HR 1040-S ...

by Kirk Heyle

for the Business Journal

The Counselors of Real Estate recently met in Boston to discuss "Trends and Transformation in Real Estate Counseling," where we were brought up to date on certain legislative and regulatory review items that ought to be considered here in Springfield.

There are four main tax proposals that are being floated around Washington, D.C., at this time. Rep. Richard Armey (R-Texas) and Sen. Richard Shelby (R-Ala.) have introduced HR 1040-S, also known as the Freedom and Fairness Restoration Act.

This bill replaces the current individual and corporate federal income taxes with a flat tax, which approaches a pure consumption tax. In this flat-tax proposal, all businesses are subject to the flat tax.

The tax base is gross revenue less purchases of goods and services, capital equipment, structures, land, and wages and pension benefits paid to employees. Tax interest expense, and fringe benefits such as health insurance, are not deductible.

The so-called USA Tax, sponsored by Sen. Pete Domenici (D-NM), introduces Senate Bill 722, the unlimited savings account (USA) tax. The bill would replace individual and corporate federal income taxes and provide a credit for Social Security and health insurance tax paid. USA is consumption tax for individuals and subtraction method, value-added tax for businesses.

The retail sales tax that Rep. Dan Schaffer (R-Colo.) and Rep. Bill Tauzin (R-La.) have introduced is HR 2001, the National Sales Tax Act of 1997. The bill replaces the current individual and corporate federal income tax with a national retail sales tax on final consumers.

The tax base is the gross revenue from each retail sale of goods and services, and all businesses must collect the tax on a final sale to consumers.

The Gephardt 10 percent tax, sponsored by Rep. Richard Gephardt (D-Mo.), has proposed broadening the income tax base by eliminating many of the current deductions and exclusions, instituting a lower, progressive tax rate schedule and eliminating the marriage penalty.

These major tax reform proposals may affect commercial real estate investments.

Voter unhappiness with income tax is very apparent, and three main factors are contributing to the current interest in tax reform: The recognition that today's balanced budget is likely to be a short-lived phenomenon; a growing awareness that the U.S. federal tax code is biased against saving and investment that is crucial to the U.S. economic growth; and that fundamental tax reform could raise rates of savings, investment and output.

Commercial real estate investments would be even further enhanced through individual investing and group investments via real estate investment trusts (REITs) in real property or other real estate opportunities.

Other current real estate matters, like tenant improvement, are improving. When a landlord makes improvements for a particular tenant, the cost of these improvements must be amortized over the life of the property (39 years for commercial, 27 1/2 years for residential properties).

If the real estate lease terminates before expiration of the amortization period, then any remaining balance in the account may be deducted.

Prior to 1996, no deduction was permitted at the termination of the lease if it was prior to the life established by the IRS. Since 1996, the permitted deduction of the cost of tenant improvements at termination of the lease prior to those time limits would allow further deductions.

The 27 1/2-year and 39-year depreciable lives for real estate were deemed completely unrealistic, therefore, property owners that used to have to recover their cost over these long periods of time were deemed economically unfeasible.

Under HR 3500, the cost of real estate leasehold improvements could be amortized over 10 years, if the lease terminated before the 10-year period expired, and any remaining balance in the account would be deducted as under the current legislation.

In regard to bankruptcy reform as it affects real estate, HR 3150, which was passed by the House Judiciary Committee in May, is expected to go to the House for a vote.

This issue affects commercial landlords and tenants in regard to allowing tenants who have declared bankruptcy 60 days or more to make a decision on whether to assume or reject their leases. This uncertainty leads to a problem for the landlords and, it is hoped, there will be some review on this item.

The second issue deals with residential rental housing where a tenant may delay an eviction for failure to pay by declaring bankruptcy. HR 3150 and S 1301 would take steps to repair the abuse of these allowances.

In regard to Section 1031, Like-Kind Real Estate Exchanges, the administration has been trying to further expand like-kind exchanges to similar or related-in-service, or -use type exchanges. This narrows the opportunities for taxpayers. The more restrictive administration proposal so far has not been adopted.

In regard to environmental real estate, the Comprehensive Environmental Response, Compensation and Liability Act or "Super Fund," which was enacted in 1980 to clean up hazardous waste contamination, has been re-introduced as the new Super Fund Cleanup Acceleration and Liability Equity Act (SCALE) to reform and reauthorize the current law.

The Super Fund Act has been strictly interpreted over the years and has been onerous to certain property owners. A reauthorization and reform of that law would be helpful to many property owners.

Our local commercial real estate economy, as always, is being driven by our local economy, the national economy and income tax- and investment-driven factors that fuel commercial real estate sales and development.

From a Torto Wheaton Research Study, we have found that the price per square foot and the rent per square foot for office, warehouse, retail and multifamily housing have all declined over the last 10 years in commercial real estate (between 1988 and 1998), with the exception of the multifamily housing price per square foot.

Rents per square foot, in part because of an oversupply of product during that period, have dropped accordingly for office, warehouse and retail. The rent per square foot on multifamily housing has dropped slightly compared to 10 years ago.

In summary, income and investment criteria, income tax reform affecting real estate, stable interest rates and more stability in the overall economy, including the stock market, have all affected and will continue to affect the commercial real estate world.

(Kirk A. Heyle, CCIM, CRE, operates Heyle Realtors & Counseling Services LLC in Springfield.)

INSET CAPTION:

Rents per square foot, in part because of an oversupply of product, have dropped for office, warehouse and

retail facilities.

INSET CAPTION:

Voter unhappiness with income tax is very apparent, and three main factors are contributing to the current interest in tax reform.[[In-content Ad]]