It's not a question of whether the "barking dog" known as 1986's historic tax reform "bites," or not. He does.
But, as the smoke clears, evidence also mounts that the bite damage to the average, relatively small real estate investor will be skin-deep at worst.
The key phrase, however, is "average, relatively small." In the higher income strata the bite deepens.
"I may be the only one in the real estate industry who thinks that it's terrific. But I love it!" That from Marvin Starr, editor of the prestigious Oakland-based The Real Estate Tax Digest.
"The surprising thing about it is how little of the conference committee's report, quantitatively, was devoted to real estate. Qualitatively, yes, it was significant, but I'll tell you now, there will be more tax benefits in real estate, relative to other investments, than under the old law."
High Roller Risks
Where blood will be seriously drawn, observers say, will be largely confined to the ranks of the high rollers: developers and syndicators who proceed (or have irrevocably gotten themselves involved) with real estate projects that "don't pencil out on the bottom line" without the ability to write losses off against other income.
But again back to the average real estate investor--from the mom and pop landlord with two or three rental units to the professional seeking a diversification in his investment portfolio, or to the small investor buying a few units in an income-oriented real estate limited partnership. The impact of the proposal that is expected to be signed into law next month should be "modest," "insignificant," "negligible," experts feel.
What has unduly frightened some small real estate investors, Starr concedes, "is the language of the bill, which is ambiguous, misleading and extremely confusing to the public. It's this suggestion that all rental income property is a 'passive' investment without any regard for how active you actually are that throws people.
Passive Income Category
"The key to the whole thing for the small real estate investor is whether your income does, or doesn't, exceed $100,000. If it doesn't, then you can write off up to $25,000 in real estate losses against other income. It's the single exception to what is otherwise categorically and arbitrarily determined to be passive income."
A curious irony here: While the investor using a professional property management firm to handle his rentals has the freedom to write off losses up to $25,000 against other income (which is gradually phased out when the taxpayer's income reaches $100,000 and totally eliminated when it hits $150,000), the investor with an income in excess of that but who works as his own property manager 24 hours a day can write off his losses only against rental income generated. So much for the fine-line "active" and "passive" distinctions.
"Most small real estate investors," Starr adds, "aren't in it to generate big tax losses. They're after income, they've got moderate leverage, and their income normally exceeds their expenses, anyway."
The impact of the legislation on one favorite avenue for the small real estate investor--the vacation home rented out sporadically--also seems minimal, but with one important proviso, according to Joe Knott, partner in charge of tax practice for the Los Angeles office of the Kenneth Leventhal & Co. accounting firm.
Put in Business Category
"If he occupies the home for more than 14 days a year--or more than 10% of the time actually rented, whichever is greater--then it classifies as a second home and, against the income generated, he can offset allocated interest, taxes and other expenses, but not below zero, of course."
Occupying it no more than 14 days a year for personal use, Knott continues, typically puts it in the business category, as under present law, and subjects it to the same new rules governing any rental-income property--and the same $25,000-a-year write-off and $100,000-a-year income rule mentioned earlier.
"But here," according to Gary Fowler, president of Beverly Hills-based Fowler Investment Inc., international real estate consultants, "the situation could get a little sticky for a lot of people. Because, when you're talking about second homes used as rentals in places like Palm Springs, you're also talking about a lot of people with incomes clearly in excess of $100,000."
And at that point the "active-passive" rule kicks in and passive losses--interest deductibility, homeowner's fees, insurance, maintenance, depreciation, etc.--can be written off only against active income generated. And the typical vacation home, under the best of circumstances, rarely produces a positive cash flow.
"This could impact billions of dollars in second-home developments," Fowler adds.