THE NATION’S HOUSING : New Tax Law to Benefit Some Rental Owners

Real estate emerged as one of the big winners in Capitol Hill’s recent 1993 tax-law marathon. But whether you personally walked away a winner depends entirely on what property you own, what you want to do with it and what you do for a living.

Here’s a quick guide to figuring how you stack up under the sometimes-tricky real estate provisions of the new legislation.

Top issue on many property owners’ list: Changes to the tax code’s controversial “passive loss” rules. The changes may not touch you, though, unless you fit--or can manage to fit yourself into--this profile:

--You own rental real estate in some form. That can mean anything from a condo at the beach or a ski resort to a downtown office building.

--You can demonstrate that you are actively engaged for over 50% of your annual work time--and over 750 hours a year--in a “real property trade or business.” What’s that? The definition includes real estate agents and brokers, builders, renovators and managers. A key limitation: If you are an employee in these activities--i.e., you don’t hold at least a 5% ownership stake in the business activity--you don’t qualify.

If you meet these tests, though, here’s what the new law does for you: It allows you for the first time since 1987 to deduct your rental real estate losses against your regular income--from your salary, commissions, bonuses and the like.

Say you own several rental properties that lose a combined $40,000 a year due to softness in the market and high property taxes. These are not paper losses; they’re real dollars out of your pocket. Under the passive-loss rules of the 1986 Tax Reform Act, you’ve been prohibited from deducting these losses against your regular (“ordinary”) income, even if all or part of that income is derived from other areas of your real estate activities. Instead you’ve had to defer your rental property losses--put them on ice--until you can either sell the real estate or generate net passive income.

With the changes just enacted, as of Jan. 1, 1994, you’ll be able to write off as much as the full $40,000 in losses against your ordinary income, no matter what its source. But you’ve got to fit the profile--and that could call for what accountants refer to as creative tax planning. For example, say you’re an executive or professional facing the prospects of higher tax brackets under the 1993 law. If you own passive-loss-producing rental real estate, you might be able to shelter part of your ordinary income if your spouse--with whom you file tax returns jointly--fits the real estate occupation definition above.

If, for instance, he or she becomes a real estate agent--earning commissions as an “independent contractor” (non-employee) affiliated with a broker--your joint return may qualify under the new passive loss rules. Here’s a big caveat: Check out your specific situation with an accountant or tax attorney. In the words of Leonard E. Hutner, a partner in the Washington, D.C., accounting firm of Bond Beebe, “you better be able to justify your use of the (real estate trade or business) definition and demonstrate the 750 hours because the IRS is going to be looking hard” at this new tax loophole.

A final note on passive losses: Property owners with adjusted gross incomes of $100,000 or less can continue to write off up to $25,000 per year in losses from rental real estate activities, regardless of occupation. Owners with incomes up to $150,000 can continue to deduct smaller amounts under a phase-out formula.

Other major tax-law changes that could affect you as a real estate owner, buyer or seller:

--If your lender forgives a portion of your outstanding mortgage debt as part of a “workout” to save you from foreclosure, the IRS no longer will automatically count the forgiven dollars as taxable income. Known as the “phantom income” problem, this tax policy encouraged owners of properties in depressed markets to abandon them--literally to mail the keys to the lender--rather than negotiate debt forgiveness. Under the 1993 revisions to the law, owners will be able to subtract the debt reduction from their “basis” or tax cost in the real estate. This will postpone taxation on the debt reduction until they sell the property--and have the cash to pay Uncle Sam.

--Capital gains taxes on all forms of real estate remain capped at 28%, despite jumps in taxes on both personal and corporate income. That differential could make real estate at least marginally more attractive as an investment than it currently is.

--Low-and moderate-income housing renters, buyers and investors should reap big benefits from Congress’ permanent authorization of the low-income housing tax credit (construction and rehab of rental properties) and mortgage revenue bonds for first-time home buyers and low-cost rental real estate.

--Pension funds, a huge potential source of new money for housing, will be encouraged to buy stock in real estate investment trusts (REITs), thanks to removal of some technical barriers contained in the current tax code. That, in turn, could eventually boost demand and property values for rental apartments and commercial real estate in numerous markets around the country.