Roundtable Weekly - May 24, 2019

Carried Interest - Tax Policy

Senate Finance Committee Ranking Member Introduces Bill to Tax Carried Interest at Ordinary Income Rates

Senate Finance Committee Ranking Member Ron Wyden (D-OR) yesterday introduced legislation to fundamentally alter the longstanding tax treatment of a profits interest in a real estate partnership. 

Senate Finance Committee Ranking Member Ron Wyden (D-OR) has introduced legislation to fundamentally alter the longstanding tax treatment of a profits interest in a real estate partnership.

  • The Wyden proposal (detailed summary of the legislation and one-pager) would depart dramatically from prior carried interest legislation by taxing partners before any capital gain or even rental income is generated by the partnership.  For example, it would give rise to large amounts of taxable (but phantom) income for a general partner with a profits interest during the pre-construction and development phase of a real estate project.
  • The legislation would treat a profits interest in a real estate partnership as an interest-free loan from the other partners. The bill would effectively tax the partner with a profits interest annually, at ordinary income rates, on his or her deemed share of the invested capital by multiplying the deemed share by a specified interest rate (9% plus the variable yield on a corporate bond index that is currently 2.93%).  The product would be considered taxable, ordinary income.
  • In addition to taxing partners currently on non-existent, illusory income, in many cases the legislation would not allow partners to recover the taxes down the road if the project ultimately fails to produce a capital gain.  That's because the losses would be treated as capital losses that generally are nondeductible against ordinary income. 
  • General partners are currently taxed at ordinary income rates on their management fees and other income that is compensatory in nature.  Partners owe tax on any guaranteed payments for services provided.  Under the Wyden bill, however, a real estate entrepreneur would be taxed today on a partnership's invested capital-capital at risk-irrespective of whether the project will ever generate income.  
  • The  Real Estate Roundtable opposes both Senate and House carried interest proposals. General partners earning a carried interest in a real estate partnership bear significant risks beyond direct capital contributions. These risks can include funding predevelopment costs, guaranteeing construction budgets and financing, and exposure to potential litigation over countless possibilities. 

  • Senator Wyden's bill came just days after a televised interview in which President Trump indicated he still intends to address the carried interest issue.  (FOXBusiness, May 20).  "If President Trump wants to address carried interest and make the tax code more fair, he'll be happy to support my new proposal," said Sen. Wyden. (Wyden news release, May 23) 
  • Other legislative proposals to reform the taxation of carried interest were introduced in March by Sen. Tammy Baldwin (D-WI) and House Ways and Means Committee member Bill Pascrell, Jr. (D-NJ).  (News releasesBaldwin and Pascrell)
  • The Roundtable and 13 other national real estate organizations sent a letter to members of the House Ways and Means Committee on March 26 about the adverse impact that the Baldwin-Pascrell legislation (H.R. 1735) would have on U.S. real estate and entrepreneurial risk taking.  (Roundtable Weekly, March 29)  
  • The letter notes how the bill would result in a huge tax increase on Americans who use partnerships in businesses of all types and sizes – and would be particularly harmful to the nearly 8 million partners in U.S. real estate partnerships.  
  • The March 26 letter states, "The false narrative surrounding the carried interest issue is that it targets only a handful of hedge fund billionaires and Wall Street executives.  The carried interest legislation is far broader and would apply to real estate partnerships of all sizes-from two friends owning and leasing a townhome to a large private real estate fund with institutional investors." 

The Real Estate Roundtable opposes both Senate and House carried interest proposals.  General partners earning a carried interest in a real estate partnership bear significant risks beyond direct capital contributions. These risks can include funding predevelopment costs, guaranteeing construction budgets and financing, and exposure to potential litigation over countless possibilities.

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Beneficial Ownership Rule - Capital and Credit

Senate Hearing on Beneficial Ownership Follows House Committee Action Affecting Corporate Entity Transactions

A Senate Banking Committee hearing this week on "Combating Illicit Financing by Anonymous Shell Companies Through the Collection of Beneficial Ownership Information" followed recent approval of legislation by the House Financial Services Committee that would affect beneficial ownership requirements for commercial real estate transactions.

