CAPITAL & CREDIT

TAX & BUDGET POLICY

Dec. 1, 2010 letter   from 14 of 20 members on the Senate Finance Committee supporting FIRPTA reform.

At the same time, The Roundtable continued to press for inclusion of reforms to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) — reforms that could help attract foreign equity investment into U.S. commercial real estate and, thereby, help rebalance hundreds of billions of dollars in “underwater” commercial mortgages. The FIRPTA effort got a boost on Wednesday, when 14 out of 20 members on the Senate Finance Committee wrote to Committee Chairman Max Baucus (D-MT) and ranking member Charles Grassley (R-IA) urging consideration of FIRPTA reforms “as soon as possible.”

The Dec. 1 letter characterized FIRPTA reforms  as “critical,” saying they are “needed to mitigate a looming equity crisis in the commercial real estate industry.” This crisis is the result of steep devaluation of commercial properties over the past 18 months as well as lender demands for more upfront equity in transactions (a result of lower loan-to-value [LTV] ratios, etc).

In The Roundtable’s view, if positive job growth were coupled with policy action to address the equity shortage — in particular, the proposed FIRPTA reforms — more transactions would take place, asset values would stabilize more quickly, and commercial real estate could begin to return to its historic position as a positive contributor to economic growth.

The House cleared a narrow FIRPTA reform bill (H.R. 5901) earlier this year that would increase (from 5% to 10%) the ownership stake that a foreign investor may hold in a publicly-traded real estate investment trust (REIT) without being subjected to FIRPTA’s onerous reporting and administrative requirements. In countries where it is consistent with U.S. tax treaties, H.R. 5901 would (when applying this ownership test) “look through” to the individual investors in foreign mutual funds that, in turn, invest in U.S. REITs.

In a July 29 letter to the bill’s author, Rep. Joseph Crowley (D-NY),  Roundtable President and CEO Jeffrey DeBoer expressed support for the H.R. 5901 while also urging expansion of the bill so that it benefits a broader range of asset types.

With Congress running out of time for debate and action on many issues, any FIRPTA reforms adopted at this point would likely be limited — e.g. increasing the portfolio exemption for foreign investment in publicly traded REITs from 5 percent to 10, and reversing IRS Notice 2007-55, which subjected liquidating distributions to FIRPTA taxation.

As for the carried interest proposal, which has surfaced repeatedly in recent years as a way to help “pay” for business tax extenders (and, thus, avoid increasing the federal deficit), The Roundtable and its real estate trade association partners continue to educate lawmakers about why a carried interest tax hike is bad for the economy, job creation, entrepreneurial activity and investment, and commercial property values.

Although the proposal appears to be aimed at hedge fund and private equity fund managers, it would disproportionately affect real estate partnerships, which account for nearly 50% of all U.S. partnerships. It would also, for the first time, affect family real estate partnerships that previously had no carried interest.

Dr. John Rutledge, author of the 2007 “Analysis of the Impact of Increasing Carried Interest Tax Rates on the U.S. Economy,” asserted in a May 22 Wall Street Journal opinion piece. “The economic impact of the proposed tax rate hike is unequivocally negative for long-term investment.”

“The longstanding practice of taxing carried interest at capital gains rates is not a loophole,” he explained. “It reflects two long-accepted tax practices: taxing partnership distributions as pass-through vehicles based on the character of the income, not the character of the partner receiving it; and taxing long-term capital gains at a lower rate than short-term capital gains, interest income, and wage and salary income in order to encourage more long-term investment.”

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