Real Estate Investors Hope to See Tax Break Restored

When President Clinton told an economic conference at the Biltmore Hotel in Los Angeles this week that he would like to change the tax treatment of “passive” real estate losses, he touched on an arcane subject dear to the heart of property investors and developers.

Builders and real estate investors seem to have found a friend in the President, who has been calling for at least a partial restoration of the passive-loss deduction for more than a year.

Though he gave no details, Clinton has said in the past that reviving this tax break would boost the economy by spurring construction of thousands of new buildings, from small apartments to high-rise office towers.

Passive losses once allowed real estate investors to deduct huge paper losses--usually much larger than the actual losses--from their real income. These deductions resulted primarily from the accelerated depreciation of buildings.

Deducting passive losses helped fuel a building boom in the 1980s as wealthy investors--seeking to shelter their income through limited partnerships--poured billions of dollars into commercial real estate.

But the Tax Reform Act of 1986 put stiff new restrictions on the deductibility of passive losses that effectively brought the practices to a halt. Property values plunged as investments slowed dramatically.

The reform “took away nearly all the tax benefits of investing in rental property,” complained Russell K. Booth of the National Assn. of Realtors, a trade group that has lobbied to have the passive-loss deduction restored.

Restoring the passive-loss deduction would not lead to an immediate boom in the construction of office buildings in Southern California, since there is already a glut of commercial space for rent, most analysts believe.

However, others say renewal of the deduction could provide a boost for the Southland’s apartment market.

“Moderate- and middle-income apartment construction has been dead in the water, especially in Southern California, because there’s just been no tax incentive to build them,” said Bill Ellingsworth, a vice president with the National Assn. of Home Builders. “Giving the tax incentives back will finally make those kinds of projects viable again.”

Small investors, however, might not benefit even if the deduction for passive losses are restored.

Shortly before Clinton addressed Congress on Wednesday night, reports were circulating on Capitol Hill that he plans to revive the deduction only for investors who spend at least half their time building, buying or managing property--similar to a plan that was introduced in Congress earlier this month.

Reviving the deduction would “help a lot of developers and owners of big apartment buildings, because they’re in the business full time,” said Joe Knott, a partner in the Los Angeles-based consulting and accounting firm of Kenneth Leventhal & Co. “But if you’re a ‘little guy’ who might own a couple of small rental properties, you’re probably not going to qualify because it’s doubtful you spend half your time managing your property.”