Senate Banking Chairman Mike Crapo (R-ID)  held a hearing this week on "Combating Illicit Financing by Anonymous Shell Companies Through the Collection of Beneficial Ownership Information."

  • Senate Banking Chairman Mike Crapo (R-ID) said in his opening statement that the committee seeks solutions "… to deter money laundering and the financing of terrorism through the use of front companies, shell companies, shelf companies, opaque nominees, and other means to conceal and disguise the true beneficial owners of property and other assets."
  • The Senate committee held a previous hearing on the subject last November.  Another hearing focusing on industry perspectives is expected in June.
  • Congressional consideration of the beneficial ownership issue comes after the Treasury Department's Financial Crimes Enforcement Network (FinCEN) amended the Bank Secrecy Act regulations in May 2018.  FinCEN added a Customer Due Diligence rule requiring financial institutions to collect the beneficial ownership information of legal entities with which they conduct commerce. (FinCEN news release, May 2018)
  • In the House of Representatives, the Financial Services Committee considered legislation (H.R. 2514) affecting beneficial ownership during a May 8 mark-up.  (Committee Memorandum, May 3)
  • The committee approved legislation introduced by Reps. Emanuel Cleaver (D-MO) and Steve Stivers (R-OH) – introduced the "Coordinating Oversight, Upgrading and Innovating Technology, and Examiner Reform Act" or the "COUNTER Act" by a vote of 55-0.   The bill would require financial institutions to determine the beneficial owners involved in certain commercial real estate transactions – similar to a FinCEN Geographic Targeting Order (GTO) requirement affecting certain residential purchases. (CQ, May 9) 

    Congressional consideration of the beneficial ownership issue comes after the Treasury Department's Financial Crimes Enforcement Network (FinCEN) amended the Bank Secrecy Act regulations in May 2018

  • FinCEN's GTO issued in November 2018 requires U.S. title insurance companies to identify the natural persons behind shell companies used in all-cash purchases of residential real estate.  The purchase amount threshold, which previously varied by city, is now set at $300,000 for each covered metropolitan area.  The GTO also covers certain counties within the following major U.S. metropolitan areas: Boston; Chicago; Dallas-Fort Worth; Honolulu; Las Vegas; Los Angeles; Miami; New York City; San Antonio; San Diego; San Francisco; and Seattle. (Wall Street Journal – Nov. 15, 2018) 
  • Another House Financials Services Committee proposal introduced by Reps. Carolyn Maloney (D-NY) and Peter King (R-NY) was postponed during the May 8 mark-up, yet is expected to be considered in June.  Their Corporate Transparency Act of 2019 ( H.R. 2513) would shift FinCEN reporting requirements on beneficial ownership from banks to the business community.  (CQ, May 9 and May 21) 
  • The Maloney-King legislation would require every business with fewer than 20 employees to register their beneficial owners with FinCEN.  Businesses would also need to update that registration with any changes (home or business address, driver's license change, change in ownership) within 60 days, and annually for the life of the business.  Failure to do so would result in federal criminal penalties.  However, the bill fails to address the required information and the process for compliance.

The Roundtable has raised concerns about beneficial ownership reporting requirements and the potential burdens they place on the real estate industry. (Coalition letter – Feb. 6, 2018).  The Roundtable will continue to work with policymakers to stake out a balanced position on the issue that would inhibit illicit money laundering activity but does not place unnecessary costs and legal burdens on the real estate industry.

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President Trump Requests Democrats Pass USMCA Before Infrastructure Bill; House Ways and Means Member Introduces Gas-Tax Infrastructure Bill

On the eve of a May 22 White House meeting to discuss a national infrastructure improvement package, President Trump sent a letter to Democratic congressional leaders requesting they first approve his trade deal with Canada and Mexico before taking up infrastructure legislation. (Bloomberg, May 21)

Legislation introduced May 22 by Rep. Earl Blumenauer (D-OR) would gradually increase gasoline and diesel taxes to invest in the nation's infrastructure.  Blumenauer is a member of the tax-writing House Ways and Means Committee.

