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With the Internal Revenue Code stretching to more than 70-thousand pages, everyone agrees that tax reform is an attractive idea, right? Economists generally believe that simplifying the code encourages growth in the overall economy by reducing the costs of compliance with the law. Both President Trump and leadership in the 115^th Congress have said that this is a priority. What would a modern tax reform look like, and why is the affordable housing industry so nervous about it?  Are they right to be?

Tax reform generally refers to some combination of reducing tax rates and simplifying the code. Usually this takes the form of eliminating certain deductions and credits, which have been added to the code over the years in various attempts to incentivize actions that are helpful to the economy or to aid a disadvantaged group. As a result, tax reform is always a heavier lift politically than expected. While everyone will benefit from the lower rates, some groups will find that valuable deductions they relied on for prior decisions are being discussed for removal from the code – and some will find that the lost deductions are a bigger financial hit than the lower rates provided in savings. With 70-thousand pages of code, there are a lot of groups that fall into this category.

The last time we saw significant tax reform at the federal level was the Tax Reform Act of 1986 that was signed by President Ronald Reagan. So although the code is long and complex and it would be great if it were simpler, a lot of inertia exists behind the status quo.

President Trump’s proposed tax reform would make a variety of changes to individuals’ income taxes, including trimming the number of tax brackets from seven to three, and reducing the highest rate from 39.6% to 35%. Corporate tax rates would be cut from a maximum of 35% to 15%. It is this proposed reduction in the corporate rate that has some surprising potential to impact the affordable housing industry and development plans that are underway or still being priced by the market. How big of a concern is this in the affordable housing industry? As a CPA and advisor specializing in this area, I speak with decision-makers just about every day who are watching the tax reform discussion very closely.

So, how exactly would reducing the corporate tax rate affect the development of affordable housing projects? Let’s look at a simple example of a project developed under the competitive, 9% low-income housing tax credits (LIHTC) that make up the majority of LIHTC development in Ohio.

• In 2016 the Ohio Housing Finance Agency (OHFA) awarded a total of $32M in annual credits to 42 projects.
• Credits run for 10 years but projects are required to operate as affordable housing for 15 years.
• For simplicity let’s say a typical project receives $720,000 in annual credits, which the investor can claim on its tax return.
• Since it’s a 9% credit, the basis required to produce this amount of credit is about $8M ($8M x 9% = $720,000).
• Assuming the whole $8M is made up of a building that will be depreciated over 27.5 years, the project will deduct depreciation expense of $291,000 per year, which the investor can deduct on its tax return. There would be other deductible losses as well, but this will keep our example simple.

So, the benefit to the investor is made up of two parts: the credits themselves, which are a dollar-for-dollar reduction in the investor’s tax liability, and the ability to deduct depreciation and other expenses, which reduce the investor’s taxable income (not its tax liability).

A lot of factors go into determining the amount an investor is willing to invest in a project, but here’s a simplified look at an $8M project funded with 9% credits, with investors hoping to see a 6% return. The first column is under current tax law, the second one reflects the impact of tax reform reducing rates from 35% to 15%.

Sorry for all the numbers. We accountants love numbers. The highlighted areas above really tell the story here. The total return to the investor drops by almost a million dollars under this scenario and required gap financing increases by $563,000. Gap financing represents additional grants, loans, or deferred developer fees that need to be obtained in order for the project to go forward at all.

So this would present a major challenge to developers of affordable housing if it comes to pass. How likely is this major tax reform?

In 2017? This accountant’s opinion: not going to happen. The 1986 Tax Reform Act took 10 months to get through Congress from the time full legislation was reported out of the House Ways and Means Committee to the time it reached President Reagan’s desk for signature. Even the Affordable Care Act took about 9 months from the initial introduction of legislation to the time it reached President Obama’s desk, despite Democratic supermajorities in both chambers of Congress.

While the Ways and Means Committee has held hearings on the subject of tax reform in May, and there are probably a number of proposals being debated behind the scenes, nothing I’ve heard suggests that anyone is ready to bring what will doubtless be a controversial bill forward any time soon. The Senate is preoccupied with debating the American Health Care Act, the ongoing confirmation of Administration appointees, and (of course) Russia. Until the Senate’s docket clears a bit, the House will not vote on anything controversial that will be months away from being taken up by the Senate, if at all.

What about 2018? That’s tougher to predict. Conventional wisdom says that if the Senate cleared the decks by the end of the year, then pushing through tax reform over the course of 9 or 10 months would have the final votes taking place on the eve of the November 2018 elections, which no one from either party would want to do. In spite of this, a consensus seems to be forming that it’s going to happen. One theory in circulation is that the run up in stock prices we’ve seen since the election represents the market pricing in a high likelihood of major tax reform. In that line of thinking, if it starts to look like reform won’t happen, a major correction to the market would occur, and a recession would become likely. While the two parties have shown little inclination to cooperate with each other on anything so far during President Trump’s Administration, perhaps avoiding a recession would be enough incentive to get the two sides to find some common ground and pull together.

Will this be enough to tip the scales in favor of moving forward with tax reform in the near term? Until the parties begin to show some cooperation and some attempts to find common ground, I’ll remain skeptical of the idea that major tax reform is imminent and will be enacted in what would be an election year. But the political world has made a habit of making conventional wisdom look silly over the past year. For the good of the nation’s economy I hope Congress defies the conventional wisdom one more time and is able to deliver some much-needed major tax reform.

As for affordable housing, in the meantime, pay attention to the House Ways and Means Committee’s Subcommittee on Tax Policy. Representative Pat Tiberi of Ohio’s 12^th District is a key member and is a reliable ally of affordable housing in Ohio. But Representative Tiberi is only one member. The message to all of Congress should be that major tax reform is an idea whose time is come – but it needs to be done carefully so as not to jeopardize the industry’s ability to develop safe, decent and affordable housing.

J Kenneth Saggese is a partner in the Audit Department of Gilmore Jasion Mahler. With the Firm since 2006, Ken is a member of GJM’s Construction and Real Estate Specialist Group. His area of expertise is affordable housing.