Navigating uncertainty: The potential impact of policy changes on construction and real estate

As the political landscape shifts, the construction and real estate industries find themselves at a crossroads, facing potential policy changes that could significantly impact their operations and bottom lines. With discussions surrounding the possible elimination of the Inflation Reduction Act (IRA) and extensions to the Tax Cuts and Jobs Act (TCJA), industry professionals are left wondering: How will these changes affect our projects, profits and long-term strategies?

The future is still uncertain; as with any political process, the final outcomes may differ from initial projections. However, an understanding of the potential scenarios and their implications can help equip businesses to adapt and thrive in an ever-changing environment.

The Inflation Reduction Act: A closer look at potential changes

The Inflation Reduction Act, a landmark piece of legislation, has been a topic of heated debate since its inception. As political winds shift, there’s growing speculation about its future. While complete elimination seems unlikely, we may see gradual reductions or modifications to certain provisions.

Understanding the 5% safe harbor provision

One of the key elements of the IRA that directly impacts construction and real estate is the 5% safe harbor provision. This clause allows projects to qualify for certain benefits if they meet specific criteria related to construction physical costs. For construction and real estate professionals, this provision has been a crucial factor in project planning and execution.

If modifications to the IRA occur, it’s essential to understand how they might affect this safe harbor provision. Projects that have already met the 5% threshold for physical construction costs may be grandfathered in, regardless of future changes. This means that ongoing projects or those in the advanced planning stages could potentially retain their benefits, even if the act undergoes significant alterations.

However, the landscape for future projects remains uncertain. Any changes to the safe harbor provision could have far-reaching implications for how new construction and real estate developments are planned and financed. It’s crucial for industry professionals to stay informed about these potential changes and consider how they might impact long-term strategies.

Energy efficiency incentives: A shifting landscape

Another significant aspect of the IRA has been its focus on energy efficiency incentives. These incentives have played a substantial role in shaping project designs and investment decisions, particularly in the realm of sustainable building practices.

If the IRA faces modifications or partial repeal, we may see changes to these energy-related incentives. This could potentially alter the cost-benefit analysis for incorporating energy-efficient technologies and practices into construction and real estate projects. Professionals in both sectors will need to reassess the financial viability of green building initiatives in light of any changes to these incentives.

Even if federal incentives change, state and local governments may step in to fill the gap with their own energy efficiency programs. This patchwork of regulations and incentives could create both challenges and opportunities for industry players who are able to navigate the complex landscape effectively.

The Tax Cuts and Jobs Act: Potential extensions and their implications

While discussions about the IRA have dominated headlines, potential extensions to the Tax Cuts and Jobs Act could have equally significant impacts on the construction and real estate industries.

Restoring full expensing of R&D costs

One of the most anticipated potential extensions relates to the treatment of research and development (R&D) costs. Currently, businesses are required to amortize these expenses over several years. However, there’s a push to restore full expensing of R&D costs, which could have substantial benefits for construction companies engaged in innovative building techniques or materials research.

If this extension comes to fruition, it could incentivize increased investment in R&D within the construction sector. This, in turn, could lead to advancements in building technologies, more efficient construction methods and potentially, reduced costs in the long run. For real estate developers, this could translate into more innovative building designs and features, potentially increasing property values and attracting tenants or buyers.

The future of the SALT deduction

The state and local tax (SALT) deduction has been a hot-button issue since the implementation of the TCJA. For individuals in high-tax states, the current cap on this deduction has had significant implications. Any changes to the SALT deduction could have ripple effects throughout the real estate market, particularly in areas with higher property taxes.

If the SALT deduction cap is lifted or modified, it could potentially make homeownership more attractive in high-tax areas. This could stimulate demand in certain real estate markets, potentially leading to increased construction activity. However, the impact would likely vary significantly by region, and industry professionals would need to carefully analyze local market conditions to understand the full implications.

Extending the Qualified Business Income Deduction

The Qualified Business Income Deduction, which allows certain businesses to deduct up to 20% of their qualified business income, has been a significant benefit for many in the construction and real estate industries. An extension of this provision could continue to provide substantial tax savings for eligible businesses.

For construction companies and real estate firms structured as pass-through entities, the continuation of this deduction could mean more capital available for reinvestment, expansion or weathering economic uncertainties. It’s important for businesses to work closely with tax advisors to ensure they’re maximizing the benefits of this deduction, should it be extended.

179D and 45L: Key provisions for construction and real estate

Two specific provisions that have garnered bipartisan support and are of particular interest to the construction and real estate industries are Sections 179D and 45L of the tax code.

