Is that most sacred of all real estate sacred cows, the tax deductibility of mortgage interest on a personal residence, about to bite the dust?
The National Assn. of Realtors, an organization with the capability of spotting toes in doors from two miles away, is convinced enough of it to launch a national blitz, zeroing in on a House Ways and Means Committee proposal that, swept up in the current debt-reduction frenzy, would for the first time, put a ceiling on such deductions.
Another target with even more immediate impact: the "as good as dead" blow to the tax-deferred exchange of income-producing real estate.
At first blush, Stephen Driesler, senior vice president of government affairs for the NAR, told The Times the proposed ceiling on mortgage interest deductibility--$1 million--would seem to have such limited applicability that the public, generally, would ignore it.
Based on Total Debt
"But it's disarming," Driesler said, "because it doesn't refer to a $1-million cap on the interest payments that can be deducted, but on the total, aggregate debt of both the taxpayer's primary and secondary, homes."
While this would still leave the majority of home buyers unaffected, he conceded, the move was labeled as "a dangerous precedent," by Sen. Lloyd Bentsen (D-Tex.), whose Senate Finance Committee flatly rejected all real estate-oriented tinkering. But, the NAR's Driesler said, it leaves the fuse on the measure still sputtering as it goes into a conference committee, perhaps as early as late November.
As originally proposed by Rep. Sam Gibbons (D-Fla.) the amount of mortgage interest that any taxpayer could deduct in a year was limited to $15,000, but when the unpalatability of this led 1953439857repeated efforts within the Ways and Means Committee to change the cap from $1 million to $500,000. And it is the ease with which any sort of cap can be yo-yoed like this, once the issue is on the table, that disturbs the NAR.
"Once any kind of a threshold gets established," Driesler said, "it becomes very easy to raise it or lower it at will. You've got perfect examples of this in the federal income tax, social security, depreciation allowances and on and on."
While the impact of the toe-in-the-door attack on mortgage interest deductibility, feared by the NAR, could take awhile to sift down enough to hurt the average home buyer, the virtual death blow to the tax-deferred exchange of commercial real estate would be almost instantaneous with passage of the proposal.
"Since the change in the treatment of capital gains," according to Richard L. Sevin, president of American Deferred Exchange Corp., 6380 Wilshire Blvd., "tax deferred exchanges have been fueling the entire real estate economy. Putting a $100,000 ceiling on the profit that can be realized from such an exchange would simply make the whole procedure prohibitive.
"As a means of creating the type of revenue that they see coming out of this," Sevin added, "the House Ways and Means Committee is being completely unrealistic. If people can't exchange property profitably, then about 85% to 90% of them simply aren't going to do it, so where's the revenue?"
And the NAR's Driesler sees the tax deferred exchange proposal as being "particularly unfair since the parties involved get hit at both ends--they don't get the tax advantage of depreciation and they're working on a lower tax base."
Exchange Defers Taxes
Currently, for instance, Sevin said, a developer who has seen his office building treble in value, from $1 million to $3 million, would face a tax bill on his $2 million gain in a conventional sale that might range from $560,000 (28%) to $660,000 (33%).
But by utilizing the tax-deferred exchange--although an intricate, finely-tuned procedure involving a third party between the two exchanging partners--the tax that would otherwise be incurred can be deferred indefinetly by trading his $3 million building for similar property of like value.
"The proposal to put a $100,000 cap on the profits involved in a transaction," according to Driesler, "hits particularly hard at the properties that are in the most trouble right now.
"For instance, let's say that I've got a property worth $1 million, but it's highly leveraged--I've got a debt burden of $800,000--but because of vacancies and the size of the debt there's a heavy negative cash flow. I can't afford this, and so I find a smaller property, worth perhaps $400,000, where the owner has about $200,000 in equity. But he's willing to trade his equity for mine, so I'll have either a positive cash flow or, at least, a smaller negative cash flow I can live with.
Kills Exchange Strategy
"But this would be impossible under this new proposal. I'm going to be hit with a big tax bill even though in the exchange I didn't get a dime in cash. I'm going to have to pay the tax out of my cash reserves, which I obviously don't have."
Even in a more conventional situation, however, the new proposal effectively kills off the deferred exchange strategy, Driesler said.
"I've got a property for which I paid $1 million and it's worth $1.3 million now. The basis I would get for depreciation is only $500,000. So, what happens if I exchange it? I'm getting hit at both ends: I'm going to have to pay taxes on it as if I'd sold it for $1.3 million, but I'm not getting the depreciable basis."