Tax Treatment of Real Estate
Issue: The impact of real estate on the nation’s economic well-being has been apparent in
recent years. Real estate plays a part in every American’s life, as it provides the space in
which we live, work, shop, recreate, learn, worship and heal. Real estate enhances our
quality of life and is vital to the nation’s productivity.
Real estate also is strongly affected by its tax treatment. The turmoil in the industry
created by the tax changes of the Tax Reform Act of 1986 was evidence of this. Real estate
tax laws should bear a rational relationship to the economics of the real estate transaction.
In cases where certain social results are clear, such as homeownership and affordable low-
income housing, tax laws should help bring about such results. They also should not
unduly restrict the ability of investment real estate owners to respond to changing
economic and market conditions – an ability critical to the competitiveness of any
Position: IREM and CCIM Institute believe that it is in our nation’s best interest for
Congress to encourage real estate investment in the United States by creating a tax system
that recognizes inflation and a tax differential in the calculation of capital gains from real
estate; while stimulating economic investment; and consequently leveling the playing field
for those who choose to invest in commercial real estate.
We support efforts to measure more accurately the depreciable life of buildings and to
conform amortization periods of tenant improvements more closely to the term of the
lease. The current 39-year time frame does not accurately reflect the useful life of a
building and its components.
We support depreciation reform for investment real estate that secures a significantly
shorter cost recovery period for real estate without adding complexity or creating artificial
acceleration of deductions, and specifically:
1. Upon recognition of capital gain, taxpayers should be able to use sales costs to first
reduce the depreciation recapture portion of the gain;
2. Suspended losses should also go to reduce depreciation recapture;
3. An installment sale as gain is recognized over a period of time, that a percentage of gain
from appreciation and depreciation recapture be used in reporting gain;
4. A partially tax deferred exchange, gain from appreciation and depreciation recapture
should be reported on an allocated percentage basis.
5. Any other proposed regulation that affects the reporting of capital gain by commercial,
industrial or investment real estate taxpayers be reported in the most advantageous
manner for the taxpayer:
IREM and CCIM Institute oppose any proposal that would eliminate capital gains treatment
for any carried interest of a real estate partnership.
Opposing Views: Some oppose favorable real estate tax treatment because the benefits are
thought to inure primarily to upper-income taxpayers. In addition, the costs of these taxes
on federal coffers can be high.
Status: Many of the Bush tax cuts are due to expire at the end of 2010. In addition, given
the current budget crisis, changes to the Tax Code could be used to pay for new or existing
programs. IREM and CCIM Institute have a number of areas of concern with respect to the
tax treatment of real estate. A number of proposals are circulating that would make real
estate a less attractive investment.
Under current law, capital gains are taxed at a maximum rate of 15%. That rate is
temporary, however, and will revert to 20% as of January 1, 2011. The Administration’s
Fiscal Year 2011 Budget would leave the 15% rate in place for those who file single tax
returns with adjusted gross income (AGI) of no more than $200,000. The 15% rate would
be retained for married couples filing joint returns with no more than $250,000 AGI. The
proposal would become effective January 1, 2011. All others would revert to the 20% tax
Those households reporting adjusted gross income of more than $250,000, for example,
are projected to make up two percent of the households. Those families will earn 24.1
percent of all income and pay 43.6 percent of all personal federal income taxes according to
the Tax Policy Center.
Favorable capital gains tax rates provide a stimulus for owners who wish to sell
appreciated property. Lower rates relieve the so-called "lock-in" effect, in which taxpayers
are unwilling to sell property because of high tax costs associated with sales. Lower capital
gains rates also mitigate in part the built-in gain that arises from inflation. Low capital
gains rates are especially important for those investors who are able to realize gains (and
not losses) during the current economic crisis.
Opposing Views: Many lawmakers and policy experts oppose a capital gains preference
because the rules are so complex and because the benefits are thought to inure primarily to
upper-income taxpayers. Also, in our current budget climate, the government can reclaim
significant monies by increasing the capital gains rate.
Action: IREM and CCIM Institute strongly support legislation to continue the capital gains
rate at 15%. Increasing the capital gains rate is especially critical at this time in our
economy. Congress should encourage real estate investment by recognizing inflation and a
tax differential in the calculation of capital gains from real estate; while stimulating
economic investment; and consequently leveling the playing field for those who choose to
invest in commercial real estate.
Real estate partnerships are often organized as limited partnerships (or LLCs) in which the
limited partners provide capital and the general partner(s) provides operational expertise.
When the partnership property is sold, the limited partners generally reap the profits in
proportion to their capital investment. Often, however, the limited partners grant a profits
interest to general partner(s). This profits interest is known as a “carried interest.”
