Agenda Summary – Taxation CommitteeDesert Vista Ballroom, Date Palm/Eldorado – Conference Center Hyatt Grand Champions Wednesday, January 23 3:30 p.m. – 5:15 p.m.Presiding: Skip Zeleny, Chair Cynthia Carley, Vice-Chair Karl Lee, Vice-Chair Malcolm Bennett, Executive Committee Liaison Susan Tilling, NAR Committee RepresentativeCAR Staff: Christopher Carlisle, Legislative Advocate Jeff Keller, PublicPolicy AnalystI. Opening CommentsII. Federal Taxation IssuesA. Discussion/Reporting Items:1. Mortgage Cancellation C.A.R. Policy: C.A.R. has previously taken the policy: “That C.A.R., in conjunction with NAR, pursue changes in federal law or regulation to exempt from unfair taxation relief of indebtedness income from short sales of principal residences.”In today's market, many homeowners have found themselves "upside down" on their mortgages (i.e., they owe more on the mortgage than the fair market value of the property). If they should sell the property and are unable to repay the full amount of any outstanding mortgage debt, known as a short sale, the lender may forgive some or the entire shortfall. Similarly, in foreclosures a borrower might be forgiven some portion of a mortgage debt if the lender is not able to satisfy the mortgage liability from the sale proceeds. Under current laws, when a portion of a debt is forgiven, income tax is imposed on any amount that a lender forgives.Example: Assume that an individual purchased a home for $450,000. At the time of a subsequent sale, the outstanding mortgage balance might be $415,000. If the home sells for $400,000, the individual has incurred a non-recognizable capital lossof $50,000 and is short $15,000 to pay off the outstanding mortgage. If the lender forgives this $15,000 debt, then the homeowner must recognize the $15,000 as ordinary income and pay tax on it.On September 25, 2007 Chairman of the House Ways & MeansCommittee, Rep. Rangel (D-NY) introduced his own mortgage cancellation relief bill, H.R. 3648, the Mortgage Forgiveness Debt Relief Act of 2007. H.R. 3648 would remove taxes from mortgage cancellation relief provided on a mortgage of a primary residence. The tax relief would only apply to the acquisition indebtedness, plus personal improvements of a primary residence and would not cover any amount over the acquisition indebtedness (plus personal improvements) if a loan has been refinanced witha “cash out” option. The relief would not apply to home equity lines of credit (unless the HELOC was used for personal improvements of the primary residence). The relief would apply to any forgiveness given on or after January 1,2007.The Senate amended H.R. 3648 and instead of making mortgage debt relief permanent, they put a 3-year sunset on the provision. H.R. 3648 covers mortgage debt relief from January 1, 2007 through January 1, 2010. Due to this change, the offsets for these provisions were also scaled back. Instead of the change on the capital gains exemption for second homes converted to primary homes, the new offsets would increase penalties on those who fail to file partnership returns, S corporation returns, and increases corporate estimated taxes by 1.5%. Included in H.R. 3648 was also a 3-year extension of the private mortgage insurance deduction, through December 31, 2010. H.R. 3648 passed the Senate on December 14, 2007 by unanimous consent and was then passed again by the House on December 18, 2007 by a voice vote. H.R. 3648 was signed by the President on December 19, 2007.2. Qualified Veteran Mortgage Bonds C.A.R. Policy: C.A.R. supports eliminating the pre-1977 service requirement for QVMB eligibility.
As home prices have risen in California, only a few select veterans in California and four other states have benefited from low-interest rate mortgages secured by Qualified Veterans’ Mortgage Bonds (QVMB). The bonds are tax exempt government obligations and are backed by the full faith and credit of the issuing state. Veterans who finance their homes through QVMBs can receive an interest rate of .50-.75 percentage points less than that of a conventional loan.
Under current law, to qualify for a QVMB a veteran must have served on active duty prior to January 1, 1977 and applied for financing before their thirty-year anniversary of leaving the service. This prohibits veterans of more recent or ongoing military conflicts such as Operation Iraqi Freedom, Operation Enduring Freedom, Kosovo, Somalia, and the 1991 Persian Gulf War from being able to benefit from these loans.
