BLOGGER COMMENT: Immediate action is required. This Bill has already been passed by the House. Our only chance to stop it is in the Senate.
This week Congress will be considering legislation that will impose the most sweeping and potentially most disruptive new tax on real estate since the Tax Reform Act of 1986, which contributed unmistakably to the recession of the late 1980s and early 1990s. The current tough economic environment is already stalling new real estate projects, but this increase, if enacted, will significantly dampen future investment.
The proposal being considered this week will increase the taxation of carried interest (also known as “the promote” or “the sponsor’s share”) from the current and more favorable capital gain rate of 15% to the higher ordinary income tax rate of 35%. This increase will dramatically change the way real estate partnerships have operated for more than 50 years, as most real estate ventures are organized as limited partnerships or LLCs. While the original stated intent of this proposal is to address the perceived tax rate inequity applied to private equity and hedge fund managers, it will disproportionately impact the real estate industry.
Unlike private equity firms, the carried interest for the general partner in a real estate partnership is not compensation for services rendered and it is not guaranteed income. Most real estate partnerships must exceed numerous hurdles, which result in the limited partner realizing a return on investment before the general partner sees the first dollar of gain. Moreover, the general partner often experiences a significant “hold” time before seeing that gain.
By treating the general partner’s interest in a partnership as compensation for services, the risk that the general partner undertakes on behalf of the partnership is not recognized. The direct risks include all partnership liabilities for environmental concerns, lawsuits, loan guaranties and carve-outs. Furthermore, the general partner is currently required to pay ordinary income taxes on the fees received from the partnership for standard services such as leasing or construction management.
With the commercial real estate industry under serious strain due to the current credit crisis, raising this anti-investment tax on real estate will not only threaten economic development projects and related jobs, but is will also hit small and medium sized developers the hardest.
A carried interest tax increase comes with serious economic consequences and disproportionately affects the shopping center/real estate sector.
ICSC Senior Vice President of Global Public Policy