If you own a home, invest in real estate and are trying to figure out what the Senate's tax-reform bill will mean to you personally, don't jump to any dramatic conclusions -- positive or negative -- yet.
That's because what you've been reading in the headlines is very likely not what Congress will pass. The tax-reform bullet-train that shot through the Senate Finance Committee last week faces a far slower, steeper track from here on in -- particularly in regard to its real estate provisions. Here's a look at what's in the bill, where it's headed and how it could affect you.
First and foremost, whether this or any other tax legislation is enacted in 1986, current owners of primary and second homes are guaranteed winners. Unlimited mortgage-interest and property-tax deductions for two homes are now carved in granite on Capitol Hill. However, the dollar value of those deductions may be diminished by the lower marginal tax brackets in the bill -- 27 percent maximum for individuals, compared with 38 percent in the House-passed bill.
But few homeowners can complain, given the heavy assaults on tax preferences elsewhere in the reform package.
The Senate bill's treatment of the nation's estimated three million small-scale real estate investors -- those owning rental homes, condominiums or other actively managed forms of residential real property -- is considerably less favorable. The Finance Committee extended the standard depreciation term for rental properties acquired after next Jan. 1 to 27 1/2 years, up from the current 19 years.
It also banned use of accelerated depreciation on such real estate and did away with cut-rate capital-gains taxation for any profits racked up at resale. Long-term real estate gains under the bill will be payable at full regular income-tax rates.
On the relatively positive side for small-scale real estate investors, Senate reform-bill proponents argue, are two important facts:
*Though it appears to be a sizable lengthening of the standard depreciation term, the bill actually provides residential rental real estate a special tax niche. Nonresidential investments under the Senate plan will have to be written off over a 31 1/2-year period, with no accelerated depreciation permitted. The fact that you own a rental condo or detached house, in other words, will give you a leg up over owners of small-scale retail, office or other commercial property.
*Owners of real estate who "materially participate" in the management or conduct of their rental properties will have an advantage over those who don't. They'll be able to write off up to $25,000 per year of tax losses from their real estate against their regular salary or dividend income. Investors with taxable incomes of $100,000 to $150,000 will be allowed to take progressively smaller amounts of this $25,000 per year in potential tax shelter.
Precisely what "materially participate" means in the context of renting out a duplex or seaside vacation cottage was not made clear in the initial Senate tax package. Pending completion of a final draft, a Senate tax staff aide said, investors can assume the words distinguish taxpayers who exert some control over their real estate holdings, compared with so-called "passive" investors in real estate limited partnerships.
Passive investors -- and those developers, syndicators and financial institutions who organize and run real estate limited partnerships -- constitute the hardest-hit targets of the entire Senate tax bill. They also represent one of the key reasons why the Senate bill is not likely to emerge from the full Senate quickly or in its present form.
The Finance Committee-approved bill would terminate retroactively the rights of hundreds of thousands of investors to use the losses generated by real estate limited partnerships to offset tax liabilities on their regular incomes. Denying those deductions could trigger massive defaults and foreclosures on apartment complexes, shopping centers, office buildings and hotels financed by limited partnerships operating under Congress' rules, provided by the 1981 tax act. That, in turn, could cost the Federal Savings & Loan Insurance Corp. (FSLIC) and the Federal Deposit Insurance Corp. (FDIC) more in bail-out dollars for lending institutions than the revenues the Senate now seeks to save through tax reform.
Once that issue hits the Senate floor in June, count on a lot of heat, and ultimately some form of retreat, by the Senate Finance Committee tax drafters.
Other controversial real-estate-related provisions in the bill also are certain to slow it down and force changes next month. The legislative package that burst out of closed committee meetings with a bipartisan 20-0 vote, in short, is about to hit the legislative meat-grinder. Those provisions that emerge unscathed from Senate debate must then face the even tougher political gauntlet of a House-Senate conference in July or August.
In terms of substance, if not the inevitability of final passage, the "bullet bill" of 1986 still has a long way to go.