While the legislation overall is considered a mixed bag by the banking and real estate industries, tax provisions of the budget reconciliation legislation that Congress was expected to pass by Aug. 5-6 contains provisions called a win-win for real estate-related investments and investors.
The provisions will treat real estate professionals the same as other business professionals under so-called "passive loss rules," facilitate debt workouts and restructurings, remove obstacles to prudent pension investment in real estate and encourage affordable housing availability.
Reflecting the banking and real estate industry's views on the issues, Steven A. Wechsler, president of the National Realty Committee, said that the "positive impact [of the tax law changes] will extend far beyond real estate--cities, financial institutions, home owners and savers all will get a boost." He noted that financial institutions hold more than $700 billion in commercial real estate mortgages.
Specific provisions of importance to the mortgage banking industry: Passive losses. Real estate professionals will be allowed to deduct losses from one segment of their business, rental real estate, which previously was defined as a passive activity per se, against income from other segments of their business, construction, management, leasing and so on.
Individuals who spend half their working time (a minimum of 750 hours annually) in real estate trades or businesses in which they materially participate could take the same test under the passive loss rules with respect to rental real estate activities as other taxpayers now use in their businesses. The provision is effective for taxable years beginning after Dec. 31, 1993.
Debt Restructuring. Section 108 of the Tax Code would be amended to facilitate debt workouts and restructuring by providing Individual taxpayers (including partnerships and Subchapter S corporations) with the option of reducing the depreciable basis of real property they own by the amount of discharged debt.
This basis reduction would be in lieu of current tax liability on discharged debt. (Tax would not be avoided, however, but paid over time in the form of lower depreciation deductions and greater gains-on-sale.)
The provision would be effective for debt discharges occurring on or after Jan. 1, 1993.
Pension Investment. The rules relating to debt-financed real estate purchases by pension investment funds would be modified to permit certain seller-financing, sale-leasebacks and participating loans. Also, the "five-or-fewer" real estate investment trust rule would be modified to treat domestic pension funds the same as foreign funds for the purposes of meeting REIT ownership standards.
This would be accomplished by applying to domestic funds the same kind of "look-through" rule now applied to foreign funds, whereby each fund beneficiary is considered to be a single investor for the purposes of REIT ownership. Thus, pension funds could make more economically feasible investments in REITs without causing REITs to be taxed as corporations. These rule changes would apply to transactions occurring on or after Jan. 1, 1994.
Affordable Housing. Two Important, widely used tax provisions aimed at ensuring an ample supply of affordable housing--the low-income housing tax credit and the mortgage revenue bond program--would be permanently extended.
Capital Gains. The top tax rate on capital gains would remain at 28%. The Senate provision raising the tax rate on capital gains to 30.8% from 28% for taxpayers whose income exceeds $250,000 was deleted from the conference committee bill. Also, as NRC urged, the current depreciation recapture rules for real estate were maintained.
Nonresidential Real Estate Depreciation. The depreciation period for nonresidential real property would be extended to 39 years from 31.5 years for property placed in service after May 13, 1993.
This change would not apply to property placed in service before Jan. 1, 1994, if the taxpayer entered into a binding contract to purchase or construct the properly before May 13, 1993, or if construction of the property was commenced by or for the taxpayer before May 13, 1993.