The tax law gave a last-minute windfall to commercial property owners such as President Donald Trump. But regulations proposed by the Internal Revenue Service could diminish the benefit.

Under the proposals, the agency’s rules would penalize real estate investors when they make like-kind exchanges — a common practice used to defer taxes by buying a building with the profits gained from the sale of another property.

If the regulations become finalized, developers could wind up surrendering tens of millions of dollars annually that they would have saved on their tax bills.

It’s a setback for the real estate industry, whose members cheered when lawmakers added a provision days before the tax bill passed that effectively allowed owners of real estate businesses to use a tax break created for pass-through businesses such as partnerships. The 20 percent deduction was extended to firms with large capital investments like buildings, but few employees.

The IRS is responsible for issuing regulations clarifying how some of the 2017 tax law’s complex provisions should be interpreted and implemented. In a surprise to the real estate industry, the rules the IRS published in August were far more onerous than what had been considered a worst-case scenario for like-kind exchanges.

“I don’t think anybody saw it coming,” said Steven Schneider, a tax attorney at Baker McKenzie who works with commercial real estate developers.

The rules reflect how the regulation writers interpreted the text of the law, but they will consider comments that they are receiving on the issue, Treasury Department attorney-adviser Audrey Ellis said at an American Bar Association panel in Atlanta last week.

A spokesman for the IRS declined to comment.

Congress did not specify how to determine the cost basis when property owners do a like-kind exchange. The IRS rules say property owners have to use a much lower price than was expected, which effectively reduces how much they can write off. Some in the industry hoped the IRS would increase the cost basis to the purchase price of the new property.

Still, the tax overhaul is ultimately a boon for real estate investors. The pass-through break is overall a win, and the law offers other carve-outs for the industry, such as preserving like-kind exchanges for real estate property and avoiding limits on deductions for interest expenses.

 

Light writes for Bloomberg.