Legislative Roundup: How Will Congress Affect Commercial Real Estate?

By Anita M. Pittman, Cherry, Bekaert & Holland, L.L.P. (CB&H)
Email: apittman@cbh.com

As Congress returns to Washington for an election year, the mood has turned toward economic stimulus, which combined with tighter fiscal control could have a dramatic impact on the financial geography of commercial real estate investors.

A Little History
For two decades, from 1982 to 2002, Congress operated under a set of rules that have come to be known as the “Paygo Rules” (pay-as-you-go), which basically dictated that any tax cut must be offset by comparable revenue increases elsewhere or by spending cuts.

Although the rules were actually a function of the Budget Act of 1974, they never saw the light of day until 1982. They were further strengthened by the first President Bush and President Clinton, both of whom spent large amounts of political capital to ensure that the rules were incorporated in Congress’s budgeting mechanisms. The rules survived until 2002, when Congress, with encouragement from the second President Bush, let them expire as it enacted a sweeping package of tax cuts designed to stimulate economic growth.

Paying for Tax Cuts
If and when Congress pulls the Paygo Rules off the shelf, legislators will be surveying the economic territory in search of ways to pay for all the tax cuts instituted since 2002. They are certain to look in directions that could have a major impact on real estate investors.

One area that is likely to be scrutinized is like-kind exchanges. Currently, requirements (under Section 1031) for properties that serve as replacement properties are extremely lenient. Congress may tighten the rules, placing many transactions in the “revenue-generating” category, thus making them subject to taxation.

Another area to keep an eye on is taxation of carried partnership interests. Thus far, President Bush and Congress have skirted the issue of treating income from such interests as ordinary income for the performance of services. Although this issue arose in the context of investment fund management, the scope of proposed legislation has expanded to include other taxpayers, such as real estate professionals.

Moreover, today’s capital gains tax rates are among the lowest in history. As a result, Congress may look to increase rates for both short- and long-term capital gains.

Legislation May Stimulate Market
The Mortgage Forgiveness Debt Relief Act of 2007, which President Bush signed into law in December, includes an exclusion of up to $2 million in qualified acquisition debt on a principal residence, and this provision is retroactive to January 1, 2007.

Additional relief for the depressed real estate sector is included in the Economic Stimulus Act of 2008, signed by President Bush on February 13, 2008, which increases the maximum mortgage amounts that various government agencies (such as Fannie Mae, Freddie Mac, and the FHA) may give to potential homebuyers. The Act, not yet signed by President Bush at the time this newsletter goes to press, also permits qualifying taxpayers to deduct first-year bonus depreciation equal to 50 percent of the cost of certain qualified leasehold property acquired during 2008.

Impact of Possible New Rules
In the “this could be more work and cost you more money” category, penalties for failure to file partnership returns on a timely basis have been increased from $50 to $85 per owner per month, and S Corporations are also now subject to similar penalties.

Efforts continue to close the “tax gap,” defined as “the difference between the amount of tax voluntarily and timely paid by taxpayers and the actual tax liability of taxpayers.” According to a Senate Finance Committee staff summary, the new options fall in the general areas of “improved information reporting and enhanced tax administration.”

The report proposed requiring additional information reporting in various areas, including real estate taxes, proceeds of auction sales, and mortgage interest. If new rules are adopted, commercial real estate investors may be required to provide the IRS with significantly more information about their commercial real estate transactions and refinancing arrangements.

Stay Informed
All in all, 2008 promises to be an active year for Congress, with several pieces of legislation that could affect the way you do business. Your tax and financial advisors can provide you with up-to-date information on how legislative issues may impact your business and investments.

Anita is a Tax Partner with CB&H and a member of the Firm’s Real Estate and Construction Industry Group.