Tax Discussions Begin a Period of Major Risk for Real Estate Industry

Last Wednesday and Thursday, Representative Kevin Brady (R-TX), the chairman of the House Ways and Means Committee with jurisdiction over tax reform, met with his Republican colleagues on the committee to flesh out the details of comprehensive tax reform legislation he plans to introduce soon after Donald Trump’s inauguration as president. The House Republican proposal will build on “A Better Way Forward on Tax Reform,” the tax reform blueprint that Speaker Paul Ryan (R-WI), Chairman Brady, and the Republican House leadership touted prior to last November’s elections. After the Wednesday meeting, Chairman Brady told reporters that the committee’s Republicans were meeting to take the broad outlines of the blueprint, fill in the specific provisions, and identify a legislative path forward.

With that, a period of major risk begins for the real estate industry on what the tax code will look like in the future. For months (and, in many cases, years) NAIOP and its real estate industry allies have argued our case with our elected officials on such tax policy issues as continuing capital gains tax treatment for partnership carried interests, maintaining tax-deferred like-kind real estate exchanges (Section 1031) in the code, and ensuring that depreciation periods reflected the true economic lifespan of assets. Over the last two years in particular, there had been much broad rhetoric on what policymakers intended to do on taxes (with the outcome obviously dependent on the results the election), but little possibility of any concrete legislation actually being debated or advanced in either the House or Senate. The House Republican blueprint, for example, has as a broad goal the elimination of “special-interest deductions and credits in favor of providing lower tax rates for all businesses” but no reference to specific provisions that would affect various industries. Now, with Republicans in control of not only the White House but also the Senate and the House, these elected officials and their staff are compelled to put down into specific legislative language what their plans are on those matters, including on issues important to commercial real estate.

And our industry faces a certain narrative in the public policy arena which creates special risk. For example, in a Washington Post editorial titled “The GOP’s Radical Tax Plan,” referring to the plan’s provisions eliminating the deductibility of business interest payments and how this would adversely impact commercial real estate and lending, the writers state that the “best response to this concern is that recent experience suggests the U.S. economy might be just a bit over-dependent on real estate and finance.”

Understandably, supporters of specific tax provisions are weighing in with the hopes of ensuring that their preferred policies are left untouched in whatever tax plan is introduced by Brady. With the many provisions affecting commercial real estate in the current tax code, NAIOP and 13 other real estate organizations submitted a joint industry letter framing the policy debate for real estate, and informing the legislators we would be submitting additional comments as they developed detailed legislative language. The letter highlights real estate’s importance to the economy, and that any changes to tax policy affecting existing real estate investments must be carefully analyzed to avoid serious unintended economic consequences, like those which befell the markets after enactment of the Tax Reform Act of 1986. We contend that tax reform should:

  • Encourage capital formation and appropriate risk-taking, while providing stable, predictable, and permanent rules conducive to long-term investment;
  • Ensure tax rules closely reflect the economics of the underlying transaction — avoiding either excessive marketplace incentives or disincentives that can distort the flow of capital investment;
  • Recognize that, in limited and narrow situations (e.g., low-income housing and investment in economically challenged areas), tax incentives are needed to address market failures and encourage capital to flow toward socially desirable projects; and
  • Provide a well-designed transition regime that minimizes dislocation in real estate markets.

Brady has been saying for months that businesses should analyze his approach in its totality and not focus on individual provisions of the current tax code, arguing that the changes will dramatically increase economic growth for all economic sectors — a not too subtle way of saying that some industry-favored provisions will be gone, without being specific on which ones. He and Speaker Ryan also know they will be negotiating this bill with the Senate, so their incentive is to pass legislation that adheres to their blueprint as much as possible, knowing compromises will be made later. Republicans hold only a 52-48 advantage in the Senate, which means little margin for error, and therefore Senate Finance Committee Chairman Orrin Hatch (R-UT) will have a big say on the final form of tax reform legislation. House action is the opening act.

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