Ensuring a Growth-Oriented Tax Code through
Rational Real Estate Tax Policies
Policy Issues SnapShot:
More detailed information on various tax policy issues can be found in recent issues of Roundtable Weekly — our weekly policy eNewsletter that can searched by key word or phrase.
Updated news on various Tax policy issues can be found in recent issues of Roundtable Weekly — our policy eNewsletter archive that can searched by key word or phrase.
• Real Estate Industry Working on 2016 Implementation Issues Following Key Tax Policy Changes in Late 2015
• Partnership Audit Reform
• Internet Sales Tax – Marketplace Fairness Act
• Comprehensive Tax Reform
• Foreign Investment in Real Property Tax Act (FIRPTA) Reform
• Condominium Tax Accounting
> Real Estate Industry Working on 2016 Implementation Issues Following Key Tax Policy Changes
✓ FIRPTA Reform
As 2015 drew to a close, Congress passed legislation long-advocated by The Roundtable to reform the Foreign Investment in Real Property Tax Act (FIRPTA), which restricts capital formation and foreign investment in U.S. commercial real estate and infrastructure. The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) raises the cap on foreign ownership of publicly traded U.S. REITs, modifies the legal presumptions used to determine whether a REIT is domestically controlled, and exempts foreign pension plans from FIRPTA altogether. (Download December 2015 summary of the FIRPTA reforms).
✓ Leasehold Depreciation
The PATH Act also permanently extended a rule that allows taxpayers to depreciate leasehold improvements—or tenant build-outs—over 15 years. The 15-year depreciation period better approximates the actual life of a lease than the 39-year depreciation period that otherwise applies. First enacted in 2004, 15-year depreciation of leasehold improvements had been in place on a temporary basis, occasionally lapsing. The provision also extends to retail and restaurant improvements, and new restaurant construction. The Roundtable was closely involved when the 15-year rule was created 12 years ago and has encouraged Congress for several years to permanently extend the provision.
✓ Partnership Audit Reform
Roughly half of the 3.46 million partnerships in the United States are real estate partnerships. When key Members of Congress — including the Ways & Means Committee Chairman — proposed tax enforcement legislation that would substantially change the pass-through nature of partnerships, The Roundtable had serious concerns. Enacted last November in the Bipartisan Budget Act, the final version of the Partnership Audit Simplification Act is greatly improved from its original version after a Roundtable-led effort to fix flawed provisions.
✓ Tax Extenders
The PATH Act also extended eight other real estate-related tax benefits for at least two years, and in many cases, permanently. The other real estate provisions in the PATH Act include:
- the minimum 9 percent credit rate for the Low Income Housing Tax Credit
- the authority for Treasury to issue additional rounds of New Markets Tax Credits
- the section 179 small business expensing allowance and extension of the allowance to real property investment
- the reduced post-conversion period (5 years instead of 10 years) in which REITs and S corporations must hold assets in order to avoid a tax on any built-in gain at the time of the conversion
- the section 45L tax credit for the contractor or manufacturer of new, energy-efficient homes
- the section 179D enhanced tax deduction for energy efficient commercial buildings
- the exclusion of up to $2 million in debt forgiveness for cancelled principal residence mortgage indebtedness
- the deductibility of mortgage insurance premiums
The two-year extensions last through the end of 2016, which eliminates any immediate need for Congress to pass a significant tax bill prior to the November election.
> Partnership Audit Reform
- The movement for partnership audit legislation reflected growing concern among policymakers that partnership tax examination and enforcement rules were broken and the IRS was incapable of effectively auditing large or complex partnerships. In its original form, however, the bill would have had severe, negative consequences for real estate investment partnerships — e.g., generating uncertainty, risk, and tax exposure that would likely deter new investors and threaten the market for real estate interests held in partnership form. It would also impede partnerships’ ability to transfer partnership interests.
- Specifically, the original bill would have imposed joint and several liability on current and former partners, and the partnership itself, for unpaid tax liabilities and tax adjustments. The bill also would have imposed and collected post-audit tax adjustments at the entity level, threatening the very nature of pass-through taxation.
