May 19, 2016
Yesterday Senator Ron Wyden (D-OR), Ranking Member of the Senate Finance Committee, released a discussion draft tax proposal that would require mark-to-market for derivative financial instruments, i.e., requiring taxpayers holding derivatives to treat the derivative as being exercised at the end of each year, thereby triggering taxable gain or loss. Also released was a one-page summary and a section-by-section summary. As requested by NAREIT in comments provided to the tax writing committees, the proposal includes an important exception relevant to REITs and real estate interests. Specifically, the statutory draft exempts from the definition of “derivative” common real estate transactions pending over the end of the calendar year.
Proposal Requiring Mark-to-Market Taxation for Certain Derivative Contracts
Former Chairman Dave Camp’s (R-MI) tax reform legislation (H.R. 1) and the annual Obama budgets have contained proposals to require mark-to-market taxation and ordinary character for the resulting income for certain derivative contracts. These prior proposals could have clearly created “phantom income” issues for REITs that utilize derivatives but could also have impacted common commercial transactions that are not typically considered derivative contracts. This would have been particularly problematic for REITs because if a REIT made a contract to sell a portfolio of properties in November that was set to close in the first quarter of the following year, the REIT would have had to take any increase in the value of the contract into account as ordinary income in December and therefore would have had to make a distribution even though it would not have had cash from the sale to distribute.
NAREIT submitted detailed comments on these issues to the House Ways and Means Committee and the Joint Committee on Taxation. Chief among NAREIT's recommendations in the comment letters was a request for an exception that would ensure that common real estate transactions, e.g., executing a sales contract, pending over the end of the taxable year would not be required to mark-to-market for income tax purposes. NAREIT also requested an exception for TBA contracts entered into by mortgage REITs which facilitate the interest rate lock market for residential home buyers.
The Wyden financial products discussion draft released yesterday provides a real estate exception for “contracts with respect to interests in real property (as defined in [the REIT rules in] section 856(c)(5)(C)) if such contract requires physical delivery of such real property.” Moreover, the Joint Committee of Taxation’s Technical Explanation indicates that the proposal intends to exempt from the definition of “derivative” “contracts that facilitate the sale or purchase of physically delivered real property.” While not explicitly stated, it appears that TBA contracts may not be treated as derivatives because they facilitate the sale or purchase of residential real estate that will be physically delivered to the homeowner.
NAREIT appreciates Senator Wyden taking its comments into account in formulating this proposal and we look forward to continuing this dialogue with policymakers. Senator Wyden has requested comments on all aspects of the discussion draft as well as other topics on the taxation of financial products within 90 days of this release (or August 17, 2016). Please click here if you would like to be on the task force evaluating this proposal. If you would like to discuss this issue please contact NAREIT's Executive Vice President & General Counsel, Tony Edwards, at email@example.com; NAREIT's Senior Vice President, Policy & Politics, Cathy Barre, at firstname.lastname@example.org; or NAREIT's Vice President & Senior Tax Counsel, Dara Bernstein, at email@example.com.