisan bill that may match Trump’s housing affordability goals.

Real estate and construction companies should consider:

• Planning for more borrowing: Discussing deals and working with lenders before any legislation starts moving will allow businesses to capture the benefits of striking first. Even if not subject to the business expense limitation, there may be more competition for loans and acquisition opportunities if other businesses discover they are free to borrow more.
• Projecting business interest options: Electing out of the business interest expense limitation can help bring down the cost of borrowing, but there are several tradeoffs to consider. Electing real property trades or businesses generally have to use longer ADS (alternative depreciation system) recovery periods on certain types of property for depreciation, and they cannot take bonus depreciation deductions where subject to ADS. Construction companies with heavy investment in shorter-lived equipment for operations and less capital expenditure on real property assets often find the real property trade or business election favorable.
• Structuring to preserve flexibility: Many developers and portfolio companies use single-purpose entities for each project and may qualify to make the 163(j) election for each individual project with the right planning. Discussing entity type and structure now can buy time to project the comparative benefits of accelerated depreciation versus limited business interest expense.
• Investigating commercial conversions: If the Revitalizing Downtowns and Main Streets Act were enacted, it could open up new tax credits that bring down the cost of multifamily development. Spending the time and money to identify potential projects and pursue zoning approvals may be worthwhile now, as the credit may justify speculative spending and ultimately offset the additional costs associated with conversion. There may also be opportunities to combine this approach with qualified opportunity zone projects, which often include high value commercial areas.

Deploying capital

Some real estate companies and construction businesses face prohibitive costs, as inflation and the cost of capital rose while many deductions diminished. Construction companies have found lesser deductions to be a roadblock to large investments in equipment or supplies, while some lessors cannot make the significant renovations to attract tenants they once could.

The tax and trade policy crossroads

• Tariffs: Trump favors the use of tariffs in certain situations. How tariffs are applied could have profound implications for U.S. importers specifically and the economy in general. Depending on the details, increased tariffs could increase construction companies’ sourcing costs, impact export revenues if trading partners retaliate, and compel companies to further reconfigure their supply chains.
• Bonus depreciation: Companies’ ability to deduct the cost of qualified assets the year they were acquired and placed in service (bonus depreciation) began to phase out in 2023. Bonus depreciation is particularly meaningful for construction businesses that buy large amounts of tangible assets. For lessors of real property, it can mean immediate deductions for large renovations (e.g., fit out for new tenants) as qualified improvement property.
• Business interest expense: The business interest deduction limitation under section 163(j) became less favorable in 2022. For real estate industry taxpayers, reinstating the depreciation addback may increase adjusted taxable income enough to open up projects and acquisitions premised on higher leverage.
• Research and development expenses: The tax treatment of specified research and experimentation expenses (R&D) under section 174 became less favorable beginning in 2022. Real estate companies may not think of themselves as performing R&D, but many that provide construction, manufacturing and engineering services incur R&D expenses, and any company developing software is likely to have qualifying costs.
• Real estate targeted deductions and credits: Special deductions or depreciation methods may help address housing affordability. Targeted deductions have been a favorite for certain building programs, like the section 179D deduction for energy-efficient commercial buildings.

Real estate and construction companies should consider:

• Performing a cost segregation study and repairs study concurrently with any planned improvement projects in order to properly classify shorter-lived property. Properly identifying asset classes and deductible repair costs is the best way to ensure the fastest recovery of capital expenditures. Identifying the assets will give more opportunity to plan to take advantage of changing tax laws.
• Maintaining flexibility on asset acquisitions. If 100% bonus depreciation is extended, it may be prospective or may use an earlier date (e.g., the date legislation was introduced). If possible, businesses that can move fast and accelerate or delay planned acquisitions may benefit considerably.
• Reviewing sector-specific benefits of bonus depreciation. Full expensing is particularly meaningful for construction businesses buying large amounts of tangible assets and lessors of real property doing large renovations as qualified improvement property. Getting ahead of the crowd could mean more availability and better prices on equipment and materials.
• Reviewing various depreciation-related elections (e.g., an election to use ADS or to not claim bonus depreciation): Some elections can be used to increase taxable income in one year without imposing similar treatment in a future year. If used correctly, these types of elections can provide a permanent benefit if tax rates change.
• Planning the timing and location of R&D spending: If full deductibility of R&D expenses is reinstated, shifting the timing of certain projects may avoid an extended recovery period. Similarly, if foreign R&D expenses become deductible on a more favorable basis, outsourcing R&D abroad may become more appealing.
• Importers may be able to capitalize on several well-established customs and trade programs to mitigate the effects of increased tariffs.
• Construction companies that source certain machinery from China should consider filing for a tariff exclusion.
• Importers should confirm the tariff classification codes they use are precise, as imprecise codes commonly result in unnecessary costs.

