BUDGET & TAX POLICY - December 19, 2014 Roundtable Weekly

Tax “Extenders” Bill Enacted With Real Estate-Backed Provisions, but Key Benefits Will Lapse Again on Jan. 1st; Coalition Letter Urges President Obama to Drop “Like-Kind Exchange” Proposal  

Hours before the 113th congressional session came to a close, the Senate on Tuesday gave final approval to a  $41.6 billion tax “extenders” package that includes provisions backed by commercial real estate.  The bill cleared the House last week, but was delayed by Sen. Tom Coburn’s (R-OK) objections that the measure was not “offset” or paid for.  The “Tax Increase Prevention Act of 2014” (H.R. 5771) ultimately cleared the Senate by a vote of 76-16, and was signed into law by President Obama this afternoon. 

Obama Signs into Law Oval Office

After the Senate on Tuesday gave final approval to a  $41.6 billion tax “extenders” package that includes provisions backed by commercial real estate, the “Tax Increase Prevention Act of 2014” (H.R. 5771) ultimately cleared the Senate by a vote of 76-16, and was signed into law by President Obama this afternoon.

The 50+ business and individual tax provisions in the bill were extended retroactively to the beginning of 2014, but are set to expire again on Dec. 31, 2014. Senators of both parties criticized the lack of certainty for taxpayers in 2015.

“Congress is turning in its tax homework eleven-and-a-half months late and expects to earn full credit,” said Finance Chairman Ron Wyden (D-OR), who pressed for an extension through 2015 and was one of eight Democrats who voted against the bill on Tuesday.

Incoming Finance Committee Chairman Orrin Hatch (R-UT) reportedly said Congress will have the “dubious distinction” of starting next year with all of the provisions expired (Bloomberg, Dec. 16).

Real estate-related provisions that will be reinstated and extended (through 2014) under the extenders bill include:

15-year straight-line depreciation for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.  The 15-year cost recovery life is far closer to the average useful life of such improvements (e.g., five to 10 years for leasehold, or tenant, improvements) than the 39-year depreciation period that came back into effect when the provision expired at the end of 2013. 

 Section 179D tax deduction for energy efficiency investments in commercial and multi-family buildings.  However, the final bill does not include changes included in the Senate EXPIRE Act that would have updated efficiency standards and allowed tax-exempt nonprofits to allocate the deduction to the person primarily responsible for designing the property.  It also omits Roundtable-supported amendments in S. 2189 that sought to facilitate taxpayers’ ability to use the deduction when retrofitting existing commercial and multifamily buildings. 

 Bonus depreciation.  The additional first-year depreciation deduction is equal to 50 percent of the adjusted basis of qualifying property.  With the exception of  2006-07, some form of bonus depreciation has been in effect since 2002.  Notably, qualified leasehold improvement property is eligible for the 50 percent bonus depreciation election. The final measure does not include a House-passed proposal contained in H.R. 4718 that would have made 50% bonus depreciation permanent. 

CRE Leashold Improvement yellow

Real estate-related provisions that will be reinstated and extended (through 2014) under the extenders bill include 15-year straight-line depreciation for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.  The 15-year cost recovery life is far closer to the average useful life of such improvements (e.g., five to 10 years for leasehold, or tenant, improvements) than the 39-year depreciation period that came back into effect when the provision expired at the end of 2013.

 Mortgage debt forgiveness — the bill allows taxpayers to exclude from income up to $2 million of cancelled mortgage indebtedness ($1 million in married filing separately) on a principal residence.  Section108(a)(1)(E) was originally enacted in 2007 to shield distressed taxpayers from having to pay taxes on discharged mortgage debt during the wave of mortgage modifications, work-outs, and short sales that occurred during and after the financial crisis. It has been extended on multiple occasions.

 Deduction for mortgage interest premiums — under the extenders bill, the tax code will continue to permit taxpayers to deduct the cost of mortgage insurance on a qualified personal residence or second home. The mortgage insurance deduction, in effect since 2007, phases out for taxpayers with incomes exceeding $100,000/year.

 Minimum 9 percent credit rate for the Low-Income Housing Tax Credit (LIHTC) Program. The LIHTC provides credits over a 10-year period after a housing facility — occupied by low-income tenants — is placed in service. The credit earned generally depends on (1) the investment in the building, (2) the portion of the building devoted to low-income units, and (3) the applicable credit rate. The original applicable rate of 9% has decreased over the years as interest rates have declined; however, Congress in 2008 reinstated a minimum credit amount of 9%, in the case of low-income housing that is not federally subsidized. The extenders package did not include a provision in the Senate EXPIRE Act that would have established a 4% minimum credit rate for the acquisition of existing housing that is not federally subsidized. 

