Last week, President Obama submitted his FY 2017 federal budget proposals to Congress – the final such submission of his presidency. No matter where one might fall on the political spectrum, from an objective viewpoint the impact upon commercial real estate industry of some of the administration’s proposals would be severe if they were to become law. Many of these are repeats from prior budget submissions that failed to pass in Congress, and others in this year’s submission are new tax increases designed to pay for new spending initiatives.
For many in Congress, the budget submissions of a lame-duck president in his final year are nothing more than symbolic expressions of policy preferences, with little chance of passage by a legislature in the hands of the opposition party. While this may be comforting to some in the short run, the continued inclusion of policy proposals inimical to commercial real estate should be troubling to NAIOP members. These bad ideas, which often arise as a response to the political exigencies of the moment, tend to live beyond their time, rising up in future tax debates like vampires refusing to die.
The scary items in the Administration’s budget proposals include:
- Limitations on Section 1031 Like-Kind Exchanges: The Obama administration proposals would severely hamper the use of Section 1031 like-kind exchanges for commercial real estate, limiting the deferral of taxable income on such exchanges to $1 million annually. Included in prior year’s submissions, the FY 2017 version of the proposal would be expanded to include other industries that use like-kind exchanges (such as exchanges by auto leasing companies), increasing the budget impact of the proposal to more than $47 billion over 10 years from $19 billion. The larger budget number is significant because it gives those wanting to reduce corporate tax rates a convenient “pay-for” to help bring down rates while claiming they are paying for it by closing tax loopholes. Like-kind exchanges for real estate have been in the tax code for nearly 100 years, and their use is firmly embedded in modern commercial real estate. Eliminating or severely limiting Section 1031 would cause widespread disruption and economic dislocation in many markets.
- Carried Interests Taxed at Ordinary Income Rates: As in prior years, the administration’s budget proposes to change the tax treatment of partnership “carried interests” (also known as “promotes” or “promoted interests”) from capital gains to ordinary income, which would be taxed at much higher rates. Rhetorically aimed at the use of carried interest compensation by hedge fund managers on Wall Street, the populist proposal would unfortunately have an outsized impact on the commercial real estate industry, where the use of carried interest compensation to reward real estate entrepreneurs for taking long-term risks has been non-controversial. Forty-six percent of partnerships are real estate partnerships according to the Treasury Department, and a large portion of the revenue that would arise from the proposal would come from our industry.
- Affordable Care Act Healthcare Tax Expanded to More Real Estate Partnerships: A new proposal would expand the 3.8 percent net investment income tax that was included in the Affordable Care Act to a large share of owners and investors in real estate partnerships. The tax currently does not affect those who qualify under the code as “real estate professionals.” The administration’s proposal would change the law so that the current exceptions to the tax would no longer be available to these taxpayers.
- Higher Capital Gains Tax Rates for Some Taxpayers: The top capital gains and dividend tax rates for higher-income taxpayers would be increased to 24.2 percent from the current 20 percent, not including the additional 3.8 percent healthcare surtax. Overall, the effective tax rate for these taxpayers would be 28 percent.
- Elimination of “Stepped Up” Basis for Inherited Assets: The budget would eliminate the use of “stepped up” basis for determining taxes on inherited assets, and make the transfer of appreciated real property a taxable event. Currently, inherited property’s value is determined as of the time of the inheritance. The budget proposal would require the taxable gain to be calculated based on the original price of the property. This would impose higher taxes for many taxpayers, a significant number of whom hold property long term in family-owned businesses.
Ironically, the president’s final budget submission was released the week that NAIOP members were advocating on behalf of the industry with their elected representatives on Capitol Hill, in connection with our annual Chapter Leadership & Legislative Retreat. In fact, many of the items in the President’s budget that would affect commercial real estate were tax reform issues raised by NAIOP members during their Hill meetings, underscoring the importance of the continued involvement of our members in support of their industry.
Aquiles Suarez is Vice President for Government Affairs at NAIOP.