Tax Reform Ahead

What will the repercussions be for the apartment industry?

Most lawmakers in Washington, D.C.—and taxpayers everywhere—agree that our Byzantine tax code needs to be reformed to generate economic growth and make the nation more globally competitive. That’s why the House Ways and Means, Senate Finance and the Joint Select Committees on deficit reduction are taking a serious look at tax reform.

But what would tax reform mean for the apartment industry? The key issues—and the key threats—the National Multi Housing Council is watching on behalf of the industry include:

Many seek to cut the 35 percent tax rate applicable to multinational corporations, but there is a danger this change could come at the expense of partnerships, which are frequently established by apartment developers, investors and operators.

Partnership income is taxed just once under the individual income tax system. Corporations, by contrast, pay tax at the business level, then shareholders pay tax again on the dividends they receive. Accordingly, apartment executives should ask their lawmakers to oppose any tax reform proposal that would seek to force partnerships with incomes over certain thresholds to pay tax under the corporate system, that would raise tax rates applicable to partnerships or that would reduce incentives available to partnerships to finance the cost of a corporate rate cut. While there is certainly a strong case for reducing the corporate tax rate, partnerships should not face higher taxes to recoup the lost revenue.

The Low Income Housing Tax Credit (LIHTC) program is a public-private partnership that has successfully led to the construction of more than 2.4 million apartment units over the past 25 years. Despite its successes, it could theoretically be harmed during tax reform negotiations should lawmakers look to trim credits and deductions in an effort to lower overall tax rates.

Given that Harvard University estimates a shortage of at least 3 million affordable rental units, the LIHTC needs to be strengthened by making the flat 9 percent LIHTC credit permanent (beyond its scheduled expiration at the end of 2013) so investors can effectively plan for the future. The 4 percent credit should be allowed to finance acquisitions in addition to new construction and substantially rehabilitated properties.

Carried interest tax increase

President Obama has proposed to rein in Wall Street hedge fund managers by taxing carried interest as regular income (rather than the current policy of taxing it at the capital gains tax rate). But let’s be clear: increasing the tax on carried interest isn’t just about the hedge fund manager on Wall Street; it’s about jobs on Main Street and would directly impact the ability to develop or rehabilitate apartments everywhere.

It’s important to remember that our nation needs incentives to get investment dollars back into the economy, where they will fuel economic growth.  A tax increase on carried interest does the opposite; it would translate into fewer construction, maintenance, on-site employee and service provider jobs when our economy is struggling under the weight of an abnormally high unemployment rate.

A “carried interest” has been a fundamental part of real estate partnerships for decades. Investing partners grant a carried interest to the general partners to recognize the value they bring to the venture as well as the risks—litigation, cost overruns, recourse debt, etc.—they take. Because carried interest represents a return on an underlying long-term capital asset, as well as risk and entrepreneurial activity, the current treatment of carried interest as a capital gain is the proper tax treatment.

Some have suggested that one reason  the economy became overleveraged in the lead-up to the financial crisis was because the tax code favors debt over equity. Proposals have emerged to eliminate this disparity by scaling back the current deduction for business interest. Unfortunately, doing this would greatly increase the cost of debt financing and severely hamper new construction.

Finally, regardless of the state of tax reform prior to the 2012 election, Congress must still make major policy decisions prior to the end of 2012, when the Bush-era tax rates expire and peak income tax rates rise up to 39.6 percent; capital gains are taxed at 23.8 percent, dividends are taxed at ordinary rates, and the estate tax will have a low $1 million exemption instead of the current $5 million. Even more pressing, the so-called “patch” that protects over 30 million taxpayers from the alternative minimum tax (AMT) expires at the end of this year, which means that millions more could face this onerous tax in 2012.

Though it’s not clear how Congress will address these tax provisions, two things are very clear. First, tax policy will be at the forefront of Congress’s agenda in the coming weeks and months. Second, the industry must be prepared to advocate for its priorities as policymakers move forward to ensure multifamily housing is not a disadvantaged relative to other industries under any future tax code.

Matthew Berger is vice president of tax for the National Multi Housing Council in Washington, D.C.