On May 5, the Institute of Real Estate Management (IREM) and the CCIM Institute will be going jointly to Capitol Hill to talk with members of Congress about capital markets and federal tax issues that can potentially solve the current economic crisis in commercial real estate.
IREM and CCIM support ways to increase short-term business lending, moderate-term capital improvement loans and longer-term financing or refinancing of commercial property. Having a proper “commercial property toolbox of options” is important when addressing today’s needs in the area of capital markets. Positive commercial property cash flow is always important and is especially important in addressing troubled properties. One way to generate a positive cash flow is to accelerate the properties’ depreciation. By shortening the recovery period and, at the same time, providing passive loss relief, an important incentive would be provided to those owning or managing commercial real estate.
Another way to provide additional financing is through the use of funds from credit unions. Existing law limits credit union business' lending to 12.25 percent of total assets. By moving the limit to 25 percent of total assets (a current proposal in the U.S. Congress) additional funds could be provided for commercial property lending. A third way is to provide a mortgage insurance program for commercial debt. This concept would support insurance from the government or private sector that would cover the difference between the current value and the debt service amount, which could free up capital for other purposes. Still another option is to encourage lenders to provide loan extensions for those properties that can support their current debt. Another issue that goes hand-in-hand with capital markets and supports capital markets is federal tax code. Federal tax code needs to be extended, new proposals should be provided, and the result of the extensions and changes are incentives to buy and hold commercial real estate in this troubled economic period.
Capital gains rates need to remain at the 15 percent level because that rate definitely encourages investors to participate in the commercial real estate market. The loss of capital gains treatment for real estate investment ownership would turn long-established buy and hold procedures upside down. Other current or past tax incentives need to be re-proposed or extended, including the 15-year leasehold improvement depreciation and the extension of the current 50 percent bonus depreciation, which allows property owners to deduct 50 percent of the cost of qualifying property in addition to the regular depreciation allowance that is normally available. Moreover, the current $1.80 per square foot energy tax credit for commercial property owners who achieve 50 percent energy savings through energy retrofits is another incentive that needs to be extended.
In the area of general partners investing in commercial real estate, there are legislative proposals that would change existing law, so that income generated from carried interest would be taxed at a rate of ordinary income (at 35 percent or more) as opposed to the current capital gains rate (15 percent). Most general partners with existing carried interests will be penalized under this proposal. Real estate partnerships, from the smallest venture to the largest investment fund, have a carried-interest component. Approximately $1 trillion of commercial and residential properties are held by partnerships. Changing the tax rates on carried interest from capital gains rates to ordinary income rates would be devastating to these businesses.
The potential change from 15 percent to ordinary income rates for general partners clearly discriminates against real estate compared to other assets and puts commercial real estate at a greater competitive disadvantage for investment dollars. Additionally, it puts more pressure on a fragile commercial real estate industry already facing a rapid rise in delinquencies and foreclosures as well as a growing challenge to access credit.
— Richard E. Juge is president of the CCIM Institute, and O. Randall Woodbury is president of IREM.