- Between introduction of the legislation and its enactment, Congress incorporated several Roundtable recommendations for changes that would address government concerns without adversely affecting real estate partnerships. A comprehensive proposal, developed by The Roundtable’s Tax Policy Advisory Committee, was published in Tax Notes and offered an alternative to the proposed entity-level assessment and collection of partnership tax debts and the proposed imposition of joint and several liability on current and former partners, as well as the partnership itself, for tax adjustments. The final bill repealed and replaced existing rules for IRS audits of large or multi-tiered partnerships. In addition to removing joint and several liability from the new regime, the final legislation adopted by Congress included a key element recommended by the Roundtable—an election that allows partnerships to pass through tax adjustments to the actual owners, thereby preserving the pass-through nature of the partnership form.
- Because the partnership audit reform law vests significant new rule-making authority in the Treasury Department and the IRS, The Roundtable is actively engaged in the implementation process, meeting regularly with key lawmakers and Administration officials regarding technical corrections and regulatory guidance.
> Internet Sales Tax Legislation
- Proposed internet sales tax legislation would address the unfair competitive landscape for “brick and mortar” stores. Under current law, states can only compel retailers to collect sales tax if the retailer has a physical presence, or “nexus,” in the state. States cannot compel online retailers selling goods into another state to collect and remit sales tax, even if the tax is owed on the transaction. Bipartisan, bicameral legislation (Marketplace Fairness Act, S. 698; Remote Transactions Parity Act, H.R. 2775) would allow states to collect taxes from online retailers, provided that the State commits to a simplified process that makes it easy for online sellers to remotely collect and remit the appropriate amount of tax.
- In May 2013, the Senate passed the Marketplace Fairness Act by a large, bipartisan vote of 69-27. Last June, Rep. Jason Chaffetz (R-UT) introduced the Remote Transactions Parity Act, which closely resembles the Marketplace Fairness Act while providing some additional protections against cross-border state tax audits and other modifications. The legislation stalled in the House, where it met strong resistance from anti-tax groups, House conservatives, and House Judiciary Chairman Bob Goodlatte (R-VA).
- Expressing concern that internet sales tax legislation is another step in which Congress is permitting States to aggressively extend their regulatory reach beyond their own borders (on the basis of “economic nexus” as opposed to “physical nexus”), House Judiciary Committee Chairman Bob Goodlatte (R-VA) has floated an alternative proposal in which internet retailers would pay sales taxes to their home jurisdiction and the State collecting the taxes would transmit the taxes to the buyer’s State.
- In February, Senate Majority Leader Mitch McConnell (R-KY) committed to holding a vote on internet sales tax legislation before the end of 2016. The Leader’s commitment came in conjunction with an agreement to move forward with customs legislation that included a permanent extension of the Internet Tax Freedom Act (ITFA), which provides a moratorium against States and localities levying taxes on internet access. Combining the Marketplace Fairness Act with ITFA had been viewed as a potential strategy for reducing opposition from both the technology industry and anti-tax groups to internet sales tax legislation.
> Comprehensive Tax Reform
- By “clearing the deck,” the 2015 year-end tax bills have created new opportunity for Congress to focus on comprehensive tax reform. By removing several perennial issues from the list of “must-pass” items, the Congressional tax committees are shifting their attention back to broad-based reforms aimed at reducing overall tax rates, simplifying the tax code, and restructuring rules for the taxation of international income.
- The Tax Reform Act of 2014, sponsored by former Ways & Means Chairman Dave Camp (R-MI), remains the most comprehensive tax reform proposal put forward in Washington and the likely starting point for reform after the Presidential election. The 979-page Camp bill would repeal or scale back hundreds of tax deductions, credits, and exemptions. The bill would adversely affect commercial real estate activity by:
- Decreasing the incentive for capital investment and risk-taking by reducing the tax rate differential between capital gains and ordinary income;
- Eliminating taxpayers’ ability to defer capital gain through like-kind exchanges;
- Lengthening depreciation schedules for real property, particularly leasehold improvements and residential rental property;
- Taxing recaptured depreciation at ordinary income rates;
- Repealing the Historic Rehabilitation tax credit and reducing the value of the Low-Income Housing Tax Credit by nearly $11 billion over ten years;
- Applying payroll taxes to income earned by partners who materially participate in a partnership’s trade or business;
- Limiting REIT-eligible assets
- Repealing the section 179D enhanced tax deduction for energy efficient commercial buildings.
- More recently, Presidential candidates and senior Members of Congress put forward tax reform plans that differ from the Camp plan by proposing to shift the United States toward a “cash flow” tax system in which the cost of property and services (including real estate) are immediately expensed, but business interest expense is nondeductible.
