Although important details of the Treasury's tax proposal are still to come, it is already clear that the plan would alter the economics of real estate in general and housing in particular in a fundamental way.
Real estate is full of risks and headaches for people who put money into it. The nation's tax writers have traditionally operated on the premise that incentives were needed if the nation is to be provided with adequate supplies of housing and commercial structures.
This philosophy reached its zenith, ironically, in the first Reagan administration with the passage of such benefits as speedier depreciation for investment property and tax credits for rehabilitation of historic and other older buildings.
The Treasury proposal is a blow to these preferences in two ways. First, it eliminates or severely curtails most of them, and, by reducing tax brackets, makes less valuable those that remain.
It is plain that prices paid in today's market for residences and investment property have these tax preferences built into them; buyers purchase not only real estate, but the right to the tax benefits that are attached. Removal of these benefits seems certain to have an adverse impact on these values, at least in the short run.
Owners of apartments will "take it on the chin," said Scott Slesinger of the National Apartment Association. "It's devasting."
But in the long run, the impact is less clear. Richard McCracken of the National Corporation for Housing Partnerships said he thinks existing "bricks and mortar will become more valuable down the road" as construction ceases and "supply is constricted."
He said he thinks the demographic patterns that there will be tenants with incomes adequate to pay higher rents, "though they will be paying a higher percentage of their incomes than today."
Brian O'Herlihy, director of tax at the syndication firm First Winthrop Corp., said "real estate has always had value, and I don't see any major depression" of prices if some of its tax benefits are withdrawn.
Most significant for single-family housing is the cut in brackets, which makes the mortgage interest deduction less valuable. The president of the National Association of Realtors charged yesterday in a telegram to Treasury Secretary Donald T. Regan that this "dilution" of the mortgage interest deduction makes it appear that the plan renegs on President Reagan's pledge to leave that benefit intact.
Coupled with the elimination of the deduction for state of local taxes, the impact would be "likely to increase the annual cost of owning a typical single-family home by $700 to $1,000," according to the NAR president, David D. Roberts.
The buyer of a $150,000 house would have to pay $3,168 more in the first year of ownership under Treasury's proposal than under current law, according to NAR calculations. This assumes a $30,000 down payment, and a $120,000, 13 percent mortgage, for which an annual income of $64,000 would be needed.
The first's year's interest payments would total $15,600 and property taxes $3,000. Under current law, this would result in a tax saving of $7,068 for an after-tax cost of $11,532. Under Treasury's plan, the tax savings would be $3,900 for an after-tax cost of $14,700, the NAR data indicate.
The result would be the equivalent of a 2.8 percentage rate, and the price would be likely to fall by 17.3 percent, or $26,000, the association's figures showed.
Officials there noted, however, that the taxpayer might still be better off in terms of total tax burden under Treasury's plan, but would have an important disincentive to buying the house.
Realtors and others in the industry are also concerned that passage of these restrictions would pave the way for further cutbacks when Congress addresses the problem of the deficit and begins looking for places to raise revenue, something the Treasury plan purports not to do.
The plan also limits interest deductions on second homes to a maximum of $5,000 over any passive investment income, which industry officials said is likely to be very hard on builders of resort and retirement homes, and on owners who may wish to sell.
The tax consequences for investment property appear likely to be even more significant. Details on the Treasury's proposal for depreciation will not be available until next week, but the department has made it clear that it will be less favorable than current treatment.
Currently, buyers of income-producing property are allowed to take a portion of the purchase price of their taxes each year to make up for the fact that the property is wearing out. This is true even if, as is often the case, the building is actually getting more valuable, rather than less.
Historically, this depreciation amount was tied to the useful life of the building, a period that commonly ran 30 to 40 years. This meant an investor could write off 1/30th to 1/40th of the building's value each year, even though he was actually out no cash.
In 1981, Congress changed this to a flat 15 years, meaning an annual write-off of l/15th of the value, effectively doubling the annual shelter. Though last summer's tax bill boosted it back to 18 years, it remains a major tax benefit for individuals seeking to shelter income.
A return to something resembling the property's useful life, which Treasury sources indicate is likely, would be a blow to this benefit.
Compounding this are other proposals that would strike at the availability of other benefits. For interest, real estate is commonly purchased with mortgages secured by the property. In many cases, these are "non-recourse" loans, meaning that in the event of default, the lender has no recourse beyond seizure of the property.
Treasury proposes to limit deductions to what the investor has "at risk." Many deals are structed today so that the investor risks only a small cash investment. Under the proposal, his deductions would be limited to that investment.
In addition, limited partnerships with more than 35 members would be taxed as corporations, so that losses could not be passed through to investors, a provision that would probably exterminate a major portion of real estate syndications.
The fate of low-income housing under all this was a question raised by many in the industry. McCracken noted that syndication is an important tool in financing this kind of housing, and if rents rise because construction slows, the impact on the poor will be the most severe.