H.R. 551, the Home Ownership for America’s Veterans Act of 2007, was introduced on January 18, 2007 by Rep. Davis (D-CA). H.R. 551 is currently in the House Committee on Ways & Means and has 65 cosponsors, including 50 from California. H.R. 551 would eliminate the requirement that youserve before January 1, 1977 and replaces it with “who applied for the financing before the date 25 years after the last on which such veteran left active service.” It would also use the Conventional Mortgage Home Price Index compiled by Freddie Mac to help determine inflation rates and after 2010 the limit of the amount a state is allowed to use would be adjusted based off this inflation rate (multiply the limit by the inflation adjustment factor).H.R. 3997, the Heroes’ EarningsAssistance and Relief Tax (HEART) Act of 2007, was introduced and also included provisions concerning QVMBs. While it did not address every issue found in H.R. 551, it did include language that would make permanent the exception that allows QVMBs tobe eligible for any housing, not just a first-time homebuyer, and included the change that instead of having to serve prior to January 1, 1977, you now would just have to apply for the QVMB within 25-years of your last date of active duty service. The Senate has passed their version of H.R. 3997 and it is fully offset. It is expected that this bill will be taken up and passed by the House when they return for the 2nd session of the 110th Congress. This will be a substantial victory forREALTORS® and C.A.R. 3. Tax Reform and AMT The issue of fundamental tax reform was quiet for most of 2007. There have been discussions of reprising the issue in 2008; however, with 2008 being an election year, it would be unlikely fora fundamental tax reform to take place. However, the issue of the AMT was highly contentious is 2007 and is expected to heat up even more in 2008.The large debate in the 1st session of the 110th Congress revolved around a one-year patch to the AMT. Early on, the concept of overall AMT reform was dropped and attention turned to a one-year patch. The main controversy surrounded the issue of off-setting the $53 billion one-year patch. Democrats tried a variety of options to find an acceptable off-set for the AMT patch in order to keep with PAYGO rules. However, Republicans in the Senate and the President refused to accept any off-sets. In the end, the Democrats decided that it was more important to help keep an extra 20 million Americans out of the AMT and in the waning days before Christmas passed a one-year patch without off-sets. This may become a larger issue and struggle during the 2nd session of the 110th Congress. The AMT patch was passed without the annual tax extensions. This includes state and local state deductions, among other popular one-year extenders. Senate Republicans have stated that they were willing to do off-sets for these deductions. However, this could change and they could try to win these extensions without off-sets, they could try to tack on more controversial tax changes, such as the estate tax or extension of the Bush tax cuts, or the Democrats could demand that in order to get these tax extenders they need to be fully off-set plus include the off-sets for the AMT. This could lead to a highly contentious and drawn out fight on these extenders when Congress returns.4. Mortgage Insurance Premium Deduction C.A.R. Policy: “That C.A.R., in conjunction with NAR, ‘OPPOSE’ the introduction of income limitations on the proposed mortgage insurance deduction provisions of the Internal Revenue Code.”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 for mortgage insurance premiums was included. This was a one-year-only provision that would allow some 2007 home buyers to deduct the cost of their mortgage insurancepremiums (PMI). In order to qualify, the loan must have originated in 2007 and can be applied to private mortgage insurance, FHA insurance, and VA and Rural Housing premiums as well. The new deduction was 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 were not permitted to prepay premiums that are otherwise due after 2007. This provision expired on December 31, 2007.H.R. 1813 was introduced by Rep. Levin (D-MI) on March 29, 2007. H.R. 1813 currently has 39 cosponsors, including Reps. Calvert, Herger, and McNerney and isin the House Ways & Means Committee. H.R. 1813 would allow for PMI to be permanently deductible and would remove any income limitations. The Senate companion bill is S. 1416, which was introduced by Senator Smith (D-OR) on May 16, 2007. S. 1416 is currently in the Senate Committee on Finance and has 12 cosponsors.Additionally, an extension of the current PMI deduction was added to H.R. 3648, the Mortgage Forgiveness Debt Relief Act of 2007. H.R. 3648 extended the PMI deduction through December 31, 2010. H.R. 3648 passed the Senate on December 14, 2007 and then passed the House on December 18, 2007.5. 1031 Exchanges The like-kind exchange provisions of Internal Revenue Code Section 1031 permits a taxpayer to defer taxationon 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.The exchange rules have not been modified since 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 therise of the Tenant-in-Common (TIC) market since 2002.The one challenge to 1031 exchanges during the first session of the 110th Congress was in H.R. 2419, the Farm Bill. Included in H.R. 2419 was a proposed rule that an exchange of “improved real estate” with “unimproved agricultural real estate” will not be eligible for like-kind exchange treatment because those two classes of properties are not “of a like kind”. At the November NAR meetings, NAR’s Taxation Committee took the following policy: “That NAR oppose changes to the like-kind exchange rules that would make specified classes of real estate ineligible for like-kind exchange tax