Banks Also Stand to Benefit from Bills in Congress

Tax relief for the commercial real estate industry and its lenders may be on the way.

The Senate Finance Committee, preparing a broad tax bill, voted last week to restore the deduction for losses on rental property, eliminate the tax on the "phantom income" created when mortgage debt is forgiven, and broaden tax-free investment in real estate by pension funds.

The bill is expected to come up for a vote on the Senate floor this week. Similar provisions have been approved by the House, and the legislation could reach President Bush's desk as early as next week.

All three provisions would make it easier for banks to restructure loans and sell commercial property.

President Bush vetoed a tax bill that contained similar provisions last March. Analysts think that the President, trailing in the polls and facing a stalled economy, is unlikely to veto a bill that contains many of his own proposals to spur economic growth.

"The threshold questions here is: Does the President want a bill, leaving aside the particulars, more than he wants to bash Congress?" said one House aide.

Tax relief for the real estate industry has been a priority of both the President and Congress.

Support Broadly Based

The partial restoration of the deductibility of losses on rental property -- known as "passive losses" -- has support not only from the politically powerful real estate industry but also from banks.

At issue is a tax shelter, ended by the 1986 tax act, that allowed passive investor -- those not actively involved in managing properties -- to deduct losses on rental properties against other income.

The new bills would restore the tax break to individuals whose primarily business is real estate. Although the House bill is more lenient than the Senate's the main beneficiaries would be larger developers who have at least one profitable enterprise against which to use the credits.

As real estate lenders, banks would benefit at least "tangentially" from a reduced tax burden on their borrowers, said Eugene Swanzey, vice president and director of government relations at Chase Manhattan Corp.

Steven A. Wechsler, president of the National Realty Committee, said the current drafts of the passive-loss provision were preferable to the bill that was vetoed, and the bill passed by the House is preferable to one awaiting consideration in the Senate.

In both of the bills, he said, the passive losses would be 100% deductible; they would have been only 80% deductible in the vetoed bill.

House Version Favored

And he said the broader House version, by allowing deduction of rental losses from any kind of income -- not just real estate income -- would be more beneficial to the industry than the plan passed last week by the Senate Finance Committee.

The costs of the tax break -- $2.16 billion in the Senate version and $2.5 billion in the House bill -- would be recovered by lengthening the depreciation schedule for some real estate investments to 40 years from 30.5 years. This would eventually increase taxes on the real estate industry by $3 billion.

Thus, the bill, which includes $650 million of other provisions benefiting real estate, is virtually a zero-sum game for the real estate industry the House staff member said.

The proposal to end the tax on phantom income, although cheaper to the government at $340 million, would have a more direct impact on banks than the passive-loss change.

"It should free up capital for workouts and make negotiations between lender and borrower more flexible," Mr. Wechsler said.

Currently, a developer must pay tax on any reduction in a loan as if it were income. At a time when many loans must be restructured to reflect lower current values, this creates an incentive for developers to turn over the keys to the lender when the loans come due. The proposal would change that by deferring any tax until the property is sold.

Pension Funds

Like the vetoed bill, both pending bills make it easier for pension funds to invest in property seized by banks and regulatory agencies.

The bill would provide "a meaningful boost," one pension adviser said, by allowing pensions funds to invest tax-free in seller-financed properties and in properties sold under contingency arrangements. "Right now, it's very difficult to sell anything, due to lack of [third party] financing," he said

He noted the bill also would ease rules on concentrations of ownership that have prevented domestic pension funds from buying big stakes in real estate investment trusts.

The pension provisions would cost about $300 million, according to a House estimate.

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