Senate tax reform proposals: “chilling effect” on real estate industry

by DLA Piper

A tax reform proposal released by the Senate Finance Committee would have a major impact on the real estate industry, according to comments submitted to the committee by a number of industry groups. If enacted in their current form, the group says, these proposals would threaten real estate activity and investment and have a negative impact on the US economy.

As part of the effort to create a comprehensive tax reform bill, the Senate Finance Committee has drafted and released a number of detailed discussion drafts on various issues, including a cost recovery proposal which includes significant changes affecting the real estate industry. Comments on the discussion drafts were due late last month.

According to the comment letter submitted to the Senate committee by the real estate groups, the “proposals in the Finance Discussion Draft could have a severe, widespread, and chilling effect on U.S. real estate activity.”

The letter warns that the proposals amount to “substantial and radical tax increases on real estate” and that they would be imposed retroactively on existing investments.

These changes, the group says, are “more sweeping and fundamental” than those enacted in the Tax Reform Act of 1986 and would “pull the rug out” from under the real estate industry.

The Finance Discussion Draft proposes a number of fundamental changes to the tax code’s treatment of real estate investments:

  • Under the proposal, all real property would be depreciated on a straight-line basis over 43 years. The proposal would eliminate the current, distinct recovery periods that apply to leasehold improvements (15 years), residential rental property (27.5 years) and nonresidential property (39 years). The new recovery period would apply to all real property, regardless of when it was placed in service.
  • The proposal would repeal Section 1031, the deferral of gain on like-kind exchanges of real property. The proposed change would apply to transactions after December 31, 2014, regardless of when the initial investment was made.
  • The proposal would raise the tax rate on recaptured depreciation, taxing all gain attributable to prior depreciation as ordinary income, instead of the current tax rate of 25 percent. The change would apply to transactions after December 31, 2014, and would apply retroactively by imposing the ordinary income tax rate to past depreciation deductions.
  • The proposal would repeal Section 179 D, the tax incentive that encourages energy-efficient improvements to commercial and larger multifamily buildings.

According to the industry groups, these proposed changes in commercial real estate taxation would have dramatic effects on real estate investments, financial institutions, pension funds and large segments of the US economy, and the potential consequences of these changes would be far-reaching.

Although the momentum for enacting major tax reform legislation has stalled in Congress, key tax-writers in the House and the Senate remain committed to fundamental reform of the nation’s tax laws. Tax reform is not going away, and the discussion drafts developed by the tax committees could be a framework for eventual legislation.

Changes in depreciation rules will be a major part of the ongoing tax reform debate, and the tax reform goal of lower tax rates and a broader base makes all tax preferences vulnerable to change.

As a result, these proposals need to be taken seriously and closely monitored. Your voice matters in this debate.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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