2- Agenda Summary - Taxation Committee
Agenda Summary – Taxation CommitteeFerrante Room II/III – Level Three
Conference Center
Monterey, California
Wednesday, January17, 2007
3:30 p.m. – 5:00 p.m.Presiding:
Robert Kevane, Chair
Ann Throckmorton, Vice Chair
Skip Zeleny, Vice Chair
Susan Tilling, Executive Committee Liaison
Raymond Karpe, NAR Committee RepresentativeCAR Staff:
Christopher Carlisle, Legislative Advocate
Jeff Keller, Public Policy AnalystI. Opening CommentsII. State Taxation IssuesA. Action Items:1. Expanding the “Portability” of Homeowners’ Property Tax Basis May Help Those Seeking to Move Up the “Housing Ladder”
One approach to addressing the housing affordability problem would be to increase the ability ofhomeowners to move up and down the “housing ladder.” Interestingly, while Proposition 13 helps homeowners remain in their homes, it also has the affect of “trapping” them in their homes. This is because each time a homeowner seeks to move up the housing ladder, they have to start over with regard to the protections provided by Proposition 13. In other words, they give up the tax basis on their current home and acquire a higher basis (based on purchase price) of the replacement home. This problem is particularly acute for seniors on limited incomes and resulted in Proposition 60 being placed on the ballot and approved by the electorate in 1986. Unfortunately, Proposition 60 was limited to seniors moving within the same county and few counties are participating in the extension of the Proposition 60 program authorized by Proposition 90 which allows seniors to move across county lines whileretaining their property tax basis so long as the county to which they are moving has agreed to participate in the Proposition 60 program. Another problem with Proposition 60 is that the replacement home must be of equal or lesser value than the originalhome. For many of the same reasons for allowing seniors to retain their property tax basis, consideration could also be given to eliminating the Proposition 60 program’s limitation to seniors so that any homeowner would be able toretain their property tax basis. The loss of revenues to government could be mitigated by adjusting the property tax basis upwards by the difference between the property tax basis of the former home and the basis established by the purchase price of the new home. (Please see attached Issue Briefing Paper.)B. Discussion/Reporting Items:1. Disclosure of “Private” Transfer Taxes
“Private” transfer “taxes” are increasingly being used to settle disputes between environmentalists and builders or, in the alternative, by builders to proactively avoid a lawsuit by environmentalists or to smooth development negotiations with thelocal government. Typically, in return for an agreement by the environmental group to not pursue a lawsuit based on one of the state’s environmental protection acts, the builder agrees to the imposition of one or more PTTs througha covenant included in the covenants, conditions and restrictions (CC&Rs). These PTTs have totaled as much as 1.75 percent of the purchase price of a home and is paid by every buyer of a home in the development for 20 to 25 years or, even, in perpetuity. At the October business meetings, the Board of Directors adopted the final report of the PTTs Task Force which included a recommendation that the Legislative Committee determine in January 2007 whether legislation is needed in connection with the disclosure of PTTs already imposed. C.A.R. is sponsoring legislation to prohibit the imposition of a PTT; however, PTTs established prior to the effective date of that legislation will remain in place and the task force believed that consideration should be given to statutorily requiring disclosure of those PTTs. (Please see attached Issue Briefing Paper.)2. Implementation of AB 2962 (Benoit) Relating to Real Estate Withholding
Until last year, the Franchise Tax Board (FTB) was required to hold 3 and 1/3% of the total sales price in all real property transactions to cover the tax on the gain to the seller of the property. However, AB 2962 was signed into law late last year which allows the seller to elect to instead have the amount withheld be equal to the actual gain to the seller multiplied by the maximum applicable tax rate. C.A.R. supported AB 2962 because the prior system often resulted in over-withholding since the amount withheld did not reflect the actual taxes due on the sale of the property; this measure corrected this defect. Since mid-December, new Form 593-E, Real Estate Withholding –Computation of Gain or Loss has been available on the FTB website. Also available on the FTB’s website is an electronic calculator that mimics the Form 593-E. The seller can use this form to calculate the lossor gain on the property as well as the alternative withholding amount.III. Federal Taxation IssuesA. Action Items:1. Employee Housing Downpayment Assistance
Due to the high cost of housing, employee downpayment assistance programs are becoming more frequent among employers as a means of attracting and retaining employees. However, under current law there are no incentives for employers to offer this benefit and this type of assistance isoften treated as taxable income to the employee. In September 2005 C.A.R took the position to “SUPPORT” in concept the creation of employee benefit plans designed to a) give employers an incentive to provide their employeeswith housing downpayment assistance and/or b) make the downpayment assistance tax-free to the employees. (Please see attached issues briefing paper)
B. Discussion/Reporting Items:
1. MortgageInsurance Premium Deduction
In the last hours of the 109th Congress, H.R. 6111, the Tax Relief and Health Care Act of 2006, was passed. Inside this tax extenders and Medicare bill, a new tax deduction of mortgage insurance premiums was included. This is a one-year-only provision that would allow some 2007 home buyers to deduct the cost of their mortgage insurance premiums (PMI). In order to qualify, the loan must originate in 2007 and can be applied to private mortgage insurance, FHA insurance, and VA and Rural Housing premiums as well. The new deduction is available to those with less than $100,000 adjusted gross income on a joint or single tax return($50,000 for married filing separately) and phases out for incomes above $110,000 ($55,000 for married filing separately). Individuals who claim the deduction are not permitted to prepay premiums that are otherwise due after 2007. Currently this provision expires on December 31, 2007 and would have to be renewed during the 110th Congress or it will expire.