A carried interest is designed to act as an incentive for a general partner to maintain and
enhance the value of the real estate so that the operation of the property is a value-added
proposition. The carried interest of general partner(s) has historically been taxed at capital
gains rates, just as the limited partners’ gains are taxed at capital gains rates. The current
tax rate on capital gains is 15%.
In 2008 and 2009, the House passed legislation that changed the rule so that carried
interests in real estate partnerships (and many other investment arrangements, as well),
would be taxed as ordinary income. This provision has been very controversial. To date,
the Senate has been unwilling to pursue this particular provision. The revenues generated
from the House provision have been identified as a way to "pay for" expired tax provisions.
In the wake of the change in leadership of the Ways and Means Committee, Congressman
Sander Levin (D-MI) has assumed the role of acting Chairman. Mr. Levin has been the
leading proponent of changing the carried interest rules to impose ordinary income
treatment on these gains. In taking the gavel, he has announced his intent to continue to
press for the enactment of this provision.
Opposing Views: There are those who believe that carried interest should be treated more
clearly as compensation for services – like salary income, and taxed at ordinary income
rates. There are some professions that use carried interest like a salary – including hedge
fund managers and some oil development companies – so many argue it should be taxed
like a salary.
Action: IREM and CCIM Institute urge Congress to oppose an increase to the tax treatment
of carried interest for real estate partnerships. The real estate sector is facing an economic
crisis. Making changes that would further hinder the flow of capital into real estate
markets will prolong the weakening of our economy.
The permanent law 39-year recovery period for interior building improvements is not
economically realistic. Neither the leases nor the improvements are likely to last that long.
When a landlord improves space to attract a new tenant, elements such as electric wiring
and cable, technology infrastructure, walls, kitchens and rest rooms are upgraded and
reconfigured to suit the new tenant. By their nature, these improvements are unlikely to
last for 39 years. Nonetheless, because these elements are part of the structure itself, the
costs for them must be amortized over 39 years. Similarly, the usual term for leases varies
between 8 and 15 years. Before 1981, tenant improvement costs were amortized over the
life of the lease. The Treasury Department released a study in July 2000 indicating that the
39-year life for real estate was longer than economic depreciation. Many commercial
property owners are still depreciating interior building space improvements that were
demolished years ago.
Because the cost recovery period for real estate is currently so long, the rate of return for
investors is diminished. A shorter recovery period for real estate would improve rates of
return for assets. In addition, investment in real estate would be more economically viable
for potential investors. Shorter depreciation periods do, however, increase the amount of
gain on sale that is subject to depreciation recapture taxes of 25%.
The benefits of lessening the cost-recovery period for leasehold improvements extend
beyond that of the property owner. A realistic cost recovery period, such as 10 or 15 years,
provides an incentive for building owners to upgrade and improve their space. With
increasing competition between suburban and downtown space in many markets, older
space must be more economically viable. A realistic cost recovery period for tenant
improvements to a building will increase the rate of return on all buildings, including older
commercial and retail space. In addition, tenant improvements and building upgrades
provide jobs in all communities. Thus, this change creates a more level playing field and
stimulates local economies.
The House and Senate have now agreed to legislation (HR 4213) that would renew and
extend the 15-year recovery period. The provision would be retroactive to January 1, 2010,
and would remain in effect through December 31, 2010. The two versions are very similar
in content, but the "pay-fors" in each bill are completely different from one another. The
House version uses the "carried interest" proposal that would tax carried interests of real
estate general partners as ordinary income, rather than capital gains. The Senate version
looks to several provisions that affect multi-national corporations and off-shore tax
avoidance. Ways and Means Chairman Levin (D-MI) has called for a conference on the two
Opposing Views: No opposing views are identified, and Congress has reached consensus
that current law recovery periods are too long. But as this proposal would cost the federal
government money, it will be debated against other tax cuts.
Action: Support HR 4213 to extend the 15-year recovery period for leasehold
improvements, and seek opportunities to make this provision permanent.
Commercial Mortgage Market Liquidity
Issue: Having a sound and well functioning commercial and multifamily real estate sector
is critical to our country’s economic growth and development, and to millions of U.S.
businesses of all sizes that provide local communities with jobs and services. It is estimated
that the commercial real estate sector supports more than 9 million jobs and generates
billions of dollars in federal, state and local tax revenue. Nonetheless, the overall economic
downturn and crisis in the broader financial markets is directly impacting not only the
fundamentals of commercial real estate finance, but also the outlook for recovery. And
while the commercial and multifamily real estate markets play a vital role in the economy,
these markets are now experiencing the worst liquidity challenge since the early 1990’s.
