Implications of Tax Cuts on Commercial Real Estate

cassidyturley.com | 1

2011 Tax Brackets

Jeffrey Kottmeier, Director of Research, DC Region

As the 2001 and 2003 Bush era income tax cuts near expiration on December 31,

Congress and the President are rushing to reach consensus on extending those tax cuts

before the start of a new year. With the federal debt climbing to $13.9 trillion, up 14

percent compared to a year ago, many are concerned about what impact any tax cuts

will have on a slowly recovering economy.

Additionally, the longevity of those tax cuts is a major factor in the current fi scal and

political debate. One argument posits that allowing them to become “permanent” could

have long-term effects on the federal defi cit. Extending current income tax cuts would

cost the Federal Government an estimated $3.7 trillion over 10 years. Many politicians

regardless of party affi liation support extending tax cuts for a shorter period of two

years. That would reopen the tax debate during the 2012 elections.

The President and leaders of the Republican Party crafted a bipartisan proposal to

extend most of the current tax cuts for two years. This proposal has yet to be voted

on by Congress. No matter what the outcome is, tax regulations have signifi cant

implications on the US economy and commercial real estate. Below we take a look at a

couple of possible scenarios.

Income Taxes – Bush era income tax cuts are extended for some or all. Most

politicians have agreed on tax cuts for the middle class, but those for the wealthy

(individuals earning $200,000+ annually or $250,000+ for couples) have been more

controversial. Cutting taxes for wealthy households would mean that the top two income

tax rate brackets would increase from 33 and 35 percent to 36 and 39.6 percent. The

US Treasury estimates the cost of permanent tax cuts for all taxpayers would equal

$3.7 trillion over 10 years, of which $700 billion would be from cuts for the wealthy.

The most likely outcome appears to be that tax cuts will be extended for everyone, but

only short-term. Cost estimates for a one to two year tax cut for all households range

between $200 billion to $500 billion.

Capital Gains – Long-term capital gains and qualifi ed dividends taxes remain

unchanged. Currently, long-term capital gains and qualifi ed dividends are taxed up to

15 percent. If the present tax cuts expire, the rates would revert to pre-2003 levels

of 20 percent for capital gains and regular income tax rates (up to 39.6 percent)

for dividend income. That could encourage high-income taxpayers to change their

investment strategies. Those anticipating higher taxes in the future may realize more

long-term gains in 2010 and fewer in 2011. This could shift some commercial real

estate transactions into 2010, as capital gains are taxed at a lower rate. The latest

bipartisan proposal is a short-term extension of the current capital gains tax laws.

Mortgage Interest Deductions – Residential mortgage interest deductions are phased

out or eliminated. With a housing market struggling to recover, the elimination or

phase out of mortgage interest deductions (MID) is highly contested. Changes in the

MID would have many implications on housing markets and federal tax revenues. We

estimate the total amount of interest deductions for existing US condominium and co-

op sales in 2009 is to have been $1.3 billion, based on an average unit sales price of

$217,000.

December 2010

Maximum Tax Rates

* Single with income over $200,000 or Married Filing Jointly

with household income over $250,000

Note: Taxable income ranges change, depending upon law

approved

Sources: Department of Treasury, Offi ce of Tax Analysis; Tax

Foundation

Expire Current Cuts for All

Extend Current Cuts for All

Expire Current Cuts for Wealthy*

10.0% 10.0%

15.0% 15.0% 15.0%

28.0% 25.0% 25.0%

31.0% 28.0% 28.0%

36.0% 33.0% 36.0%

39.6% 35.0% 39.6%

Source: Tax Policy Center

0%

10%

20%

30%

40%

50%

60%

70%

80%

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

Personal Income Long-Term Capital Gains

Implications of Tax Cuts on Commercial Real Estate

cassidyturley.com | 2

December 2010

Limiting Itemized Deductions – Another proposal to limit the value of itemized

deductions to 28 percent would affect high-income earners. The Tax Policy Center

estimates limiting deductions to 28 percent would increase federal taxes by $27,000, on

average, for those earning over $1 million.

Estate Taxes – The top estate tax rate decreases to 35 percent and exemptions

increase to $5 million. In 2010, there are no federal estate taxes due to a phase-out

schedule established in 2001. In 2009, couples qualifi ed for a $7 million tax exemption

($3.5 million for individuals) to distribute their estates, and amounts over $7 million were

taxed up to a top 45 percent tax rate. Current law has the estate tax resuming in 2011,

which includes a lower tax-free allowance of $1 million per person and a higher top tax

rate of 55 percent. Making the estate tax permanent using 2009 parameters would cost

$265 billion.

Implications

Debt/GDP

Public debt has increased signifi cantly over the past few years due to increased federal

spending. Currently, federal debt accounts for approximately 64 percent of GDP. A

congressional panel on debt reduction recently suggested recommendations that would

cut $4 trillion from the federal defi cit through 2020, reducing the defi cit to 2.3 percent

of GDP by 2015, and reducing public debt to 40 percent of GDP by 2035. Concerns

over the tax cuts stem from how heavily debt will weigh on the nation’s economic output.