  • "Before we get to infrastructure, it is my strong view that Congress should first pass the important and popular [United States-Mexico-Canada Agreement (USMCA)] trade deal," Trump wrote. "Once Congress has passed USMCA, we should turn our attention to a bipartisan infrastructure package," he added.
  • Democrats and Trump agreed during a meeting last month to pursue a $2 trillion infrastructure package and meet again this week to discuss funding.  (Roundtable Weekly, May 3).  Trump cancelled the May 22 White House meeting and the talks failed to move forward.
  • In the House, legislation introduced May 22 by Rep. Earl Blumenauer (D-OR) would gradually increase gasoline and diesel taxes to invest in the nation's infrastructure.  Blumenauer is a member of the tax-writing House Ways and Means Committee.
  • The Rebuild America Act would raise the fuels' tax by five cents a year over five years, index it to inflation, and aim to replace it with a more stable source of funding within 10 years. (Blumenauer press release, May 22) 
  • The Roundtable on April 29 submitted infrastructure policy recommendations to House Committee on Transportation and Infrastructure Chairman Peter DeFazio (D-OR) and Ranking Member Sam Graves (R-MO).  As part of a suite of infrastructure recommendations, The Roundtable also proposed a gas "user fee" increase that aligns with Blumenauer's bill.  (Roundtable Weekly, May 3)

House Ways and Means Committee Chairman Richard Neal (D-MA) is scheduled to discuss tax policy with Roundtable members on June 11 during the organization's Annual Meeting in Washington, DC. 

 

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Capital and Credit - Current Expected Credit Losses (CECL) Accounting Standard

Senate Legislation Introduced to New CECL Accounting Standard Affecting Treatment of Expected Loan Losses

Legislation introduced May 21 by Sen. Thom Tillis (R-N.C.) would delay implementation of the Current Expected Credit Losses (CECL) accounting standard, which will force banks to book losses on bad loans much faster.  (ABA Journal, May 22)

  Legislation introduced May 21 by Sen. Thom Tillis (R-N.C.) would delay implementation of the Current Expected Credit Losses (CECL) accounting standard, which will force banks to book losses on bad loans much faster.

  • The independent Financial Accounting Standards Board (FASB) is proceeding with its plan to implement CECL for publicly traded U.S. banks at the beginning of 2020 – and later for other financial institutions. (Roundtable Weekly, April 5)
  • FASB  Chairman Russell Golden reiterated the organization's commitment to implementing CECL in an interview this week with Bloomberg Tax. "We think we need to continue to work with community banks to make sure that they understand what CECL is and what it's not," Golden said.  (BGov, May 22)
  • The new CECL model will require certain financial institutions to estimate the expected loss over the life of a loan – a significant change to the way banks calculate reserves on assets.  The regulatory change in how banks estimate loan and lease losses (ALLL) will require substantial changes in data analytics and financial methodologies. (Wall Street Journal, April 3)  The accounting rule change was issued by the FASB in June 2016 as a result of the 2008 financial crisis.
  • For real estate, there is concern is that banks may reduce lending volumes as they build up additional capital reserves to be in compliance with CECL.  The new standard may cut into earnings and regulatory capital by forcing some banks to boost their loan-loss reserves.  (Roundtable Weekly, March 8)  
  • A business coalition that included The Real Estate Roundtable in March urged further study amid concerns that CECL may soon begin to reduce aggregate bank lending.  (Coalition Letter, March 5)

    The  Financial Accounting Standards Board (FASB) plans to implement CECL.

  • Sen. Tillis' bill (S. 1564) would require the Securities and Exchange Commission (SEC) and bank regulators to study CECL's effect on the availability of credit and on bank capital before the new  accounting standard takes effect.
  • Fourteen Senators – seven Democrats and seven Republicans – on May 10 sent a letter to the Federal Reserve Board and the Federal Deposit Insurance Corp. requesting a delay of CECL until the regulators analyze how the new rules could impact lending.  Twenty five members of Congress on May 6 sent a letter to the SEC requesting a delay in implementation of the new FASB rule until the SEC studies it.

At a House Financial Services Committee hearing May 22, Treasury Secretary Steven Mnuchin responded to a question about the ability of community banks to lend under  CECL.  "I share some of your concerns. This is an issue we continue to study," Mnuchin said.  (BGov, May 22)

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