Expert Sees Tax Reform in Good Light

You can pick your own degree of gloom or joy in wondering how real estate might suffer from tax reform.

One authority’s pessimistic guess is that “real estate will operate under the most unfavorable tax conditions in 50 years.”

Another suggests that the “tax reform panic may create opportunity for real estate investors.”

And then, in between, are all those usual “mixed reactions.”

But Anthony Downs, senior fellow at the Brookings Institution, in Washington, has a strong opinion on what may occur in the wake of tax reform and, writing in the August issue of Urban Land, the monthly publication of the Urban Land Institute, he says:

“With the exception of homeownership and housing for low-income households, there is really no compelling reason why the real estate industry should enjoy any particular tax or other advantages over alternative types of investments. The fact that the industry generates a lot of jobs and revenues is really irrelevant; so would whatever other activities sprang up if investors spent more of their funds on something else.

“Treasury II recognizes this situation and tries to reform the existing tax system in a reasonably equitable manner.

“If passed, it would harm some elements of the real estate industry substantially but it would leave the basic nature and functions of the industry intact--and perhaps even in a healthier condition than their present one.”

Shift of Tax Burden

What would tax reform do for overall economic conditions? Downs lists seven essential points:

--Reduce marginal tax rates for both individuals and corporations.

--Reduce tendencies of investors to use capital on the basis of tax considerations.

--Shift some of the overall federal tax burden from households to corporations.

--Shift a significant part of the federal tax burden ($33 billion as of fiscal 1988) to state governments by prohibiting deduction of state and local income and other taxes from federally taxable income by individuals and households while businesses could still deduct state non-income taxes.

‘Revenue Neutrality’

--Make borrowing money somewhat less attractive and lending somewhat more attractive.

--Reduce total federal revenues compared to the present tax system, thus violating its supposed “revenue neutrality.”

--Finally, it would not help resolve the major problems of continuing large federal budget deficits.

Downs more specifically believes that construction of new rental housing would decline. “The profitability of building new rental housing would fall enough to curtail sharply new building of such units for at least two years. A major cause would be unavailability of tax-exempt financing for such housing. But this drop in new construction would not cause any immediate, spectacular jump in residential rents,” he said.

Rent Raises Seen

The National Apartment Assn., takes immediate issue with that opinion, however, believing that rents could be raised--after enactment of the tax bill--by as much as 22%, if owners want to maintain current yields in their investment.

Generally, Downs continues, equity ownership of income real estate--apartments and non-residential properties--would decline somewhat in relative desirability as an investment compared to many corporate stocks and most taxable bonds. Consequently, pension funds and other major investors would slightly reduce their allocations of funds to equity real estate compared to stocks, bonds and mortgages or mortgage-backed securities.

He foresees dramatic shifts by investors to long-term equity ownership from tax sheltered properties. One of the goals of the Reagan Administration is to diminish the attraction of real estate tax shelters, and while the current Treasury II plan does not accomplish this goal as fully as the initial Treasury plan, “it nevertheless gives pure tax-shelter investing a strong kick in the teeth,” according to Downs.

Good News for Builders

The proposed tax bill would enhance the ownership of homes, compared to renting. That would be good news for builders and home sales agents and brokers. As tax benefits lessened for tax-sheltered housing construction, pressures on rents would increase, “tilting the balance of attractiveness back to homeownership.”

His conclusion:

“I believe the nation needs tax reform so badly that now is the time to pass it. Treasury II can be improved upon in the legislative review process. But even in its present form, it is far superior to the current tax system. So something like it deserves the broad support of the American public, including the real estate industry.”