The year 2011 will almost certainly witness a debate about the future of government spending and tax revenues. During the latter half of 2010, numerous groups, including the president’s deficit commission (the National Commission on Fiscal Responsibility and Reform), presented plans that included proposed overhauls of the nation’s tax code.
While the mortgage interest deduction and employer-provided health insurance exclusion generate the most attention in the press with respect to tax reform discussions, because of their budget size and broad impact, there are many tax expenditures that would be at risk that would affect those in the multifamily sector. These include the Low-Income Housing Tax Credit, the 27.5 year depreciation period for residential rental property, the capital gains tax rate, and perhaps business deductibility of interest expense.
The Low-Income Housing Tax Credit (LIHTC) is the nation’s only production program for the construction of affordable housing. In recent years, the program has been used in connection with the development of approximately 75,000 affordable housing units a year. Created as part of the last major tax reform effort, the Tax Reform Act of 1986, the program is a private-public partnership that utilized a tax credit and market investment to ensure quality affordable housing is available across the nation.
The depreciation period for residential rental property is 27.5 years. Like the LIHTC, this recovery period was defined by the Tax Reform Act of 1986. However, it is listed as a tax expenditure because it is “accelerated,” or a smaller period than the less advantageous 39 year period assigned to commercial real estate.
The capital gains tax rate is also an important element of tax law for multifamily builders. The recent debate over raising the rate of tax on carried interest revealed the economic harm that would occur if the tax rate assessed against the sale of residential rental property was increased. Some tax reforms proposals have suggested taxing all gains at ordinary income rates. Doing so would have an immediate negative impact on the prices of residential rental and commercial real estate properties.
Finally, some commissions, such as the President’s Economic Recovery Advisory Board, which reported in August of 2010, recommended limiting the ability of businesses to deduct interest expense allocable to business debt. Such proposals ignore the differing importance of debt financing for various sectors of the economy, including notably real estate. Financing costs for real estate are very high compared to other economic activities, and the role of debt is critical, especially for small businesses.