• Section 179D: Energy efficient commercial building deduction

Section 179D provides a tax deduction for energy-efficient commercial buildings. This provision has been a significant driver of green building practices in the commercial real estate sector. Under current rules, building owners can claim a deduction per square foot for qualifying energy-efficient improvements.

If this provision is extended or expanded, it could continue to incentivize the incorporation of energy-efficient systems in new construction and major renovations. This could lead to long-term operational cost savings for building owners and tenants, as well as contribute to broader sustainability goals.

For construction companies specializing in commercial projects, familiarity with the requirements of 179D could be a competitive advantage. Being able to guide clients through the process of qualifying for this deduction could be a valuable service offering.

• Section 45L: Energy efficient home credit

Section 45L provides a tax credit for energy-efficient residential construction. This credit applies to new homes and apartments that meet certain energy efficiency standards. The current credit is up to $5,000 per unit, making it a significant incentive for homebuilders and multifamily developers.

An extension or expansion of 45L could continue to drive innovation in residential construction, pushing the industry towards more energy-efficient building practices. For construction companies and real estate developers focused on the residential sector, understanding and leveraging this credit could be crucial for project feasibility and profitability.

It’s worth noting that while these provisions have enjoyed bipartisan support in the past, their future is not guaranteed. Industry professionals should stay informed about any potential changes and be prepared to adjust their strategies accordingly. 

Bonus depreciation: A powerful tool for real estate investors

One of the most impactful provisions of the TCJA for the real estate industry has been the 100% bonus depreciation allowance. This provision has allowed investors to immediately deduct the full cost of certain property improvements, significantly impacting cash flow and investment decisions.

As it stands, the 100% bonus depreciation is set to begin phasing out, reducing by 20% each year until it reaches 0% in 2027. However, there are discussions about potentially extending this provision at its full rate.

For real estate investors and developers, the continuation of 100% bonus depreciation could have significant implications. It could make certain renovation projects more financially attractive, potentially spurring increased investment in property improvements. This, in turn, could create more work for construction companies specializing in commercial renovations and tenant improvements.

Strategies for leveraging bonus depreciation

Regardless of whether the 100% rate is extended, understanding how to effectively use bonus depreciation remains crucial for real estate professionals. Some strategies to consider include:

• Timing of improvements: If the phaseout proceeds as currently scheduled, there may be advantages to accelerating planned improvements to take advantage of higher depreciation rates.
• Cost segregation studies: These studies can help identify which components of a property improvement qualify for bonus depreciation, potentially maximizing the tax benefits.
• New construction versus acquisitions: The availability of bonus depreciation could influence decisions between new construction and acquiring existing properties, depending on the specific circumstances.

The impact of potential tariff changes on construction costs

Another area of potential change that could significantly impact the construction and real estate industries is trade policy, particularly regarding tariffs. The possibility of increased tariffs on imported construction materials could have far-reaching effects on project costs and feasibility.

Understanding the ripple effect of tariffs

Tariffs on imported materials like lumber, steel or aluminum can directly increase construction costs. However, the impact often extends beyond just the cost of the tariffed items, for instance:

• Supply chain disruptions: Tariffs can lead to changes in global supply chains, potentially causing delays or shortages of certain materials.
• Domestic price increases: Even domestically produced materials may see price increases as demand shifts away from more expensive imported options.
• Labor costs: If material costs increase significantly, it could potentially impact wages in the construction industry as companies try to balance their budgets.
• Project feasibility: Higher construction costs could make some projects financially unviable, potentially reducing overall construction activity.

An uncertain future

As we navigate the uncertain waters of potential policy changes, it’s important to remember that with change comes opportunity. The construction and real estate industries have long been characterized by their resilience and ability to adapt to shifting landscapes.

While the potential elimination of the Inflation Reduction Act and extensions to the Tax Cuts and Jobs Act may present challenges, they also offer opportunities for innovation, growth and strategic positioning. By staying informed, planning proactively and leveraging expert advice, industry professionals can not only weather these changes but potentially thrive in the new environment they create.

Remember, the key to success in uncertain times is not to predict the future perfectly but to be prepared for various possibilities. By taking proactive steps — from understanding the nuances of potential policy changes to developing flexible business strategies — you’ll be well-positioned to navigate whatever changes come your way.

By staying adaptable, informed, and strategic, you can help ensure that your business remains at the forefront of these essential industries, ready to build the future, whatever form it may take.

How Wipfli can help

The future is uncertain, but professional guidance can help guide a course toward stability. Our team of dedicated professionals are carefully monitoring the changing landscape and are ready to help your business chart a course for growth. Contact an advisor today and see how you can turn uncertainty into opportunity.