2. Tenant Improvements Depreciation
Alsoincluded in H.R. 6111, the Tax Relief and Health Care Act of 2006, Congress continued its stopgap approach to allowing the 15-year leasehold improvement. This deduction had expired on December 31, 2005. However, Congress renewed the deduction retroactive to January 1, 2006 and it will expire again, unless renewed, on December 31, 2007. If this provision had not been extended then the recovery period for leasehold improvements would have returned to39 years. While this tax extension passed before the 109th session had ended, the IRS had already gone to publication of the tax forms; without this tax provision included. While this deduction is allowed on a 2006 return, this can potentially raise issues which can result in delayed returns/refunds as well as potential audits. Please consult a tax professional with questions concerning how to properly deduct this tax deduction.
3. Pay-As-You-Go
One of the promises the Democratic Party made during their campaign to gain a majority in Congress was that they would reinstitute the Pay-As-You-Go (PAYGO) budget rules. The basic idea behind PAYGO is that for any additional spending or tax cut that is created there must be an offset so that the budget deficit is not increased. While this decision should help reduce the large budget deficits that have been seen in the past few years, it also raises some interesting dynamics when it comes to major reforms being discussed, such as the elimination of the Alternative Minimum Tax (AMT) and changes to the Medicare prescription drug coverage. (Please see attached issues briefing paper)4. Tax Reform
Since the President’s Advisory Panel on Tax Reform published their recommendations in November, there was a quick fury of renouncement of aspects of the recommendation; especially the proposed elimination of the mortgage interest deduction. Since then, talks of tax reform have been brief and mostly without details. Currently most people are waiting for Treasury Secretary Paulson to announce his report on how Treasury would like tosee the tax code reformed. Prior to the midterm elections it was believed that any major reform discussion would wait until after this report was issued. At this time, no timetable has been given for when this reportmight be issued.However, with the midterm elections bringing control of both houses of Congress to the Democrats, the tax reform picture has changed. Democrats have often talked about reforming the tax code, especially theAlternative Minimum Tax (AMT). The Alternative Minimum Tax (AMT) is becoming a major problem that threatens to engulf the middle class in this special tax rate. Incoming Chairman of the House Ways & Means Committee, Rep. Rangel (D-NY) has said that he plans for one of his major initiatives to be the elimination of the AMT. The new Democratic Congress may not be willing to wait for the long delayed Treasury report. One major issue concerning this is that the AMT is currently projected to bring in $1.2 trillion over the next ten years. Replacing that lost revenue, especially if this is done under PAYGO rules, means having to eliminate tax breaks and spending in order to make the reform revenue neutral. This means that changes to the mortgage interest deduction, deduction of interest for Home Equity Lines of Credit, and deduction of mortgage interest for second homes will be debated and potential targets during future calls for reform.5. FIRPTA
Over the past several years as identity theft has become more of a concern for everyone, sellers have grown increasingly uneasy with providing their taxpayeridentification numbers. The concern has become so great that some sellers are refusing to provide the required non-foreign affidavit to the buyer or are providing an affidavit with the seller’s taxpayer identification number removed. This creates a dilemma for buyer’s who may be liable for the sellers’ tax liability from the sale of the real property if they do not receive a fully completed sellers’ affidavit. C.A.R. believesa seller should be able to provide the information required by FIRPTA to escrow or another settlement provider as an alternative to providing that information to the buyer. In the January 2005 meetings C.A.R. adopted policywhich stated, “That C.A.R. in conjunction with N.A.R., ‘SUPPORT’ legislation that would permit a seller to provide the information required by the Foreign Investment in Real Property Tax Act (FIRPTA) to escrow or another settlement provider as an alternative to providing that information to the buyer.”With Congress now being under Democratic control C.A.R. will be working with a new House Ways and Means Committee Staff to find appropriate language that can be attachedto tax legislation during the 110th Congress.6. Tenants in Common (TICs)
TICs (tenant in common interests) are fractional interest or co-ownership in real estate. The ownership structure, in 2002, qualified as a valid option for 1031 tax deferred exchange purposes and since then, the TIC industry has grown exponentially.TICs hold the promise of many advantages for buyers and sellers. For sellers, a high value property can be“fractionalized” or cut into multiple shares that can be sold more affordably to smaller investors or investors that want to buy only a portion of a property, and thus can be made available to a larger audience of exchange buyers. For exchange buyers, there are multiple attractions as well. Fractionalized interests create a much larger universe of properties into which the property seller can exchange.TICs are generally brokered in two ways, as a real estate offering and as asecuritized offering. The distinction between a securitized TIC and a non- securitized TIC largely depends on how active investors are in the management of the property, and the extent to which the sponsor retains an interest in the property. When TICs are securitized they are subject to federal and state securities regulation, including the requirement that persons promoting the purchase of them have the necessary securities license. Because securitized TICs also involve the ownership of real property interests, their sale is also subject to state real estate license laws, which require a real estate license to engage in the promotion and sale of real estate.
