Real Estate Tax Reform Challenges 2014

Tax Reform Challenges

The National Real Estate Investors Association has been closely monitoring the discussions on tax reform. As we await word on extensions of current provisions and news of potential changes we strive to keep real estate investors updated and informed so that we, as an industry, can voice our views and opinion on the potential effect to our industry and individual businesses. The law of unintended consequences is always present in well intended legislative initiatives and we believe that tax reform is apt to be riddled by this. For example, the post below from the Journal of Accountancy gives us insight into some of our upcoming challenges:

“Kenneth R. Harney, in his recent Washington Post article “Congress’s inaction on real estate issues leaves homeowners and investors unsettled,” predicts difficulty for homeowner’s and those investors who invest in repairing and improving property. “When House Ways and Means Committee Chairman Dave Camp (R-Mich.) announced that he not only will not reveal the details of his long-awaited comprehensive tax reform bill this year but also will not seek passage of a so-called “extenders” bill for expiring tax code benefits, it was a sweet and sour mix for real estate interests.”

The article provides an excellent summary of the potential effect on those that deal with real estate:

“The plus side for this failure to take action:

Camp’s big reform bill, which would attempt to lower individual and corporate income tax rates to a maximum of 25 percent, is expected to call for significant cutbacks in — possibly elimination of — prized real estate deductions for home mortgage interest, local property taxes and other write-offs in order to pay for lower marginal rates. With major changes such as these now pushed back well into 2014 for even preliminary debate — in the middle of a reelection year for Congress — homeownership advocates are at least moderately relieved.

On the negative side, exempt being California

. . . The failure of tax writers to put together an extenders bill means that important Internal Revenue Code provisions affecting large numbers of homeowners — especially relief from taxation on mortgage debt forgiveness by lenders in most states, along with current deductions for mortgage insurance premiums and energy-saving home improvements — will lapse Dec. 31. . . . . . . . Senate tax writers’ reform-bill proposals for real estate should be unsettling for anyone owning residential investment property, such as rental houses.”

And one of the biggest concerns of all for creative investors who have long employed the use of the 1031 exchange:

“Under Senate Finance Committee Chairman Max Baucus (D-Mont.) proposal the tax deferred exchanges under Section 1031 of the Internal Revenue Code “the oldest financial planning techniques used by real estate investors.”

In a 1031 exchange, property owners can defer taxes indefinitely when they swap “like kind” investment real estate within time periods specified by IRS regulations. Under current law, investors can exchange rental real estate without incurring immediate tax liability even if they’ve racked up huge paper gains on their properties. Taxes generally are not due until the investors actually sell their real estate for money.”

One of best reasons to buy and hold property were the tax deductions put in place in the ‘80s. These tax incentives have changed throughout the years but have held strong as encouragement for investing, specifically in rental properties. If the Senate accepts the new proposal the massive tax incentive previously afforded investors may be cut significantly as stated in the Journal’s report.

“Baucus also would sharply increase the depreciation period for residential investment real estate from the current 27.5 years to 43 years. Stretching out the depreciation schedule means investors would be able write off less per year on their properties than at present.”

According to the article, Baucus’ bill “ . . . tax so-called “recapture” of depreciation — where the IRS requires payback of a portion of an investor’s earlier write-offs — at property owners’ ordinary income tax rates, rather than at lower capital gains rates, as at present.” The article states that smaller investors would be particularly affected. “Besides the depreciation-deduction stretch-out, the inability to exchange properties tax-free for others of similar or greater value would put a severe crimp in their ability to grow and manage their investments over time.”

William Horan, president of Realty Exchange Corp. of Gainesville, Va., says that “if Section 1031 of the code is repealed, then small investor owners would be facing massive taxes and most likely would not sell their properties. [Real estate] values for everyone would be lowered by removing vital investors from the market.”

The summary in the Journal sums up many of our own concerns:

“Harney concludes:

A more immediate concern for homeowners, however, is Congress’s inability — or unwillingness — this year to extend key tax laws. Tops on the list is the mortgage debt forgiveness law. Unless Congress agrees to a retroactive extension, large numbers of owners could face big tax bills following short sales, foreclosures or loan modifications next year when lenders cancel a portion of the balances owed them. To bring that home: A $100,000 debt cancellation could lead to $28,000 in additional taxes for a short seller — solely because Congress could not get its act together to extend a popular, pro-consumer law.” National REIA will continue to monitor the movement of this bill and will provide ways to speak out and shape perception about the bill. We, as an industry, must take strong action to ensure that our lawmakers understand the devastating effects that will be far reaching from this legislation. Please stay tuned for ongoing updates on this and other important legislation effecting real estate investors.

Research provided by National Legislative Consultant, Charlie Walner.

Schreiber, Sally P., J.D. & Nevius, Alistair, J.D. (September 13, 2013). Repair Regulations are Finally Issued Journal of Accountancy
Harney, Kenneth R. (December 12, 2013). Congress’s Inaction on Real Estate Issues Leaves Homeowners and Investors Unsettled

Add Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.