- Recognizing the need to respond to the various tax reform plans with well-reasoned, fact-based arguments, The Roundtable has been working with other national real estate trade associations to commission a number of outside tax policy studies by highly regarded scholars and economists. These studies have focused on the economic impact of repealing like-kind exchanges for real estate, examining the economic rate of depreciation of structures, and the tax policy implications of new real estate depreciation research.
- A recent Roundtable-sponsored study by Professors David Ling (Univ. of Florida) and Milena Petrova (Syracuse U.) analyzed more than 1.6 million real estate transactions over an 18-year period to understand the effect that like-kind exchanges have on real estate prices, leverage, holding periods, market liquidity, capital expenditures, tax revenue, and investment. The study demonstrates how section 1031 results in larger acquisitions and increased capital expenditures, which translates into job growth and greater net investment. Repealing section 1031 would put downward pressure on property values and upward pressure on rents. It would also increase the use of leverage in real estate purchases and reduce market liquidity by extending holding periods.
- Another study by the MIT Center for Real Estate analyzed and estimated the economic rate of depreciation for structures. Unlike prior work in this area, it incorporated data on capital expenditures by property owners. Utilizing data from Real Capital Analytics, NCREIF, and Green Street Advisors, the study has shown how real estate depreciates much faster than previously recognized. Leading accounting firm PwC has prepare a tax policy analysis of the MIT study, which supports a straight-line depreciation period between 18-19 years for commercial real estate, including rental housing—much lower than current law.
> Foreign Investment in Real Property Tax Act (FIRPTA) Reform
- The FIRPTA reforms in the PATH Act are boosting job creation and long-term investment in the development, construction, and operation of productive commercial real estate in the United States. Already, the changes are helping mobilize foreign capital for U.S. real estate projects. The new investment spurred by the FIRPTA changes will strengthen local communities, create jobs, and expand the tax base.
- Going forward, the implementation and regulatory interpretation of FIRPTA reform will have important consequences for U.S. commercial real estate and the millions of jobs supported by the industry. The lack of legislative history for the PATH Act increases the need for clear, unambiguous statutory language. The Roundtable has urged Congress to consider including clarifications in a technical corrections bill—the corrections would help ensure that regulatory interpretation of the statute is consistent with the purposes of the legislation and the sponsors’ intentions.
- For example, The Real Estate Roundtable has encouraged the tax-writing committees to further clarify the definition of a FIRPTA-exempt foreign pension fund so that it covers governmental pension plans or arrangements where the beneficiary and the benefit provider do not have a direct employer-employee relationship. Technical corrections legislation should clarify that the foreign pension fund definition does not exclude Social Security-type arrangements in which benefits are tied to wages or length of employment, the arrangement is generally financed (or the cost is offset) by taxes on employment, but the provider of retirement benefits (typically, the government) is not the beneficiary’s current or former employer.
> Condominium Tax Accounting
- Current tax accounting rules unjustly accelerate income tax liability for the developers of new residential condominiums. The rules require developers to recognize income and pay tax on their expected profit as construction is ongoing, well before pre-sale transactions are closed and full payment is due from the buyer, creating a mismatch of cash flow and tax liability. Left unchanged, the rules threaten new housing production, continued growth in construction employment and related jobs, and economic activity.
- The Roundtable is leadings a campaign for industry relief, ideally by regulation, or by legislation if necessary. In March, 10 members of the Senate Finance Committee joined forces to urge Treasury Secretary Jack Lew to change tax accounting rules. Led by Senators Johnny Isakson (R-GA) and Ben Cardin (D-MD), the co-chairs of the Senate Real Estate Caucus, the Senators said the existing rule “creates artificial hurdles to high-density condominium construction, distorts the economics of residential construction, and appears to serve to tax policy purpose.” The Members offered two potential regulatory solutions, either of which could be included in an ongoing Treasury regulatory project related to long-term contracts and methods of accounting.
For weekly updates on key policy issues affecting commercial real estate, see our eNewsletter Roundtable Weekly
The Roundtable's Tax Policy Advisory Committee (TPAC) is led by Frank G. Creamer, Jr. (Trimont Real Estate Advisors, LLC) as chairman, and Adam Cohen (iStar) as vice chairman. TPAC members are leading experts on tax issues affecting commercial and multifamily real estate, and include representatives from the major national real estate trade associations.
For additional information on TPAC issues, please contact Ryan P. McCormick, Vice President and Counsel, The Real Estate Roundtable, at (202) 639-8400.
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