In February, Moody’s proposed that “Losses on commercial real estate loans could top
$150 billion by the end of 2011.” In fact, in January more than 6% of commercial
mortgages in the U.S. were delinquent and continue to rise at an alarming rate. By year
end, delinquency rates on loans for commercial properties could rise to between 9% and
14%, according to Jefferies & Co., as consumer spending and confidence continues to be
low. Furthermore, commercial property values have fallen 43% across the board from
their peak in 2007, according to Moody’s. Moody’s also estimates that commercial
property values could fall between 44% and 55% from 2007 prices. Billions of dollars in
U.S. mortgages are now underwater, meaning the loan balance is higher than the value of
the underlying asset. Falling real estate values have forced many banks to reduce their
commercial real estate loan volumes, which is down 86.5% from 2007.
A crisis is looming in the commercial real estate market due to a confluence of issues that
include: (1) economic conditions, especially high unemployment; (2) weakening
commercial property fundamentals; (3) declining commercial property sales volume and
price; (4) slowing commercial property lending; and, (5) increasing commercial loan
delinquencies. These challenges, paired with $1.4 trillion of anticipated commercial
mortgages’ maturities through 2014, create a challenging commercial real estate finance
Position: We support protecting and enhancing the flow of capital to commercial real
Opposing views: There are some who believe that the government should not interfere
and free markets should be left to operate on their own.
Status: Congress has resisted any further “bailouts” or rescues for the financial sector. As
this crisis grows, and due to its complexities, we are offering an array of suggestions for
lessening the impact on our still recovering economy.
Credit Union Lending
During previous crises consumers and businesses have relied on credit unions to fill in the
gaps where banks could not serve them. Credit unions have been providing business loans
for more than 100 years. Today, however, credit unions are hampered by a business
lending cap of 12.25% of total assets. Many commercial real estate professionals have
reported having strong, long-lasting relationships with credit unions, which could help
them refinance and sustain their properties but find the lending cap presents an obstacle.
More than half of the outstanding business loans held by credit unions have been extended
by those approaching or at, the cap. That means that credit unions with experience in
handling commercial loans are unable to continue to help get us out of this crisis. We are
pleased to support H.R. 3380, introduced by Rep. Kanjorski (D-PA) and Rep. Royce (R-CA);
and S. 2919 introduced by Senator Udall (D-CO) that will increase the cap on credit union
lending to 25% of total assets.
Opposing views: Some of the larger financial institutions oppose expanding credit union
Action: We urge support for H.R. 3380 and S. 2919 to increase the cap on credit union
Improved cash flow for investors/owners of commercial real estate would help to fend off
some of the challenges the market faces. The most effective means of improving the cash
flow on real property is to provide more generous depreciation allowances. We believe that
some combination of accelerated depreciation (or shorter recovery periods) and passive
loss relief would be significant investor incentives. Proposals related to depreciation would
have the most immediate and beneficial impact on investment incentives and carry great
potential for improved cash flow. Improved cash flow can soften some of the coming
commercial liquidity crisis, particularly as it affects performing loans that are underwater.
Legislation has not yet been introduced.
Opposing Views: No opposing views are identified, but the costs of the proposal have not
been determined, but as it would cost the federal government money, it will be debated
against other tax provisions.
Action: IREM and CCIM Institute urge support for an accelerated depreciation model that
will incentivize new investment in performing properties.
For properties that can support their current debt, a simple loan extension makes perfect
sense. As most commercial loans are short term, these loans refinance frequently. If instead
of requiring a refinance at the end of a loan term (and having to deal with the equity gap),
lenders could be encouraged to extend the term of the current loan. Currently lenders are
not offering extensions because they are wary of oversight and regulatory concerns.
Federal guidance encouraging these types of extensions for appropriate properties could
be a helpful tool.
Opposing Views: None identified.
Action: IREM and CCIM Institute ask Congress to urge the Federal Reserve and Treasury to
provide greater guidance to holders of commercial debt. A simple term extension for
performing loans could prevent many properties from going into default or foreclosure.
Commercial real estate loans are generally short-term - sometimes even less than five
years. The problem commercial properties are having is that when they go to refinance an
existing loan, there can be a significant difference between the current appraised value of
the property and the debt currently serving the property. Even on performing properties,
lenders will not refinance at the existing debt level and are instead demanding a new
infusion of capital into the project—capital which simply isn’t available.
A mortgage insurance program would not insure the entire value of the loan, but instead
would offer insurance on the difference between the current value and the debt service.
Such a proposal or even a government guarantee program could bolster commercial
markets during this difficult time. The program could be structured to limit eligibility to
performing properties that have been found to be income producing and viable in the long-
term. Banks would pay a guarantee or insurance fee that would help fund the program. The
insurance could be short-term and designed to cover the equity gap until the market
Opposing Views: The vehicle for such a program (public or private or combination) has
not yet been identified. Many would oppose a federal role in such a program for fear of
putting the taxpayer at risk.
Action: IREM and CCIM support a short-term insurance or guarantee program limited to
performing properties, to cover the equity gap.