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New Study Slams Proposed Tax Hike

New Study Slams Proposed Tax Hike

The latest assault in the heated battle over legislation that could double taxes on real estate partnerships and private equity firms comes in the form of a new study that argues the law would squeeze $5 billion in additional taxes from real estate investors alone.

The study, released in November by the Real Estate Roundtable, a trade group based in Washington, D.C., also asserts that the law would weaken commercial real estate markets by prompting investors to pass on projects that don't offer a “competitive return,” specifically marginal projects in less desirable locations. But advocates of the tax change disagree with the study's basic premise.

At stake is the treatment of income for general partners, who manage partnerships. Usually, they're compensated with fees and a share of the partnership profits. Those profits are typically “carried” with the partnership until partnership property is sold.

Currently, that so-called “carried interest” is taxed at the capital gains rate of 15%. Under proposed legislation, it would be taxed as ordinary income, which could drive up the rate to as high as 35%.

The U.S. House of Representatives has already passed the proposed measure. The U.S. Senate, however, has yet to vote on it. Majority Leader Harry Reid (D-Nev.) has said a Senate vote may be delayed until after the chamber's December recess.

Advocates have portrayed the change as closing a tax loophole on flamboyant Wall Street investors who make millions by investing private equity in large deals.

But the bill isn't targeted only at Wall Street hot shots — it would affect general partners of all partnerships, including those investing in real estate. That's what prompted the Real Estate Roundtable to commission the economic analysis of the legislation.

Other key findings:

  • The change would encourage heavier use of debt to finance projects; that increase in leverage would make the real estate sector more financially fragile.

  • Higher taxes would reduce real estate partnerships' ability to attract quality managers who can make their capital productive. “Inevitably, the lower quality management will diminish performance,” the study concludes.

  • Workers would also be hit because the change would reduce the number of jobs in construction and real estate, and lower their earnings.

The study is “misleading,” says Aviva Aron-Dine, a policy analyst at the Center on Budget and Policy Priorities, a think tank in D.C. that supports the change. She says one of the study's main assumptions — that the legislation discriminates against real estate partnerships — is faulty. Instead, the current tax treatment amounts to a subsidy that provides preferential treatment to real estate partnerships, she argues.

Aron-Dine also sees no problem with fewer projects being undertaken as a result of the change. If real estate partnerships invest in marginal projects because a “special subsidy” makes them worthwhile, that's a sign of economic inefficiency, she argues.

A former member of President Reagan's Council of Economic Advisors who supports the tax increase, William A. Niskanen, is also standing firm after reading the study. Niskanen, chairman of the Cato Institute in Washington, D.C., says he hadn't thought much about whether real estate partnerships should be taxed differently than private equity or hedge funds before reading the study.

“But the information in the report doesn't convince me that they ought to be [taxed differently],” he says. “My general position on carried interest hasn't changed.”

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