Chances of real estate tax relief remains strong.

Even though no tax relief was enacted in 1995, the real estate industry still remains in a good position to benefit from many of the tax provisions contained in the Republican Congress' Budget Reconciliation bills. The major issues now are what tax provisions will be enacted and when they will be effective, reports KPMG Peat Marwick LLP's National Real Estate, Hospitality and Construction Practice.

The practice also is concerned that the effective date of capital gains reform only will be retroactive to January 1, 1996, not January 1, 1995 as many had hoped.

"As the Republicans continue to push their agenda through Congress, the real estate industry continues to be a beneficiary of many of the proposed changes," said Philip J. Wiesner, national director of KPMG's Real Estate Tax Services. "The original 'Contract With America' may have been layered back a bit, but the main initiatives of the package are still being aggressively sought."

Wiesner points out that the focus on reducing government program expenditures, especially changes in Medicare and Medicaid, must be balanced against the revenue-losing tax provisions, such as many of those contained in the Republican Congress' Budget Reconciliation bills, to achieve the target of a balanced budget in seven years.

According to Wiesner, the most favorable change likely to occur is the proposed capital gains reform passed by both the House and the Senate, which was vetoed by President Clinton. Under this provision, individuals and corporations would be provided with reduced tax rates for most capital gains. However, an area of increasing uncertainty now is the effective date for the capital gains tax relief. The effective date was originally January 1, 1995. However, as 1995 ended with no tax bill, the likelihood greatly increases that the effective date will be shifted to January 1, 1996.

While such a change may help the Congress meet its revenue targets, it would not help taxpayers who sold property in 1995 in anticipation of the proposed change in the tax law. "These people may have to take a hard look at their last estimated tax payment due on January 15, 1996," said Wiesner. "Also, where possible, property sales should be deferred until 1996, or, at least, where the taxpayer qualifies to use the installment method, payment should be deferred until 1996 to help insure the benefit of capital gains changes."

One significant item of the original "Contract With America" - the Neutral Cost Recovery system of depreciation, which would have introduced a new depreciation system for all assets, including real estate has been removed from the bill. "No one really wanted it anyway," said Wiesner.

The bills also contain alternative minimum tax (AMT) relief for corporations. Wiesner predicts that although complete repeal of the AMT is not anticipated, the final bill should lessen the future impact of the AMT for many 'corporations, especially those who anticipate significant capital acquisitions.

Further, although the original "Contract With America" was very limited in scope, there have been some significant additions made that were not in the original version. Specifically, the proposed repeal after 1997 of the low-income housing tax credit adds a new wrinkle. With President Clinton's veto of the conference bill, its ultimate resolution remains cloudy.

Finally, both the House and Senate substantially expanded their tax packages to incorporate proposals on such items as family tax relief, extensions of specific expiring tax provisions, estate and gift tax reforms, and expatriate taxes, to name a few. However, if these provisions are not contained in the final bill, the development of a second bill would be necessary to reintroduce such proposals.

"Unfortunately, unless these expanded provisions are contained in the present bill, their chances for enactment in the near future will be significantly reduced,' said Wiesner. "One major tax bill is difficult enough to pass, but two is impossible."

Flat Tax Poses Serious Threats to Industry

As the budget reconciliation process drags on, it must not be forgotten that many in Congress are setting the stage for consideration of more wide-reaching changes to the tax system. According to Wiesner, the industry must prepare itself for the potential enactment of a so-called fiat tax, or a similar consumption-based tax system, which would eliminate many of the industry's current tax incentives.

"While a truly flat tax has the apparent advantage of simplicity, real problems would be encountered during the transition period between current law and the effective date of the new system. The real test will be the ability of the tax writers to fashion rules that facilitate a smooth passage from the old tax system to the new without causing major economic disruptions," said Wiesner.

Wiesner also warns that a flat tax could pose a serious threat to the industry. For example, under the current Armey proposal, while wages and capital expenditures would be deductible, no deduction would be allowed for interest, taxes, or other expenses. Also, no transition rules would be provided for property placed in service prior to enactment of the new tax code. "This is a major concern for the industry," said Wiesner. "Unless transition rules are provided for and unless certain items, such as mortgage home interest and taxes, remain deductible, the real estate industry could experience severe economic dislocations."

Outlook

At this time, passage of tax relief remains bright in 1996. However, according to Wiesner, the fate of capital gains and the other tax provisions that impact the industry are captive to resolution of more fundamental issues, such as how to mix budget cuts with tax changes to achieve the budget targets. As Yogi Berra reportedly said, "It ain't over until it's over," and unfortunately the deliberations on capital gains are not yet over.

As for the flat tax proposals, Wiesner comments that "while at first blush they seem quite appealing - a tax form on a postcard - the reality is that the tax writers are going to have to reintroduce some of the current law's complexity in order to prevent some of the abuses Congress has tried to stamp out over the past 30 years. Also, regardless of the flat tax provisions themselves, serious time and effort will have to be placed on transitioning into the new tax system so that major economic disruptions do not occur."

Although it is unlikely any serious actions will be taken until after the 1996 presidential election (and probably not until 1997 at that), Wiesner warns that the industry must stay on top of the proposals, since they could have a tremendous impact on the industry.