How Kentucky’s Falling Income Tax Rates Impact CRE Investing

Morgan Merrill and Sarah Shanks

As the Kentucky legislature continues to lower the state income tax rate, commercial real estate investors should consider investment properties in the Commonwealth since they may offer an opportunity to buy at a discount.

Reducing the income tax rate in Kentucky is a goal of current Republican majority state representatives to further economic development, and the Democratic governor is also supporting this reduction as a way to help ease the burden of inflation for residents. Legislation passed in 2022 dropped the individual tax rate from 5 percent to 4.5 percent for tax year 2023, and a bill signed earlier this year by the Governor drops it again for 2024 to 4 percent. The goal is to ultimately get income tax rates down to 0, or very close to zero, in 0.5 percent steps as certain budget metrics are hit.

As recently as 2017, Kentucky had graduated income tax brackets from 2 percent to a top rate of 6 percent, as well as a 6 percent sales tax. In 2018, a change was made to a flat 5 percent income tax rate. In order to offset current measures to drop income tax rates, the sales tax has expanded to include certain services performed as well, which is a trend that’s been happening in several states across the U.S. to increase tax revenue.

These measures seem to be working for growth in the Commonwealth. In March, Site Selection Magazine released its Governors’ Cup rankings for 2022. Kentucky ranks 2nd in the U.S. in qualified capital investment projects per capita and ninth overall with 212 projects in 2022.

One of those capital projects is the Ford partnership BlueOval SK Battery Park going in south of Louisville near Elizabethtown. It is estimated to employ over 5,000 people and add $800 million to the Elizabethtown area once complete.

What this means for real estate investors

For the past several years, there’s been a movement of investors’ funds from higher tax jurisdictions to low or 0 income tax jurisdictions, and the cap rate compression in those states has reflected that demand. If Kentucky continues to follow through with its plans to drop the rate, the slightly higher cap rate offerings available in the Commonwealth now represent an opportunity to buy at a discount.

The growth that will happen around Elizabethtown alone will spur many new real estate investment opportunities across all categories: retail, multifamily and industrial. Savvy operators have seen this growth south of Louisville happening for the past several years and have been in search of prospective sites.

Given the current state of real estate investment across the country, investors are in search of ways to bridge the gap between buyer and seller expectations in price/cap rate. With the dropping tax rate in Kentucky, there’s a delayed incentive in place for buyers that may provide some of that relief.

Investors’ overall tax strategies will also need to take into account current interest rates, depreciation, and other tax goals specific to their individual situations. Looking at income tax rates in isolation, we see significant upside opportunities to investing in Kentucky right now.

Morgan Merrill and Sarah Shanks are first vice presidents at SRS Real Estate Partners’ Net Lease Group.