Currently, there is a lot of confusion among REALTORS® about the TIC market place. More than a few REALTORS® have participated in securitized TIC transactions only to find that they could not be compensated for their work. Furthermore, a number of REALTORS® may not be aware of the risks investors might face in purchasing asecuritized or non securitized TIC. The TIC industry is growing rapidly and is viewed as an attractive option for investors. Therefore, NAR published two education pieces on the TIC industry; one geared for commercial real estate professionals and another geared for the general practitioner.In their midyear meeting, NAR sought to affirm that TIC transactions are real estate transactions that can be both securitized and non-securitized. This will help consumers be served by the expertise of real estate professionals as well as allow them the protections of state real estate laws and applicable state and federal securities laws. NAR is in discussions with the SEC on defininga role for real estate professionals in the brokerage of securitized TIC interests, whereby they can provide real estate services and derive compensation. REAKTORS® believe that it is in the consumer's best interest to work with a real estate professional in identifying any real estate investment opportunity, including a securitized TIC interest.
7. 1031 Exchanges
The like-kind exchange provisions of Internal Revenue Code Section 1031 permits a taxpayer to defer taxation on capital gains if within 45 days of selling a "relinquished property," the taxpayer identifies a "replacement property" and closes on the acquisition of that property within 180 days of the sale of the “relinquished property”. The regulations for these rules provide a roadmap for securing the benefits of deferral and a well-established body of law governs these transactions.
If a real estate investor were to create a hierarchy of tax provisions based on their utilityand the benefits provided, the like-kind exchange rules would be at or near the top of the list. Real estate investments are, by their nature liquid and they also require substantial investment of capital. The exchange rules permit an investor who can satisfy the criteria to preserve capital for ongoing real estate investment.
The exchange rules have not been modified since about 1991. Two developments, however, have brought new scrutiny of the rules. The first of these is an effort to repeal the exchange rules that has been mounted by farmers located primarily in Iowa and Illinois. They believe that the exchange rules have the effect of driving up the price of farmland. A second development is the rise of the Tenant-in-Common (TIC) market since 2002.
In 2007, the Senate Finance Committee is likely to review several aspects of Section 1031. There are numerous areas they will examine, ranging from the basic to the more complicated of matters concerning 1031 exchanges. The more basic issues to be examined are whether the IRS Form 8828, which is used to figure and report the recapture tax on a federal mortgage subsidy, should be made a mandatory filing; and examining how long a 1031 exchange must be held before a replacement property can be purchased. They may also examine the issue of withholdings on boot. Boot is any part of a 1031 exchange that is not like-kind property. This can be other property or cash. An example would be if you are selling a house for $500,000, but doing a 1031 exchange on a house that cost $400,000, and you are receiving $100,000 in cash, the $100,000 would be considered boot. The boot must also berecognized as gain under current law. More complicated issues that may be addressed are the deferral of fees and collection of fees involved in TIC properties. The issue surrounding deferral amounts on TIC propertiesrelates to fees. The fees associated with TICs are said to range as high as 25% of the acquisition cost. Congress may examine whether taxpayers engaged in exchanges should be permitted deferral treatment for these fees. Congress will also examine whetherdeferral treatment is appropriate for collectibles.
8. REMIC
During the 109th Congress legislation was introduced in both the House and Senate that would amend the section of the IRS Tax Code governing commercial-mortgage-backedsecurities, also known as real-estate mortgage investment conduits (REMIC), allowing for modifications and/or changes to be made to the properties. Under current rules, a property owner would have to obtain a tax opinion before renovating space toaccommodate a new tenant. If the tax opinion found that more than ten percent of the loan’s collateral would be changed, the renovation could not go forward. Under the proposed changes, this type of modification, as well as many others (e.g., selling an adjacent parcel, demolishing part of a building, etc.) would be able to go forward provided that the terms of the loan (e.g., maturation date, principal, etc.) do not change. As a result of these changes, more commercial loans willlikely be securitized which will, in turn, increase the flow of capital to commercial development.While no bills involving REMIC were able to make it out of committee during the 109th Congress, this issue will likely arise again during the 110th Congress. The change in leadership means that new staffers will be coming into the House Ways & Means committee as well as the Senate Finance committee. This shift can sometimes reenergize an issue that was dormant in the previous Congress.IV. Other BusinessV. Adjourment
