If you invest in real estate--or plan to in the next few years--you ought to focus on a major new piece of tax legislation that's just been introduced on Capitol Hill. The bill, known as the Fair Tax Act of 1983, would take away most of the financial incentives that have attracted you and thousands of other small and large investors into real estate.
It would end the current system of cut-rate taxation of long-term capital gains, significantly lengthening the time over which you depreciate rental property--thereby cutting the deductions you can take-- throw out all tax credits for preservation of historic and other buildings, and end federal tax exemptions for locally issued mortgage bonds.
In short, it would thoroughly change the rules of the game for ownership of real estate--and leave anyone who's dependent on the old rules paying sharply higher federal taxes.
But that's impossible, you say. No legislation with such radical objectives could have a political prayer on Capitol Hill. It'll never have any influence. But you're wrong. The bill in question--developed over the past two years by Sen. Bill Bradley (D-N.J.) and Rep. Richard Gephardt (D-Mo.)--could be one of the most important federal tax-reform proposals in many years.
At the very least, its arrival on Capitol Hill is symbolic of the deep, bipartisan discontent within Congress (and within the public as a whole, according to opinion polls) over the current federal maze of tax credits, loopholes and subsidies.
At the most, the bill could become the foundation for a vastly streamlined system of progressive income taxation--one with only a handful of exemptions, and just three or four basic tax rates, all much lower than the current brackets.
The Bradley-Gephardt plan, as outlined in last week's column, would impose a flat-rate 14 percent income tax on all individuals, and 30 percent on corporations. Individual taxpayers with incomes over $25,000, and taxpayers filing jointly with incomes over $40,000, would have "surcharge" rates of either 12 or 16 percent in additional taxes imposed on top of the 14 percent. The maximum rate anyone would pay, however, no matter how high an income, would be 30 percent compared with the present 50 percent.
The bill would retain homeowners' mortgage-interest and property-tax deductions intact, but not many others.
Besides cutting taxes outright for as many as seven of 10 current taxpayers without reducing revenue collected by the federal government--a neat political feature--the Bradley-Gephardt plan would not raise or lower the amount of total taxes paid by any other group.
The upper 20 percent of the nation's earners, in other words, would contribute roughly the same percentage of federal revenue as it does at present. The lower 50 percent of taxpayers still would contribute the same proportion. The Fair Tax Act of 1983 is neutral when it comes to socioeconomic class lines--and that's one of its major strengths over "flat-tax" and other tax-simplification legislation.
What would change drastically, though, would be the identities of the people whom Bradley calls the "winners and losers" within each bracket.
"Those taxpayers who make the greatest use of the existing preferences will experience the most significant increases in tax liabilities under the proposed system," Bradley explained. Those taxpayers who make relatively little use of tax incentives, on the other hand, would experience the biggest tax reductions.
And guess which taxpayers are among the highest on the list of users of tax preferences built into the law by Congresses, past and present? They are the owners of any form of investment real estate, ranging from two-unit rental town houses and condominiums in the suburbs to commercial office-building megastructures downtown. As a group, they would "take a bath," in the words of a House Ways and Means committee staff member. "They would pay for everybody else's tax reductions."
For example, take the case of a married, two-earner couple who invest in a small rental property and decide to sell it under the "reform" provisions of the Bradley-Gephardt plan. Assuming $30,000 apiece in annual income, and a $60,000 long-term capital gain on the rental units, the couple would pay $8,000 more to Uncle Sam in the year of the sale than they'd pay right now. Bear in mind that that sharp boost in taxes would come although their marginal tax bracket would have dropped from 42 percent to 30 percent under the new law.
Multiply that result by hundreds or thousands and you get a feel for the potential impact of the Bradley-Gephardt plan on large investors in residential and commercial real estate.
Partnerships and corporations that had factored favorable tax treatment into their financial projections from a shopping center, office building or rental apartment project no longer will be able to do so. They will respond either by raising the direct income produced by the project--by charging substantially higher rents--or simply by abandoning investments in real estate.
Even with phase-in periods stretching out the effective dates of the Bradley-Gephardt bill for several years, residential and commercial real estate inevitably would experience disinvestment.
The seeming benefits of lower personal and corporate tax rates, in short, wouldn't cushion the jolts for the economy's most tax-sensitive industry.