treatment”. H.R. 2419 passed the House on July 27,2007 and the Senate on December 14, 2007. H.R. 2419 will now go to conference to work out the differences between the bills.Additionally, at the November NAR meetings, the Taxation Committee had a guest speaker from the Federation of Exchange Accommodators (FEA) to discuss what they were doing in the wake of the recent unlawful activities of some Exchange Accommodators that left property owners with serious financial and tax consequences. The FEA is pursing changes to their own bylaws as wellas asking the Federal Trade Commission whether they can decide regulatory rules or if any new rules have to be passed through Congress first.6. Carried Interest Under most real estate partnerships when a private equity partnership is developedthere are two categories of participants. There is the general partner (GP) and the limited partner(s) (LP). The LPs are the ones who contribute the capital to fund the projects. The GP either puts up a small (usually 1-2%) amount of capital, or none, but handles the financial dealings of the partnership and brings their expertise and experience to the project. When that property is sold, the profits are divided, primarily among the LPs. However, there is a common practice in partnerships, including real estate partnerships, that gives the GP a portion of the profits. This is separate from his annual management fee which covers his salary and overhead. This part of the profit is known as carried interest. The carried interest (which can be up to 20% of the profit from the investment) is part of the setup of the partnership and is done to give the GP an incentive to push for the success of the partnership venture and is a return on their “sweat equity”. The House has introduced H.R. 2834, which is currently in the House Ways & Means Committee with 23 cosponsors. H.R. 2834 would eliminate taxing carried interest at capital gain rates (currently 15%) and instead tax them at thestandard income rates (currently up to 35%). The Senate has introduced S. 1624, which is currently in the Senate Committee on Finance with four (4) cosponsors. S. 1624 currently focuses on private equity groups and does not include real estate carried interest in the language of the bill, but it is expected that this will be amended in the future to include real estate and mirror H.R. 2834. The House has also looked at carried interest as on off-set for the one-year AMT patch. However, that provision has been removed as an option for an AMT off-set for the one-year patch.At the October 2007 C.A.R. business meetings both the Taxation and Federal Issues Committees choose not to take any action on carried interest. At the November NAR meetings, NAR took the following policy: “That NAR oppose legislation that would change the taxation of a general partner’s income from a carried interest in a real estate partnership from capital gains rates (current law) to ordinaryincome rates.”7. Internet Taxation C.A.R. Policy: In 2000 C.A.R. took the policy that there should be no state/local taxes on internet access and that there should not be federal efforts to preempt states’ efforts to address sales and usetax issues.In 1998 the Internet Tax Freedom Act was passed, which created a moratorium on federal, state, and local government from imposing taxes on internet access, creating “internet only taxes” such as taxes on bandwidth or emails, and also restricted multiple taxes on e-commerce. Since 1998 the moratorium has been extended twice and is currently set to expire in November 2007. The House and Senate had a difficult fight determining whether the moratorium should be extended or made permanent. The fighting continued close to the expiration of the current moratorium, which was to end on November 1, 2007.After arduous debates and compromises, Congress agreed to a seven year, through 2014, extension of the Internet Tax moratorium. The House passed H.R. 3678, the Internet Tax Freedom Act Amendments Act of 2007, on October 16, 2007 by a vote of 405-02. The Senate then received and passed H.R. 3678 by unanimous consent, with amendments, on October 25, 2007. TheHouse then passed the amended version of H.R. 3678 on October 30, 2007 by a vote of 402-0 and it was signed into law on October 31, 2007.H.R. 3678 extended the current moratorium for another seven years, through November 1, 2014. It still would onlyapply to taxes on Internet access; not to sales tax on items purchased over the internet. III. State Taxation IssuesA. Action Items:1. Expanding the Mello-Roos Law to Fund Environmental Mitigation and/or Affordable Housing There is no politicalwill within the legislature to prohibit the imposition of PTTs. Nor is there the will to place reasonable restrictions on their imposition. Consequently, PTTs will continue to be imposed by developers because existing law does not prohibit their imposition. Expanding the purposes for which Mello-Roos districts may be formed to include the funding of environmental mitigation and/or affordable housing – the primary purposes for which PTTs are now imposed – would have the advantage of placing the funding derived via Mello-Roos districts for these purposes within the heavily regulated statutory structure that has been developed over the years. Mello-Roos funds, for example, have to be spent to benefit the particular development in which they are collected as opposed to PTT funding where there is no requirement that the development be benefited. In fact, expansion of Mello-Roos in this manner could be tied to an outright prohibition on PTTs. Legislators may lookmore favorably on enacting a prohibition on PTTs if funding for environmental mitigation and/or affordable housing can be derived from another source – namely, via a Mello-Roos district.B. Discussion/Reporting Items:1. Property Tax Basis Portability