Tax Reform

CONGRESS HAS EXPRESSED THE DESIRE to overhaul the tax system, with some indicating that “everything is on the table.” While there are no specific proposals yet, both the House Ways and Means Committee and the Senate Finance Committee have begun discussions to look at all current-law tax provisions, which may include the following issues of importance to commercial real estate practitioners:

  • Leasehold Improvements: The provision permitting the cost of leasehold improvements to be recovered over 15 years expires at the end of 2013. Without it, leasehold improvements will be depreciated over a period which has no relation to the economic life of the assets and will artificially depress rates of return. Although there is no controversy over the merits of this provision, the extension may take a backseat to overall tax reformin Congress.

Nar's Action/Position: NAR supports efforts to establish a permanent rule that more accurately reflects the depreciable lives of buildings and to conform amortization periods for tenant improvements more closely to the term of the lease. NAR supports the 15-year recovery period, but would eagerly support an even shorter term.

How this Could Impact You: Correcting the depreciation rules and the tenant improvement amortization rules allows upgrades for technology and modernization to be more economically feasible. These types of improvements assure that nonresidential buildings will be adequately maintained and remain technologically current,and such properties are more readily bought and sold.

  • 1031 Like-Kind Exchanges: The like-kind exchange rules permit the deferral of capital gains taxes, if the taxpayer satisfies numerous requirements and consummates both a sale and purchase within 180 days. Real estate investors and NAR commercial members place a very high priority on retaining the current like-kind exchange rules. So far, Section 1031 has not been singled out as a target in tax reform discussions, but NAR continues to monitor this situation closely.

Nar's Action/Position: NAR opposes any change that would undermine the deferral mechanisms associated with exchanges. Safeguards should be available to protect the real estate investor’s assets during every phase of the transaction, particularly during the phase when the qualified intermediary holds property and funds on behalf of the investor.

How this Could Impact You:  Real estate investments that are held in partnerships with both general and limited partners would be harmed by changes to the treatment of carried interest compensation. By increasing the tax burden on these real estate partnerships, and particularly on those with operational expertise,such changes would make real estate a less attractive investment.

  • Depreciation:Current law depreciation rules sets the cost recovery periods for real property at 27.5-and 39-years. NAR supports a depreciable life for real estate that accurately reflects the economic life of the property, which would make real estate a more attractive investment. 

Nar's Action/Position: A working group that convened in 2001 determined that a more realistic depreciable life for real estate would be about 22-24 years, which NAR supports.

How this Could Impact You: A more realistic rate of return on depreciable assets would make real estate a more attractive investment.

  • Bonus Depreciation: The American Taxpayer Relief Act of January 2013 contained a provision extendingthe current 50% expensing provision for qualifyingproperty purchased and placed in service before January 1, 2014 (before January 1, 2015 for certain longer-lived and transportation assets) and also allowing tax payers to elect to accelerate some AMT credits in lieu of bonus depreciation

Nar's Action/Position:NAR supports the current bonus depreciation treatment, and hopes it will continue to aid in the economic recovery of the commercial real estate sector. 

How this Could Impact You: When the current bonus depreciation provisions end, businesses purchasing depreciable assets will revert to th emodified accelerated cost recovery system or other methods for determining annual depreciation deductions. This will reduce the first-year depreciation deduction on most business assets,which then extends the time over which businesses realize the benefits of reduced tax liabilities by cost recovery deductions, and increases the up front costs of acquiring business assets.

  • Carried Interests: Carried interest compensation is treated as ordinary income, instead of being taxed at the capital gains rate. However, if tax reform does occur it may be a target as a way to offset loweringgeneral tax rates. Real estate accounts for almost 50% of the partnerships in the U.S., so changes to this treatment would be an increase on a substantial amount of real estate activity.

Nar's Action/Position: NAR opposes any policy that would eliminate capital gains treatment for any carried interest of a real estate partnership. The current-law treatment of carried interests helps better align real estate managers’ interests with those of investors, and the existing policy has played an important role ineconomic development and job creation.

How this Could Impact You: Real estate investments that are held in partnerships with both general and limited partners would be harmed by changes to the treatment of carried interest compensation. By increasing the tax burden on these real estate partnerships, and particularly on those with operational expertise,such changes would make real estate a less attractive investment.

