March 6, 2014
Camp Releases Tax Reform Discussion Draft:
Supports REIT-Based Real Estate Investment, but Includes Restrictive REIT and Real Estate Provisions
In the midst of NAREIT's 2014 Washington Leadership Forum on Capitol Hill last week, Rep. Dave Camp (R-MI), chairman of the House Committee on Ways and Means, released his comprehensive discussion draft on tax reform (Camp Discussion Draft) consisting of 720 pages of technical explanations and 1,000 pages of statutory language. Release of the Camp Discussion Draft follows after almost three years of Camp-driven hearings, meetings and highly targeted discussion drafts.
Camp's draft plan, as described in a 200-page section-by-section summary, would lower the corporate tax rate to 25 percent from 35 percent. It would also lower the maximum individual rate to 25 percent from 39.6 percent, but with the addition of a 10 percent surtax on joint filers with income above $450,000, amounting to a top 35 percent tax rate for such taxpayers. According to the Camp Discussion Draft, most dividend and capital gain income would be subject to ordinary income tax rates, and receive an 40 percent exclusion in calculation, meaning a top rate of 21 percent. REIT dividends would continue to be taxed at ordinary income tax rates, with only REIT dividends attributable to certain items such as distributions from taxable REIT subsidiaries meeting the qualified dividend tests, the same as under current law.
To achieve these lower rates on a revenue neutral basis, the Camp Discussion Draft would "broaden the tax base" by ending most corporate and individual income tax credits, and by ending or curtailing a large number of individual and business-related deductions from income.
The Camp Discussion Draft continues longstanding tax policy support for REIT-based real estate investment; also indicating it strives to make REITs more attractive. However, the Camp Discussion Draft contains a number of proposed changes to the REIT rules and related provisions, as well as to rules important to real estate investment generally, several of which appear to be at odds with this desire, which are unwelcome and which would unduly and inappropriately restrict or constrain REIT-based real estate investment.
In considering the Camp Discussion Draft, it is important to keep in mind that it is a discussion draft rather than a bill introduced in Congress; and, it appears unlikely to move forward in any significant manner this year. It is also notable that Congressional leaders have not embraced the draft and have indicated it is exceedingly unlikely that Congress will address tax reform this year.
Here is a short summary of the provisions in the Camp Discussion Draft most relevant to REITs and real estate investment.
1. Definition of REIT-eligible Real Estate Would Be Limited
The Camp Discussion Draft would require real estate other than land under the REIT asset test to have a depreciable class life of at least 27.5 years. Under this test, telecommunication towers and billboards, among other types of property, would not be considered real estate under the REIT rules. In addition, the Discussion Draft would exclude timber as qualifying real estate under the REIT rules.
2. Taxable REIT Subsidiary (TRS) Limit Would Be Reduced
The Camp Discussion Draft would reduce the amount of gross assets a REIT could hold as stock in taxable REIT subsidiaries from 25 percent to 20 percent.
3. Tax-free Spin-offs Would Be No Longer Available to REITs
Under the Camp Discussion Draft, the tax-free spin-off rules would not apply when a non-REIT C corporation distributes the stock of a REIT (including a non-REIT corporation that elects REIT status within 10 years following the spin-off) to its shareholders or when a REIT distributes the stock of either a REIT or a non-REIT corporation (including a taxable REIT subsidiary) to its shareholders. Accordingly, both the distributing corporation and its shareholders would be subject to tax.
4. Cash Distributions of Pre-REIT C Corporation Earnings and Profits Would Be Mandatory
A non-REIT corporation electing REIT status must distribute the earnings and profits earned in the years before it is a REIT to its shareholders before the end of its first year as a REIT. A similar rule applies when a non-REIT corporation becomes part of a REIT in a tax-free transaction such as a merger. The Camp Discussion Draft would require these "purging" distributions to be made in cash rather than a mix of cash and REIT stock.
5. Built-in Gain Would Be Immediately Recognized Upon Conversion to REIT or Upon Acquisition by a REIT
Under current law, if a non-REIT corporation elects REIT status, the gain stemming from the excess of value of the corporation's assets over its tax basis (the Built-in Gain) is not triggered unless the REIT sells those assets in a taxable transaction within ten tears of the REIT election. Similar rules apply when a non-REIT corporation transfers assets to a REIT when the REIT adopts the transferor's tax basis in the assets (such as a tax-free merger, but not including a like-kind exchange). The Camp Discussion Draft would require any such Built-in Gain to be immediately recognized by the REIT.
