With Donald Trump returning to the White House and Republicans holding control of Congress, construction and real estate businesses should anticipate significant changes to tax policies in 2025. While the specifics are still unclear, a unified government is focused on making broad tax reforms, especially as over 30 provisions from the Tax Cuts and Jobs Act (TCJA) are set to expire at the end of 2025.
As the legislative process moves forward, there remains uncertainty around which provisions will be enacted and when. In the meantime, companies should prepare by modeling how potential tax changes could impact their tax profiles, cash flow projections, valuations, and net income.
Here’s a breakdown of what construction and real estate firms should know regarding how potential tax policy changes could affect raising, deploying, and earning returns on capital.
Raising Capital
High interest rates have made real estate acquisitions or construction projects more expensive. Republicans may push to bring back TCJA provisions that benefit real estate, aiming to stabilize returns and reduce project costs. New measures may also be introduced to lower construction or acquisition expenses.
Key Tax Policy Areas:
- Business Interest Expense: One of the biggest factors influencing investment in new projects is the business interest expense limitation. Under the TCJA, the limitation became stricter in 2022, and while there is some bipartisan support to make it more favorable, it hasn’t been a major priority. Many real estate businesses opt out of this limitation, though commercial lessors may benefit from a more favorable limit, especially when using accelerated depreciation methods.
- Relaxed Interest Expense Deductions: Easing the 30% cap on interest deductions could help offset the higher interest costs resulting from recent loans. Many commercial real estate businesses are already feeling the pressure of these increased rates.
- Tax Rates on Capital and Ordinary Income: Lower corporate and potentially capital gains tax rates could spur more commercial activity by freeing up more capital for reinvestment.
- Credits for Residential Conversions: The new administration may push for the Revitalizing Downtowns and Main Streets Act, which would offer tax credits for converting older office properties into residential spaces.
Deploying Capital
Some real estate and construction businesses face increasing costs due to inflation and higher capital expenses, combined with reduced deductions. Construction companies in particular have found that fewer deductions hinder large investments in equipment and supplies. Meanwhile, some lessors are struggling to make the necessary renovations to attract tenants.
Tax and Trade Policy Areas:
- Tariffs: Increased tariffs from the U.S. and its trading partners are expected to raise sourcing costs and affect export revenues.
- Bonus Depreciation: The phaseout of 100% bonus depreciation began in 2023. Reinstating full capital expensing could significantly benefit construction businesses. Trump has indicated that restoring immediate, full capital expensing is a priority, potentially retroactive to January 2025.
- R&D Expenses: The tax treatment of research and development expenses became less favorable in 2022. Bipartisan support exists to restore immediate deductibility. While real estate companies may not consider themselves as doing R&D, those involved in construction, manufacturing, engineering services, or software development often incur R&D expenses that could qualify for deductions.
Return on Capital
If ordinary tax rates are reduced closer to capital gains rates, development projects and property sales become more attractive. Lower capital gains tax rates would incentivize structuring projects to benefit from capital gains rates on property sales.
Tax Policy Areas Affecting Return on Capital:
- Capital Gains Tax Rates: Lower capital gains tax rates would encourage structuring projects to qualify for capital gains treatment on property sales.
- Corporate Tax Rates: A reduction in corporate tax rates could influence the types of entities that participate in real estate ventures.
- Qualified Business Income Deduction: Extending this deduction would benefit contractors and real estate held in pass-through entities.
- Qualified Opportunity Zones (QOZ): Extending preferential capital gains treatment for QOZ investments could spur further real estate investments.
- Like-Kind Exchanges: The ability to defer gains on real estate sales by reinvesting in qualified property remains a valuable tool for real estate investors.
Real estate and construction companies that collaborate closely with tax advisors can stay ahead of proposals and model how these tax changes would impact cash flows and tax obligations. By preparing for potential policy shifts, companies can make timely, informed decisions and maximize the benefits once new tax laws are implemented.