Ensuring a Growth-Oriented Tax Code through
Rational Real Estate Tax Policies
Policy Issues SnapShot: Q1 2017
More recent, 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. The Roundtable's 2017 National Policy Agenda, Real Estate: A Foundation for Growth, includes a section on Tax Policy.
• Comprehensive Tax Reform
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 Engaged in the Post-Election Tax Reform Debate
• Real Estate Industry Moves to Solidify Recent Tax Policy Victories
• Internet Sales Tax Legislation – Real Estate Industry Looks for Options to Break the Impasse
• Partnership Audit Reform
• Treasury Proposes Sweeping “Debt-Equity” Regulations with Implications for Real Estate Investment
• “Bad-Boy” Loan Guarantees – IRS Reverses Position After Meeting with Roundtable Delegation
• Condominium Tax Accounting
✓ Comprehensive Tax Reform
With the November 2016 general election behind the nation, Members of Congress and the Trump Administration have spent considerable time developing and rolling out their visions for tax reform. House Republicans, under the leadership of Speaker Paul Ryan (R-WI) and Ways and Means Chairman Kevin Brady (R-TX), released their tax reform blueprint in June 2016. Although it is a summary document and lacks many details, it is a clear signal of how the House Majority intends to approach tax reform.
The House blueprint represents the House Republican Conference’s vision for comprehensive tax reform, prior to negotiations with the Senate or the White House. According to its drafters, the House tax reform blueprint is aimed at creating jobs and spurring economic growth while making the tax code “simpler, fairer, and flatter.” It includes the following key elements:
- Maximum marginal tax rate of 33% on individuals and 25% on corporations;
- New 25% tax rate on the active business income of pass-throughs;
- A 50% exclusion for investment income (capital gains, dividends, and interest); o Full and immediate expensing of capital investment, including structures but not land;
- Elimination of the deductibility of business interest expense o Unlimited carry forward of losses, increased by an interest factor that compensates for inflation and a real return on capital;
- Repeal of other business and individual tax breaks (excluding deductions for mortgage interest and charitable giving). Presumably, this includes the deduction for state/local taxes and the deferral of gain on like-kind exchanges);
- Repeal of the AMT and estate tax.
The House Ways and Means Committee continues to fill in the details related to the House tax reform blueprint. Key real estate-related questions that have not been fully addressed, in addition to the fate of like-kind exchanges, include: the future tax treatment of rental income; the tax treatment of an expensed investment when it is subsequently sold; and the parameters of the new 25% category for active, pass-through business income.
In the Senate, the current Chairman of the Senate Finance Committee, Orrin Hatch (R-UT), has focused much of his attention on corporate tax reform, and more specifically, ending the double taxation of corporate income by integrating the individual and corporate income taxes.
Although most real estate investment in the United States is conducted through pass-through entities or real estate investment trusts (REITs), corporate tax integration could have major implications for the real estate industry. For example, Senator Hatch’s proposal, which has not yet been publicly released, is widely anticipated to include a deduction for dividends paid to shareholders, as well as an entity-level withholding tax on interest payments. If interest income is not subject to tax because the lender is foreign or otherwise tax-exempt, the payor of interest (debtor) would owe a withholding tax on interest paid to the creditor. .
* Senate Finance Committee Ranking Member Ron Wyden (D-OR) in recent months released a number of tax reform-oriented proposals focused on specific issue areas, including: depreciation and cost recovery, financial products, infrastructure financing, and retirement savings.
✓ Real Estate Industry Engaged in the Post-Election Tax Reform Debate
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 prepared a tax policy analysis of the MIT study and found that it supports a straight-line depreciation period between 18-19 years for commercial real estate, including rental housing—much lower than current law.
The Real Estate Roundtable and 25 other real estate and land conservation organizations wrote to Mr. Trump in September 2016 encouraging the candidates to preserve tax-deferred, like-kind exchanges as important components of their policy agendas for economic growth and job creation, as well as the protection of public lands.
✓ Real Estate Industry Engaged in Post-Election Tax Reform Discussion
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) raised 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.
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. The provision also extends to retail and restaurant improvements, and new restaurant construction.
The PATH Act extended eight other real estate-related tax benefits for at least two years, and in many cases, permanently, including the minimum 9 percent credit rate for the low-income housing tax credit and the section 179D enhanced tax deduction for energy-efficient commercial buildings.