Task Force – Whether property tax basis portability can be expanded depends on how much it will cost government in lost property tax revenues – if the losses are significant, any proposed expansion of portability will be vehemently opposed. At the June business meetings, $20,000 was appropriated to estimate the revenue impact. A consultant has been retained and receipt of at least preliminary revenue estimates is expected in January.2. Private Transfer Taxesa. AB 980 (Calderon) Disclosure of Already Imposed Private Transfer Taxes – This bill will require recordation of a separate document, as well as a seller-provided disclosure, to inform potential home buyers as to whether the home they are considering purchasing requiresthe payment of a private transfer tax (PTT), the percentage of the home price constituting the PTT, the duration of the payment obligation, and the use to which the PTT funds will be put. If the separate document is not recorded, the homebuyer will not have to pay the PTT.Position: Sponsor Status: Signed into law by the Governorb. AB 1574 (Houston) Private Transfer Tax – An interim hearing may be held during the fall to investigate the imposition of private transfer taxes (PTTs) by developers.AB 1574 was the builder-sponsored response to C.A.R. sponsored SB 670. A loophole in California law lets developers and other non-government entities impose PTTs on homes every time the property is sold – with no oversight, no accountabilityand no limit on the number of separate private transfer taxes that can be piled onto a home. As introduced, AB 1574 legitimized the practice of imposing these “taxes” by making that loophole permanent. As amended, AB 1574 requires that the Department of Real Estate provide oversight of the imposition of PTTs and allows PTT revenue to only be directed to a public entity or a nonprofit organization providing a public benefit within the property’s region. AB 1574 allows the PTT to be imposed for a period up to 99 years, allocates a maximum of 10 percent of the proceeds for administrative costs, caps the amount of the PTT at two percent of the home sale price and prohibits the use of PTT funds for lobbying. C.A.R. continues to oppose AB 1574because it legitimizes PTTs without providing adequate safeguards.Position: Oppose Status: Stalled in Senate Judiciary Committee3. Legislation on Debt Forgiveness Income in Short Sales and Foreclosures Senator Machado is planning to introduce legislation this month to partially conform to the recently enacted federal legislation on debt forgiveness income in short sales and foreclosures. The federal legislation provides that debt forgiveness income will not be imputed in cases of short sales or foreclosures for three years. The state legislation will conform for a period of two years. In addition, as introduced, the state legislation will only pertain to the original debt; however, after introduction, the legislation will be amended to conform to the federal legislation which besides the original debt also includes debts incurred for home improvements.4. 1031 Exchange Accommodators Legislation Senator Machado introduced legislation last year to license 1031 exchange accommodators. However, the Senator has decided to not require licensure since there are so few independent exchange accommodators that a licensure program could not be sufficiently funded by those independent accommodators. (Many exchange accommodators are associated, for example, with financial institutions which already have regulatory and fidelity requirements with which they must comply.) Instead, the legislation will require exchange accommodators to have a $1 million fidelity bond and$250,000 in errors and omissions insurance, as well as to comply with a list of “do’s and don’ts.”5. State Legislative Analyst Proposes Modifying the Mortgage Interest Deduction to Increase Homeownership Rates The state legislature’s non-partisan LAO has recommended that the MID be modified because it doesn’t help achieve the policy goal of increasing homeownership. Most of the benefit derived from use of the MID accrues to high-income taxpayers who would owna home regardless of the MID. The LAO outlines a number of options for reformulating the MID so that the rate of homeownership is increased. The LAO also suggests that replacing the MID with a mortgage tax credit. By virtue of the tax assistance being a credit instead of a deduction, all homeowners would benefit. Given the projected state budget deficit for next year of approximately $14 billion, it is quite likely that the Legislature will be looking at tax expenditures such as the MID that may not be achieving their stated policy goals as a means of addressing the projected deficit. In keeping with long standing C.A.R. policy, C.A.R. will oppose any changes restricting or otherwise limiting the MID.6. An Initiative is Being Considered to Increase the Amount of the Homeowners’ Exemption The San Luis Obispo Association of Realtors approved a motion that C.A.R. consider an initiative that is being contemplated for circulation for qualification for the ballot that would increase the amount of the HOE. However, C.A.R.’s long-standing policy is to not consider initiatives prior to qualification for the ballot. The rationale for this policy is that in any given election cycle, there are many initiatives in circulation; however, only a handful of those will ultimately make it to the ballot. A REALTOR® from the San Luis Obispo Association of REALTORS is considering circulating an initiative on the HOE that would increase the amount of the exemptionto 25 percent of a home’s assessed value to a maximum of $100,000. Unless directed otherwise, C.A.R. will maintain its position of not considering taking a position on an initiative until it has qualified for the ballot.IV. Other BusinessV. Adjourment