  • Lease Accounting:THE FINANCIAL ACCOUNTING STANDARDS BOARD (FASB) and International Accounting Standards Board (IASB) proposed lease accounting changes which could be detrimental to commercial real estate businesses. They require using a “right-to-use” accounting model where both renters and property owners recognize assets and liabilities arising from lease contracts, as opposed to the current rules which allow many leases to be classified as “operating expenses,” which do not show up on balance sheets. Under the proposed changes, some companies may see their debt-to-equity ratios increase, and find it more difficult to obtain credit; it could also affect the length of time lessees want a lease to last, and the amount of space they are willing to rent, which could negatively impact commercial property owners and force them to increase rent rates due to market uncertainty. The proposal will likely be finalized in 2014, effective 2017. NAR is working closely with FASB/IASB and other groups to assure that modifications to lease accounting rules will not negatively impact commercial real estate practitioners. 

Nar's Action/Position: NAR is concerned that the new lease accounting proposal will be detrimental to the economy by reducing the overall borrowing capacity of many commercial real estate lessees and lessors, and is also opposed to lease accounting changes that would treat the income producing real estate business as a financing business on company balance sheets. NAR continues to work with FASB/IASB and other stakeholders to ensure that any modifications to lease accounting rules will not negatively impact commercial real estate practitioners.

How this Could Impact You: If ratified, the proposal would hurt businesses of all sizes,especially lessees and lessors of commercial real estate. With more bloated balance sheets, some companies may see their debt-to-equity ratios increase and find it more difficult to obtain credit,especially those with heavy debt loads.Additionally, the elimination of off-balance-sheet financing would be detrimental to commercial property owners, causing more frugal lessees to want less space and shorter term leases without renewal options or contingent rents, which will decrease cash flow for property owners.

Basel III

IN 2012, BANKING REGULATORS RELEASED BASEL III, a proposal to help improve bank capital standards. It proposed high risk weights for certain commercial asset classes, creating a new risk-based capital category for commercial acquisition, development, and construction loans. In response to the proposed changes, it is likely banks would substantially change their current lending practices and reduce the amount of available commercial real estate credit in order to avoid the higher capital charges associated with those loans. NAR submitted a comment letter to the relevant agencies voicing these and other concerns with the proposed rule. In July 2013, the Federal Reserve released the final U.S. implementing regulations for Basel III, which unfortunately includes many of the provisions that apply to commercial real estate lending.

Nar's Action/Position:  NAR supports the Basel Committee’s goal of preventing another financial crisis, but is concerned that requiring banks to hold far more capital could further exacerbate credit challenges for real estate and broader credit capacity.Furthermore, NAR seeks to protect and enhance the flow of capital to commercial and residential real estate by making sure that the capital rules do not require excessive capital to be held by banks. NAR submitted comments to the Federal Reserve, FDIC,and OCC prior to the agencies’ October 2012 comment deadline expressing its views on and concerns with the proposal, and sent several letters to Congress on the proposal as well.

How this Could Impact You: The Basel III proposal will require banks to hold more capital.The changes could significantly curtail the flow of capital to real estate and harm the commercial and residential property market and property values.

National Flood Insurance Program (NFIP)

IN JULY 2012, CONGRESS REAUTHORIZED THE NFIP
for five years with the “Biggert-Waters” Act. This act also phased out subsidized flood insurance rates for properties purchased after July 2012 and“grandfathered” properties which are allowed to keep lower rates based upon older flood maps when new maps are issued. It also directed FEMA to report on the affordability of these reforms to Congress in order to consider their impact; that report is now overdue.The possibility of a delay in the rate provisions is uncertain at this point.

Nar's Action/Position: NAR supports renewing and strengthening the long-term viability of the federal flood insurance program, maintaining funding to update and improve the accuracy of flood maps, and including comprehensive coverage for properties including non-primary residences and reforms to ensure “full risk” premiums for properties with repetitive insured losses. NAR has sent several letters to Congress on the issue, and was deeply involved in the reauthorization process in 2012.

How this Could Impact You: Without NFIP, 5.6 million home and business owners in 20,000 communities nationwide would not be able to obtain a mortgage or insurance to protect their properties against flooding.

To find out more about what NAR is doing on behalf of commercial real estate, view our Issues & Actions piece on REALTOR.org/Commercial

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