Hold on to Your Hats: Regulatory, Tax & Accounting Changes Accelerate

June 2017

After a tumultuous 2016 general election cycle, risks tied to the installation of the new presidential administration are cited by more than 4 in 10 REITs (44 percent). 

Some elaborated, pointing to resultant shifts in legislative and regulatory priorities that could have a material effect on their business. Among those mentioned specifically? Travel restrictions, tax reform and the ongoing efforts to repeal and replace the Affordable Care Act. 

Beyond these high-profile initiatives, regulatory, tax and accounting changes that could impact REITs’ operations are already underway—and REITs are taking note in their disclosures to shareholders.


Regulation

Nearly all REITs analyzed cited federal, state and local regulations (99 percent) and environmental liability (98 percent) as a risk to their operations, consistent with our analysis year-over-year. While much of the dialogue around regulation in prior years has focused on a tightening regulatory belt and mounting costs of compliance, there appears to be a turning of the tides toward a more pro-business current under the new administration. 

For example, more than one in five (21 percent) REITs mentioned the Dodd-Frank Wall Street Reform and Consumer Protection Act in their disclosures, a slight uptick from 2016 but still lower than 2013 to 2015 levels. One of President Trump’s stated campaign pledges was to repeal Dodd-Frank and the administration appears keen to fulfill that promise of regulatory easing. In early May, the House Financial Services Committee voted to send the Financial CHOICE Act—which would roll back significant pieces of Dodd-Frank—to the House floor, where the bill passed this June. In a letter to committee Chairman Jeb Hensarling, R-TX, Real Estate Roundtable President and CEO Jeffrey D. DeBoer cited the act as an opportunity “for balanced reforms of a number of burdensome Dodd-Frank provisions affecting real estate,” including credit risk-retention and other rules impacting “real estate credit capacity, liquidity, capital formation and job growth.” 

On the incentives side, 26 percent of REITs cite changes in government programs as a risk, notably down from 39 percent two years ago. One key change that could signify a shift toward a more favorable environment for real estate developers and owners was the revival of New York’s 421(a) developer tax abatement, renamed Affordable New York, as part of the state’s $163 billion budget. Key changes in this revival from the version of 421(a) that expired in 2016 include wage requirements for construction workers on certain projects, as well as a longer break from property taxes (35-year break, as opposed to 25-year break in the previous version) on large projects that pay those wages.

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Taxation

With tax reform on the table—and the White House’s initial tax framework announced—REITs are simultaneously assessing the impact proposed reforms could have on their business models and implementing changes to comply with IRS requirements going into effect at the end of the year. 

Proposed Tax Reforms High on REITs’ Radar 

Among the changes proposed in the White House’s tax reform framework and the GOP’s initial tax reform blueprint, the following are top of mind for REITs: 
  • Elimination of corporate alternative minimum tax (AMT)
  • Limitations to interest deductibility and net operating loss (NOL) deductions
  • Reductions in corporate tax rates
  • Alterations to the tax treatment of carried interest
  • Changes to the current depreciation deductions 
  • Elimination of 1031 exchange, or the “like-kind” exchange 
  • Changes to the repatriation tax rate on profits held overseas

Of key concern are the provisions that could alter rules related to REITs’ tax status and have a material impact on their taxable income. With tenants spanning diverse industries, REITs’ fiscal health can also be sensitive to tax changes affecting tenants’ operations. As the future of tax reform still hangs in the balance, REITs are closely watching how proposals develop. 

Immediate Tax Changes: PATH Act 

Of more immediate concern for REITs is a key provision of the Protecting Americans Against Tax Hikes (PATH) Act which has an implementation deadline for taxable years beginning after Dec. 31, 2017. Under the new guidance, the value of all taxable REIT subsidiaries (TRS) and non-real estate assets cannot exceed 20 percent of the value of the REIT’s total assets. This is a departure from prior guidance, which set the threshold limit at 25 percent.

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“REITs are particularly focused this year on what those changes under the PATH Act mean for their businesses. To prepare for the new requirement, REITs will need to divest some of their assets housed in TRSes or other non-real estate assets, without sacrificing tenant services to maintain a competitive advantage relative to other properties.”

REITs-RFR-Web-headshot-circle3_Bilsky.jpgJeff Bilsky
Partner in BDO USA’s National Tax Office

 



REITs Underestimate Lease Accounting and Revenue Recognition

Internal controls and financial reporting risks and accounting rule changes are cited by 71 percent, up from 69 percent in 2016 and 50 percent in 2014. One accounting standard update that’s particularly key for the commercial real estate industry is the newly finalized Lease Accounting Standard, ASC 842, from the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), which will take effect in December 2018. 

But just 15 percent of REITs specifically noted lease accounting in their filings, consistent with 2016 levels (14 percent). While the rule isn’t expected to change accounting practices for lessors on its face, there will be implications around ground and equipment leases. And lessors should be aware of the steps lessees may consider taking to manage their own balance sheets. REITs may also need to consider the impact on non‑Generally Accepted Accounting Principles (non-GAAP) financial metrics that they report in shareholder letters and earnings releases.

REITs are also paying attention to the interaction of the lease accounting standard with ASC Topic 606: Revenue from Contracts with Customers (revenue recognition), which goes into effect for public companies in 2018 and non-public companies in 2019, with early adoption available this year.  Depending on the sector, the new standard may impact how rental income and other related charges, including common area maintenance reimbursement, are recorded, as well as when a sale of real estate should be recognized.

“REITs may think the lease accounting and revenue recognition standards won’t significantly impact them, but they may be surprised. Applying the new standards can be complicated, and organizations that aren’t making headway on an adoption plan—establishing it and putting resources behind it—risk falling behind.”

REITs-RFR-Web-headshot-circle4_Newell.jpgAngela Newell
National Assurance Partner