Partnership Audit Reform
Also in 2015, Members of Congress introduced tax enforcement legislation that would have substantially changed the pass-through nature of partnerships. The final version of the Partnership Audit Simplification Act, enacted in November, is greatly improved from the original bill after a Roundtable-led effort to fix flawed provisions.
Focus Shifts to Implementation Issues
Following passage of both the PATH Act and Bipartisan Budget Act, real estate industry attention has shifted to a number of questions related to the interpretation and implementation of the new laws. Both the FIRPTA improvements and partnership audit reform will be heavily influenced by decisions made during Treasury’s rule-making process. The Roundtable is actively working to solidify the gains in late 2015 by encouraging favorable tax guidance.
The Roundtable has encouraged Congress to enact technical corrections to the PATH Act to clarify that the definition of a foreign pension includes a number of different retirement structures and arrangements commonly used outside the United States. For example, unlike U.S. corporate plans, foreign pension funds are often sponsored by professional associations, unions, and governmental bodies. Alternatively, implementing regulations should adopt a broad definition of a foreign pension fund for purposes of the FIRPTA exemption.
Partnership audit reform guidance
The Roundtable has also urged the Treasury Department to fully preserve the pass-through treatment of partnerships in the new partnership audit regime. The new law makes a number of changes in how tax obligations are enforced with respect to partnerships. Failure by Treasury to allow partnership tax adjustments to flow through tiers of partnerships to the final partners would dramatically change the partnership tax landscape by creating entity-level tax obligations. The Roundtable is working with Congress and the Treasury Department to protect the improvements made to the bill prior to passage.
✓ Internet Sales Tax Legislation – Real Estate Industry Looks for Options to Break the Impasse
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.
House Judiciary Chairman Bob Goodlatte (R-VA), however, has expressed 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”).
In recent months, The Real Estate Roundtable, ICSC, and NAREIT have had a series of discussions with Chairman Goodlatte, Speaker Ryan, and other key lawmakers to explore various policy options in the House that could level the playing field for Main Street businesses while avoiding the concerns raised by Chairman Goodlatte and some of his colleagues. On August 25, 2016, Chairman Goodlatte released, for the first time, draft legislative language on an internet sales tax proposal. Under the Chairman’s draft, 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. The prospects for the Chairman’s proposal remain uncertain..
✓ “Bad-Boy” Loan Guarantees – IRS Reverses Position After Meeting with Roundtable Delegation
In February, a legal memorandum issued by the IRS threatened to alter the tax treatment of billions of dollars in outstanding commercial mortgage-backed securities and commercial real estate loans. Commercial real estate securities and loans frequently include so-called “Bad-Boy” guarantee provisions that protect lenders from voluntary bad acts by a borrower. The IRS memo concluded that these provisions effectively convert otherwise nonrecourse loans to recourse.
Roundtable members met with IRS staff in March to explain the role and purpose of the Bad-Boy loan guarantees at issue. On March 27, 2016m the IRS Chief Counsel issued a revised memorandum that effectively reversed the position taken in the February memo. The new IRS guidance preserved the nonrecourse treatment of outstanding and future real estate loans, notwithstanding the inclusion certain Bad-Boy provisions in the loan documents. bill prior to the November election.
✓ Treasury Proposes Sweeping “Debt-Equity” Regulations with Implications for Real Estate Investment
In early April, as part of its anti-inversions effort, the Treasury Department released proposed regulations that would recharacterize a significant share of related party loans as equity rather than debt. While the regulations are only in proposed form, they provide that, once finalized, the rules will apply to debt instruments issued on or after April 4, 2016. Depending on their final form, the proposed Section 385 regulations could unintentionally deflect foreign capital to other parts of the world and discourage new real estate and infrastructure investment. On July 7, 2016, The Real Estate Roundtable submitted comments to Treasury on the proposed regulations. In order to minimize their detrimental impact, the letter argues that the regulations should look through partnerships when applying the control test for related party lending. A look-through approach is consistent with both the underlying objectives of the proposed regulations and historical precedent.
✓ 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 leading 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. (FGC Advisors, LLC) as chairman, and Jeffrey S. Clark (Host Hotels & Resorts, Inc.) 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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