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Proposed Tax Change for Real Estate Partnerships Has Investors Seeing Red

Opponents argue that dropping capital gains treatment could damage recovery efforts.

Several major commercial real estate groups are fighting a proposed federal tax provision that they say would have a devastating effect on real estate investment partnerships.

Commercial real estate groups contend that the Tax Extenders Act of 2009 (HR 4213) would more than double the taxes on carried interest received by general partners in real estate partnerships because the carried interest would no longer be taxed as capital gains at 15%, but as ordinary income with rates as high as 35%.

“That's a huge increase at a time when the industry is on the precipice, so to speak,” says Thomas Bisacquino, president of NAIOP, the commercial real estate development association. “There really isn't any real estate-related group that supports it. We're trying to stimulate the industry. We feel it would create a huge impediment.”

The House of Representatives passed the tax extenders bill on Dec. 10, and the legislation now goes to the Senate Finance Committee for consideration. If approved, it would restore a number of tax breaks that expired in December.

Although the bill contains elements that benefit commercial real estate, such as an extension of tax credits for owners who conserve energy through retrofits or who remediate brownfields, the prospective change in policy toward real estate investment partnerships has many investors seeing red.

NAIOP issued a “call to action” to its 16,500 members urging them to contact senators to defeat the proposal. If enacted, it could bring about the largest modification to the taxation of real estate in more than 20 years, since the Tax Reform Act of 1986, NAIOP said in its alert.

The group said the proposed tax change would have an effect far beyond the Wall Street hedge funds whose practices originally gave rise to the proposal.

The Institute of Real Estate Management (IREM), an association of property managers, sent a joint letter with the National Association of Realtors and the CCIM Institute, urging all 100 U.S. senators not to change the current capital gains treatment.

Other organizations express similar concern. “Changing the current capital gains treatment of carried interest would undermine job creation and have a negative impact on commercial real estate values, which would devastate local property tax revenues and put pension fund investments at risk,” says IREM's senior legislative liaison Vijay Yadlapati. “Just as importantly, such a policy would slow the national economic recovery.”

In a recent legislative report, IREM said the loss of capital gains treatment for real estate investment partnerships would turn long established taxation rules upside down and have a profound ripple effect. “Real estate partnerships, from the smallest venture to the largest investment fund, have a carried interest component. Approximately $1 trillion of commercial and residential properties are held by partnerships.”

The tax measure would put additional pressure on the commercial real estate industry at a time when it already faces heavy burdens, IREM noted, including a rapid rise in delinquencies and foreclosures and restricted access to credit.

If the Senate Finance Committee takes action on a tax extenders bill early this year, it's not known whether the carried interest provision will be included in that legislation.?

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