WASHINGTON, DC—The comprehensive tax reform proposal unveiled by Rep. Camp last week has the potential to remake commercial real estate transactions. Over the past two days, CEO Real Estate Roundtable Jeff DeBoer has been dissecting the proposal and how it could play out for the industry. This is the third and final installment of that series.
GlobeSt.com: How would Chairman Camp’s proposal to repeal like-kind exchanges affect the real estate industry?
DeBoer: The proposal is detrimental to our industry and the broader economy. It would raise the tax burden on property owners by nearly $41 billion over 10 years. When an investor in real estate exchanges one property for another of like kind, economically, nothing has changed. The taxpayer has not yet exited the fundamental investment. That is the heart of the rationale for allowing taxpayers to defer the recognition of capital gain on the exchange of real property. Congress has wisely left the like-kind exchange rules largely unchanged since 1924. The benefit is limited and does not extend to investments that are liquid, readily convertible to cash, and easy to value, such as stocks, bonds, notes, securities, and inventory. Allowing capital to flow more freely among investments facilitates commerce and allows individual owners and families to transfer property into the hands of active owners who can create jobs by investing the capital necessary to ensure the property is put to its best use. Moreover, like-kind exchanges generate revenue for state and local governments when properties are transferred and property values are reassessed. In short, the proposal is penny wise and pound foolish.
GlobeSt.com: Also, the draft would make a series of changes to the Low Income Housing Tax Credit. What would these proposals mean for the marketplace?
DeBoer: The Low-Income Housing Tax Credit (LIHTC) is widely regarded as one of the most successful and efficient programs funded by the federal program. It has succeeded where public housing programs have failed because it relies on the power of market forces to fill a social need – access to affordable housing. In addition, it takes Washington largely out of the equation and empowers State authorities to experiment and do what works in their particular communities. It should be a model that we seek to replicate, not one that we tear down and reconstruct. Chairman Camp’s proposal would shave over $10 billion from the program over the next decade. It would repeal elements of the credit that facilitate housing rehabilitation and the construction of new rental housing in low-income census tracts and difficult development areas. It would also eliminate the reduced credit that can be used in projects that are combined with tax-exempt bond financing. I am confident that when Congress really conducts a careful review of the LIHTC, these proposals to scale back the credit will be rejected.
GlobeSt.com: Are there other provisions in the 976-page tax reform discussion draft that are likely to impact the real estate industry?
DeBoer: One major concern is the proposal’s failure to extend the Section 179D enhanced deduction for energy efficient commercial buildings. The deduction fills a critical void created by the market’s failure to accurately take into account and price the value of energy-efficiency upgrades to commercial buildings. Also, the plan would repeal the historic rehabilitation tax credit, which has leveraged over $62 billion in private investment to preserve 38,000 historic properties since 1976. The credit helps communities preserve their unique history and character. By amending tax rules related to partnerships and pass-through entities, real estate investment trusts, and tax-exempt investors, the Camp plan would touch on nearly all aspects, and organizational forms, of real estate activity. We are continuing to review the full scope and impact of these changes.
GlobeSt.com: Were you surprised by any issues that did not make it into the Camp tax reform plan?
DeBoer: For the last few years, The Roundtable has argued that Congress could accelerate and strengthen the economic recovery by removing tax barriers that block foreign investment that is needed to recapitalize the commercial real estate sector, refinance maturing commercial real estate loans, and support property improvements and upgrades that would boost employment in the construction and related trades and increase U.S. productivity. Those efforts have resulted in proposals to reform the Foreign Investment in Real Property Tax Act (FIRPTA) that have garnered the support of the President, more than 400 Members of the House of Representatives, and more than three-quarters of the Senate Finance Committee. While we had hoped to see FIRPTA reform included in the Camp proposal, we understand that the need for these changes cannot, and should not, wait for comprehensive tax reform, and so we are continuing to look for other potential legislative vehicles.
Second, Chairman Camp’s proposal recognized the importance of retaining the full deductibility of business interest expense, and thus did not include a proposal. Debt is a fundamental part of a typical real estate entity’s capital structure and, in addition to property acquisition costs, is often used to finance day-to-day operations and fundamental business activities like meeting payroll, buying raw materials, making capital expenditures, and building new facilities that allow the firm to expand as the economy improves. Like rent, wages, and the cost of supplies or productive assets, interest payments are an expense of producing income. Business interest expense is fully deductible because it is incurred as an ordinary and necessary expense in the course of business. Chairman Camp’s plan demonstrates that the Chairman clearly understands and appreciates this important aspect of our industry.