 New Markets Tax Credit (NMTC) program. New markets tax credits are available to qualified community development entities (CDEs) operating in low-income areas. The credits are transferred by the CDEs to equity investors and are claimed over a 7-year period.  Treasury allocates the credits to CDEs on a competitive basis through annual allocation rounds. Many of the projects funded through the NMTC program involve major, mixed-use urban redevelopment initiatives.  The bill authorizes Treasury to allocate an additional $3.5 billion in New Markets Tax Credits, the same amount that has been authorized in each of the past four years.

Real property and the “small business expensing allowance”:  The bill extends a tax benefit that allows certain taxpayers to deduct — rather than capitalize — the cost of qualifying property purchased for use in an active trade or business. The Small Business Jobs Act of 2010 extended the expensing allowance, for the first time, to certain investments in real property.  The real property must meet the definition of leasehold improvement, restaurant, or retail improvement property for purposes of 15-year depreciation.  In 2013, taxpayers could deduct up to $500,000 of qualifying property (including $250,000 of qualifying real property) placed in service, with the deductible amount gradually reduced to the extent the taxpayer placed in service more than $2 million of qualifying property. 

 pen and calculator x200

The bill also extends a tax benefit that allows certain taxpayers to deduct — rather than capitalize — the cost of qualifying property purchased for use in an active trade or business

The bill extends these dollar limitations, including the authority to deduct up to $250,000 in real property investment, through the end of 2014. The bill does not include modifications that passed the House, which would have made permanent the higher-dollar limitations and authority to expense real property, while repealing the rule that made the dollar limitation on real property lower than the maximum deductible amount. 

 Reduced built-in gains recognition period for REIT conversions. If a taxable corporation converts into an S corporation., the conversion is not a taxable event.  However, following such a conversion, an S corporation must hold its assets for a certain period in order to avoid a tax on any built-in gains that existed at the time of the conversion. The same rules apply in the case of RETI conversions.  The 2009 stimulus bill temporarily reduced the holding period from 10 years to 7 years.  The Small Business Jobs Act reduced the holding period, even further, to 5 years for sales of assets in 2011.   The bill extends the reduced 5-year holding period for sales occurring in calendar year 2014.  It omits a House-passed proposal that would have made the 5-year holding period permanent. 

 Credit for construction of new energy efficient homes. Since the Energy Policy Act of 2005, Congress has provided a tax credit of up to $2,000 to the contractor or manufacturer of a new home that meets specific energy efficiency standards.  The bill extends the credit to new homes that are acquired, for use as a residence, from an eligible contractor or manufacturer in calendar year 2014.

Coalition Urges Obama to Omit “Like-Kind Exchange” Proposal in FY2016 Budget Plan

 2014_12_16 image Real Property LKE - Admin5 

The Real Estate Roundtable and 24 other real estate, farmland, and conservation-related groups urged President Obama to omit an earlier proposal that would limit the ability to defer taxable income on real property like-kind exchanges to no more than $1 million annually.

Meanwhile, with the 2015 State of the Union address just around the corner and the President’s economic team preparing a new budget submission, The Real Estate Roundtable and 24 other real estate, farmland, and conservation-related groups urged President Obama to omit an earlier proposal that would limit the ability to defer taxable income on real property like-kind exchanges to no more than $1 million annually.

If enacted, the proposal (which was contained in last year’s budget plan) would:

raise the tax burden on hundreds of thousands of real estate transactions

undermine the functioning of the real estate marketplace

reduce capital investment 

discourage job-creating property improvements and land conservation efforts

“The like-kind exchange rules are a basic tool that facilitates the smooth functioning of the real estate market in the United States,” the coalition wrote in its Dec. 16 letter.

“Real estate owners use the like-kind exchange rules in section 1031 to efficiently retain and allocate capital to its most productive uses,” the letter continued. “Section 1031 enables owners to reposition portfolios, exchange peripheral assets for core assets, realign property by geography or real estate sector to improve operating efficiencies, and manage risk. By avoiding a tax-induced ‘lock up’ of properties, like-kind exchange rules increase the frequency of property transactions and ensure a more dynamic real estate sector that supports more reinvestment in real estate and a higher level of construction activity.”

The letter was also sent to key Treasury officials; House and Senate leadership tax staff; staff of the congressional tax-writing committees; most of the tax staff for individual members of the Senate Finance Committee and key tax staff for individual members of the House Ways and Means Committee. 

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