6. Percentage Rents and Interest Limited if not Sufficiently Diversified From Tenants
Under the current REIT income test, qualifying real estate rents do not include amounts based on the income or profits of a tenant (other than rents based on a fixed percentage of receipts or sales). The Camp Discussion Draft would tighten this rule by excluding as qualifying rent under the REIT rules any fixed percentage rents received by the REIT from any C corporation if more than 25 percent of all the fixed percentage rents or interest payments received by the REIT in a taxable year are received from a single C corporation (other than from a taxable REIT subsidiary).
7. Several Provisions of the Update and Streamline REIT Act (U.S. REIT Act) Would be Included
The Camp Discussion Draft incorporates many of the provisions that were in the NAREIT-backed H.R. 5746 that was introduced in the previous Congress. These provisions include repealing the preferential dividend rules for SEC-registered REITs; treating ancillary personal property leased with real estate (e.g., kitchen appliances in an apartment) to be considered real estate under the REIT asset tests; and, making it easier for a REIT to acquire distressed debt instruments without violating the REIT income tests.
Real Estate Investment Proposals
1. Like-Kind Exchanges Would End
Similar to the staff discussion draft issued by Baucus last year, the Camp Discussion Draft would eliminate Section 1031 of the tax code, and thereby end all tax deferral associated with like-kind real property exchanges.
2. Depreciation/Cost Recovery Lives Would be Extended
The Camp Discussion Draft would extend the depreciation periods for all real estate to 40 years, thereby increasing the period for residential real estate from 27.5 years to 40 years and for non-residential real estate from 39 years to 40 years. In addition, the Camp Discussion Draft would permanently end the special 15-year depreciation period for leasehold improvements.
3. Real Estate Would No Longer Qualify as an Asset for Publicly Traded Partnerships
The Camp Discussion Draft would end the use of real estate as a qualifying asset for publicly traded partnerships, meaning that such partnerships would be taxed as corporations.
4. Depreciation Recapture Would be Taxed as Ordinary Income
The Camp Discussion Draft would eliminate the special 25 percent depreciation recapture tax rate and, instead, would tax all depreciation recapture as ordinary income.
5. Energy Efficient Commercial Building Deduction Ended Permanently
The Camp Discussion Draft would end permanently the Section 179D deduction.
6. State and Local Taxes
The Camp Discussion Draft would repeal the deduction of state and local taxes (including property taxes) for individuals, but it would not change the deduction of such taxes if they are incurred in a trade or business.
Financial Instrument Rules
In its financial instrument provisions, the Camp Discussion Draft adopts many of NAREIT's prior suggestions in connection with an earlier targeted discussion draft to manage the potential for "phantom income" applicable to equity and mortgage REITs due to the use of derivatives.
International Tax Rules
NAREIT commented on REIT-related aspects of the earlier targeted discussion draft on international taxation. The Camp discussion draft addresses some of the NAREIT-identified issues.
Unlike the Baucus discussion draft, issued in November 2013 by the now-departed Senate Finance Committee Chairman Max Baucus, the cost recovery proposed changes in the Camp Discussion Draft generally would not apply to investments made before 2016. However, some of the proposed changes, which would target non-REIT corporations converting into or merging with REITs, would apply to transactions consummated after the day the draft was released (Feb. 26, 2014).
NAREIT will organize a variety of member task forces to review the Camp Discussion Draft to ensure our industry follows up appropriately with Chairman Camp, his staff and other Members of Congress, especially with respect to the specific proposals which are unnecessarily restrictive and contrary to support for competitive, healthy and vibrant REIT-based real estate investment. As the dialogue on tax reform moves forward in the years ahead. NAREIT looks forward to working closely with all members of the REIT community to ensure policymakers fully understand the important role REITs serve in the economy and for savers and investors from all walks of life.
If you have any comments or questions, please contact Tony Edwards, NAREIT's EVP & General Counsel, at email@example.com.
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