As Congress looks at overhauling the nation’s tax code, the multifamily industry may become a collateral victim.
The bipartisan “super committee,” formally called the Joint Select Committee on Deficit Reduction, is charged with finding $1.2 trillion in deficit cuts by Thanksgiving. And several tax programs and provisions that multifamily owners and developers have enjoyed for years may be on the chopping block.
The low-income housing tax credit (LIHTC) arena is the most obvious segment of the industry that could be directly affected by the super committee’s recommendations and subsequent tax reform efforts. But industry trade groups like the National Multi Housing Council (NMHC) are keeping a close watch on at least three other areas critical to multifamily owners and developers—partnership taxation, carried interest, and the business interest deduction—that could also be compromised.
The LIHTC program is probably the most successful public/private enterprise in the history of our nation’s housing finance system, helping to create more than 2.4 million units since its introduction in 1986. But the program represents one of the government’s larger tax expenditures, making it a target in any deficit-reduction talks. Earlier this year, Sen. Tom Coburn (R-Okla.) called for eliminating the program, saying it would save at least $57 billion over the next decade. But that effort was an outlier—the program also enjoys broad bipartisan support in Washington, D.C. So it’s not as though the program will suddenly disappear—but it certainly may be trimmed back.
“One of our top priorities as an association is to protect, defend, and maintain the credit,” says Matthew Berger, vice president of tax at the Washington, D.C.–based NMHC. “There is widespread support for it on the Hill, but everything is on the table right now.”
The NMHC is calling for the 9 percent LIHTC program—which expires at the end of 2013—to be made permanent, so that the investor community can plan for the future with more visibility. And the council is also seeking to expand the applicability of the 4 percent credit so that it could be used for acquisitions in addition to new construction and rehabilitation.
There’s widespread agreement in Congress that the corporate tax rate has to come down. At 35 percent, the United States has the second-highest corporate tax rate in the world, behind only Japan. And Japan is gearing up to trim its corporate tax rate, so the United States may soon claim the dubious top spot.
Yet, the rate shouldn’t come down at the expense of partnerships, the NMHC says. In many ways, partnerships are the lifeblood of the multifamily industry. But if the corporate tax rate is cut, all of that missing revenue will need to be made up somehow, and certain deductions and credits widely used by partnerships, like accelerated depreciation, may go away.
There are also proposals currently being floated in Congress that would tax partnerships with incomes of more than $50 million under the corporate tax system. But corporations are effectively taxed twice—at the entity level and again at the individual level—while partnerships are only taxed once.
“I’d be worried that it could end up being a fairly sizable tax increase for partnerships,” says Berger. “And that means they would then have less money to invest in planned equipment purchases and employment.”
The Obama administration has proposed eliminating capital gains treatment of carried interest, instead taxing it as regular income. The intent is to rein in irresponsible hedge fund managers, but multifamily developers would get caught in the crosshairs—about 45 percent of the partnerships that would be affected by this change are real estate partnerships, estimates the NMHC.
Carried interest is a critical component of real estate partnerships. Basically, carried interest is a share of profits in a partnership—it’s how general partners in an apartment deal are compensated, a sort of incentive to maximize the performance of a fund. General partners will often receive 2 percent of the fund’s value every year, and, more importantly, they’ll receive 20 percent of the gain.
But how that carried interest is taxed makes all the difference. “If you’re taxed under capital gain, you’re taxed at a 15 percent rate, but if you’re taxed as ordinary income, you’d be taxed at a 35 percent rate under current law,” says Berger. “So that would really cut into your rate of return, and the effect is that you’re going to invest less, or in fewer projects.”
Business Interest Deduction
Some lawmakers posit that the tax code favors debt over equity, which may have led to our economy becoming overleveraged in the run-up to the recession. So, there are proposals on Capitol Hill to remove the deduction for business interest as a way of curbing this perceived disparity.
Under current law, businesses can deduct mortgage interest, thereby lowering an organization’s effective tax rate. But if this law is scaled back or eliminated, it could greatly increase the cost of borrowing.
“If you start cutting back on how much of that interest can be written off, suddenly the cost of capital essentially goes higher,” says Berger. “And if it costs more to borrow, you’ll probably borrow less, or put up fewer buildings.”
Still, despite all the momentum to trim the deficit, the possibility of a true rewrite of our nation’s tax code in the near term is somewhat remote. Next year is an election year, after all, and Congress remains bitterly divided.
“The way that Washington is now, it might be a tall order to do this before the next elections,” says Berger. “But lightning can strike—you never say never.”