Return on capital

The closer ordinary tax rates get to capital gain tax rates, the more attractive development and repeated home sales become. Conversely, if capital gains rates drop, separation of investment and development activity becomes a more important strategy.

The tax policy crossroads

• Capital gains tax rate: A lower capital gains rate would put a premium on structuring projects to achieve capital gains rates on property sales.
• Corporate tax rate: A lower corporate rate could change the thinking about the type of entities participating in real estate activities. If the corporate rate drops, it would create arbitrage opportunities and offer benefits for taxpayers that can shift income or expense.
• Qualified business income deduction: Most real estate is held in pass-throughs and many contractors operate as pass-throughs. For noncorporate taxpayers, TCJA provided a deduction of 20% of qualified business income earned in a trade or business. Sunset of this provision would have a profound impact on contractors, who would face higher effective tax rates and would need to consider restructuring to achieve more favorable after-tax cash flow.
• Qualified opportunity zone (QOZ) investments: QOZs were created by the TCJA and designed to spur real estate investments with a limited timeframe for preferential tax treatment. In many cases, QOZ projects have not generated the early returns investors expected, and properties may not be as marketable as anticipated. Investors eager for relief on gains generated beyond 2025 would seemingly welcome some extension or renewal of QOZ investment opportunities.
• Like-kind exchanges: Taxpayers may defer gains on the sale of real estate if they invest the proceeds into qualified property. The first Trump administration restricted like-kind exchanges to real estate but preserved the ability to defer gains. This represents a significant tool in conjunction with rate changes, as it gives real estate businesses the ability to sell properties without recognizing gain into income until a later tax year.

Real estate companies should consider:

• Separating development activity from capital asset sales: If the capital gains rate decreases, the value of selling property to a related entity to perform development activity would increase.
• Merging development activity with capital asset sales: If the corporate rate drops to 15% for U.S. producers, there might be opportunities for developers and construction companies to qualify. If there is not a corresponding drop in the capital gains rate, this may create an opportunity to cut against the conventional wisdom and avoid separating development activity from capital asset sales to convert gains into ordinary income taxed at a lower rate.
• Modeling after-tax outcomes for different entity types: The best returns on investments and business income may favor one type of entity depending on whether corporate rates drop and whether the qualified business income deduction is extended. Projecting these scenarios will help real estate businesses to acquire or sell property without any lag time or uncertainty.
• Pursuing deferral/acceleration strategies: If capital gains or corporate rates decrease, arbitrage opportunities appear, and timing differences become permanent reductions in tax liability. Deals may not wait around for new legislation, however. Sellers should consider like-kind exchanges to facilitate sales while deferring income recognition to a future period when rates fall. For others, changing methods of accounting may allow taxpayers to recognize certain expenses earlier, when their deduction has a larger impact, or defer income into a lower rate year.

The tax policy road ahead for real estate

Expect the path to new tax legislation in 2025 to be unpredictable, difficult to follow at times and lined with conflicting claims by lawmakers, think tanks, news media and other analysts. However, real estate and construction companies have a guide.

Those that work closely with their tax advisor to monitor proposals can model how tax changes would affect their cash flows and tax obligations. This can equip companies to stay confidently on course and make smart, timely decisions once policy outcomes become clear.

In recent years, many tax law changes have become effective on the date a bill was introduced rather than the date it was signed into law or later. Businesses that are prepared for law changes and their effects will likely experience the greatest benefits.

This article was written by Marlon Fortineaux, Gene Garcia, Mac Carroll, Christian Wood, Scott Helberg, John Charin and originally appeared on 2024-11-14. Reprinted with permission from RSM US LLP.
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