Short-term, economists estimate that the proposed temporary tax cuts and spending

increases will help boost the economy in 2011. The latest estimates by Moody’s

Analytics show that extending tax cuts would accelerate real GDP growth to 4 percent

in 20111 . Longer-term tax cuts would add to the public debt. Making the 2009 tax code

permanent would decrease federal revenues by $234 billion over 10 years according to

the Tax Policy Center.

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1980

Q1

1982

Q1

1984

Q1

1986

Q1

1988

Q1

1990

Q1

1992

Q1

1994

Q1

1996

Q1

1998

Q1

2000

Q1

2002

Q1

2004

Q1

2006

Q1

2008

Q1

2010

Q1

Rea

l GD

P, Y

/Y C

hang

e

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Tax

Rat

e

US GDP (Ch. 2005 $, SAAR) Average Income Tax Rate

Tax Reform Act ‘86

’81 Tax Cuts Revenue Reconciliation Act ‘93

’01 & ’03 Bush Tax Cuts

GDP & Tax Rates

Sources: Bureau of Economic Analysis, Moody’s, Bureau of the Public Debt Online

1Mark Zandi, “Tax Deal Improves Odds for U.S. Economy in 2011”, Moody’s Analytics, 7 December 2010.

Implications of Tax Cuts on Commercial Real Estate

cassidyturley.com | 3

December 2010

Disclaimer

This report and other research materials may be found on our website at www.cassidyturley.com. This is a

research document of Cassidy Turley in Washington, DC. Questions related to information herein should be

directed to the Research Department at 202-463-2100. Information contained herein has been obtained

from sources deemed reliable and no representation is made as to the accuracy thereof. Cassidy Turley is a

leading commercial real estate services provider with over 2,800 professionals in 60 offi ces nationwide. The

fi rm completed transactions valued over $13 billion in 2009, manages over 420 million square feet on behalf of

private, institutional and corporate clients and supports over 25,000 domestic corporate services locations.

Employment Commercial real estate demand is highly dependent upon job creation. Employment

dropped drastically during the 2007-2009 recession. National employment levels

for Professional & Business Services, a key driver of offi ce sector demand, bottomed

out in 3Q 2009, while employment in the retail and manufacturing sectors troughed

in 4Q 2009. Since then, employment has improved in all three sectors. Changes

in the tax code could affect the outlook of businesses toward hiring additional, full-

time employees, thus altering demand for commercial real estate. Moody’s Analytics

estimates that an additional 1.6 million jobs could be added in 2011 by extending tax

cuts and increased spending. Historically, offi ce using jobs account for 20 percent of

job growth. This would equate to an additional 320,000 offi ce using jobs for the US

economy.

Small Businesses

Many small business owners could be signifi cantly affected if some current tax laws are

allowed to expire on December 31. If personal income tax rates and capital gains rates

increase, capital expenditures and small business employment could suffer. Nationally,

employment for small businesses with fewer than 50 employees has already decreased

by 1.9 million workers over the past two years. Placing a larger tax burden on small

business owners could spur a continuation of this downward trend.

Consumer Spending Many argue that an increase in taxes will restrain consumer spending, hampering a

full economic recovery. History shows that decreases in the average income tax rate

have coincided with increased consumer spending. With a recent pick-up in consumer

demand, the retail and manufacturing sectors have shown some signs of improvement

that could fade if tax rates suddenly increase.

Other Implications

There are many other issues about current tax laws being debated that could impact

the decisions businesses make about hiring, investing and operating. One such issue

is whether or not to extend tax deferrals on profi ts. Companies could use this deferral

to fi nance equipment or other large purchases. Another issue is higher taxes on carried

interest. In investment partnerships, carried interest is a form of profi t-sharing for the

fi rms’ general partners. Carried interest can qualify for lower capital gains rates. These

policies and others will affect the amount of money businesses, investors, and owners

retain, and thus have an impact on business activities including the investing in and

leasing of real estate. With the fi nal verdict still out on tax laws, the clock is ticking

quickly towards midnight on New Year’s Eve.

10

11

12

13

14

15

16

17

18

2000

Q1

2001

Q1

2002

Q1

2003

Q1

2004

Q1

2005

Q1

2006

Q1

2007

Q1

2008

Q1

2009

Q1

2010

Q1

Mill

ions

Em

ploy

ed (S

A)

Retail Professional & Business Services Manufacturing

32%

33%

34%

35%

36%

37%

38%

39%

40%

1993

1995

1997

1999

2001

2003

2005

2007

2009

Inco

me

Tax

Rat

e

1010.51111.51212.51313.51414.515

Mill

ions

Em

ploy

ed

Total Employed (Businesses <50 Employees) Top Income Tax Rate

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

0%2%4%6%8%10%12%14%16%18%

Av Annual Consumer Expenditures ($)Av Federal Income Tax Rate (%)

National Employment

Income Taxes Down, Small Business Employment Up

Income Taxes Affect Consumer Expenditures

Source: Bureau of Labor Statistics

Sources: Bureau of Labor Statistics, Moody’s, Internal

Revenue Service

Sources: Bureau of Labor Statistics, Moody’s, Tax

Foundation