WASHINGTON : Tax Ruling Could Put Squeeze on Developers’ Cash Flow
If real estate developers do not have enough to worry about with soft markets and a nationwide credit crunch, they can now fret over higher tax bills.
But their plight has a sympathetic ear in Washington. Sens. David Pryor (D-Ark.) and Steve Symms (R-Idaho) plan to introduce the Real Estate Fairness Act of 1990 on Tuesday in an attempt to allow developers to continue to calculate their taxes on economic gain as they have for decades.
The legislation is intended to address the Internal Revenue Service’s recent reinterpretation of a 60-year-old law in a way that could double the tax bills of developers if not reversed.
Since 1928, the law governing the sale of subdivided land has held that estimated costs of future improvements may be included when establishing the basis of the sold property as long as the improvements are required by contract. It is fairly typical for a developer to operate with a negative cash flow in the early stages of a project. Initial sales then pay for the land improvements to come.
The IRS has decided that developers can no longer use the projected cost of land improvements to offset profits of the sale of their properties unless the improvements have been completed. This is the new interpretation even if the developers are obligated by contract to build roads, construct parks or install sewer lines.
In other words, in the past, if a developer paid $500 for a lot and resold the land for $1,000, while contracting to make $250 worth of improvements, he was liable for taxes on the $250 profit. Under the new IRS plan, he must pay taxes on the gain of $500 if the improvements have not been made.
“This couldn’t come at a worse time,” said Ken Kies, tax counsel for the American Resort and Residential Development Assn. “For many developers already caught in the credit crunch, cash flow is already a problem.”
Tom Franks, senior vice president of the developers’ trade group, said: “The interesting thing is that there has not been any pattern of abuse here. We see no justification to change a law that has worked fine for 50 years now.”
“The situation is a real cash flow problem,” said Jeff Trinca, Pryor’s legislative aide. “Now, a developer’s line of credit will have to include money to make improvements. Before, you could sell off a third of the lots to pay for the improvements on all. If the law says you have to improve the property up front before you can get the tax benefits, it will just add to the industry’s problems.”
Both the industry and the two senators hope that the problem can be ironed out at an IRS hearing scheduled for late October. If it cannot be solved by reinterpreting the regulations, the fight to restore the old way of doing it will move to Congress.
The Battle Rages Over Purchasing Law
The 1988 law regulating how the government spends $200 billion a year for everything from tanks to toothbrushes had hair on its chest. But within three months of its enactment, its provisions were suspended in the face of strong opposition, led by the defense industry.
Since then, Congress has waited for the Administration to write the regulations to implement the Procurement Integrity Law. But instead of new regulations, the Bush Administration has written a whole new bill that does away with the earlier law and has sparked a new debate.
The 1988 law is scheduled to go back into effect Dec. 1 unless Congress and the Administration can craft a compromise on new legislation or new regulations to implement the law. But those involved in the talks say that the sides are still far from agreement.
Sen. William V. Roth Jr. (R-Del.) introduced the Administration’s new bill 2775, saying little more than “the Administration’s proposal is a good starting point.”
The Senate has tried to buy extra time to work out a deal by approving an amendment offered by Sen. Carl Levin (D-Mich.) to extend the suspension for another six months. But word from the House is that some members are upset with the Administration’s tardy proposal and prefer not to act on Levin’s measure. That would have the effect of reinstating the law on Dec. 1.
Two of the most influential House committee chairmen, Reps. John Conyers (D-Mich.) of Government Operations and Jack Brooks (D-Tex.) of Judiciary, are said to prefer the tougher provisions of the 1988 law over the Administration proposal.
Meanwhile, under pressure from Brooks and Conyers, the Administration published draft regulations for the existing law late last week.
The suspended law would do three major things. First, it would prohibit contractors or government employees from accepting gifts or gratuities during the course of a contract or employment. They would even have to bring their own coffee and bagels to meetings with outsiders.
Second, it would prohibit the release or acceptance of any sensitive inside information. And third, it would deal with the revolving-door issue by prohibiting government employees from working on contracts that they had negotiated for two years after leaving the government. It would not, however, prohibit a former employee from working for a private company on another contract.
The suspended law also had strict penalties. If caught violating the provisions, a company could forfeit its government contact and face debarment from further government business. Both companies and individuals involved also could face substantial fines.
The Bush Administration has complained about the “cumbersome, duplicative and burdensome structure” of the measure.
The White House proposal covers only the protection of inside information and leaves the issues of gifts, gratuities and the revolving door to existing criminal, civil, and regulatory prohibitions.
“The suspended law has enormous ambiguity and stifled communication between contractors and the government,” said Lorraine Lavet, director of procurement policy at the U.S. Chamber of Commerce. “The chamber supports the Administration’s package because of its clarity and simplicity. Yet it still has strong language. It is to our advantage in industry to be able to train our employees about exactly what they can and cannot do.”
And from the other side, a congressional source said: “This whole system is based upon an open competitive environment where no company is favored over another. When a government employee receives gifts, however small, from the very people with whom he is negotiating a contract, it undermines the integrity of the system. If a contractor hears that a government employee was wined and dined by his competitor who won the contract, he is going to believe the worst, not that his competitor had the best product at the best price.
“When people start to believe that, it corrupts the system. The system runs on good faith and if its participants feel it is corrupt, they will behave accordingly.”
