Industry victor in budget plan.

Several key elements of the Federal budget package will render some stability and liquidity to the shaky real estate business, according to industry supporters and analysts.

In addition to long-awaited changes in the passive-loss rules, the package includes a provision that reduces the tax burden of workouts, permanent extension of housing programs and expanding investment possibilities for pension funds.

Real Estate Board of New York Vice President Deborah Beck said the conference bill contained many of the changes the industry has been fighting for over the last four and a half years beginning with the Reagan and Bush administrations. The real estate provisions, in great measure, resemble those of H.R. 11, a bill the industry lobbied for successfully but was vetoed by former President Bush immediately after he lost the election.

"Real Estate has the best possible provisions it could have hoped for," she said.

Passive Losses

The bill alleviates for many professionals the problem created in 1986 when Congress deemed all rental real estate "passive" and dissalowed using losses from such activity to offset income from active real estate activities or any other income. Now, those who participate in rental activity for more than 750 hours annually or employees who own more than 5 percent of the employer, may use losses from this work to offset all other business income.

According to Beck, the bill limited the offsetting of income to real estate related income until the final days of negotiations when the word "all" was included.

Without that term, said Cary Brazeman, spokesperson for the National Realty Committee, real estate professionals would continue to be discriminated against because other business professionals are permitted to use passive losses to offset any other business income.

"People in the real estate business are [now] treated like everyone else," said Brazeman.

This provision returns to the market an investment incentive that had been wiped out in 1986.

Debt Restructuring 

The critical Section 108 provision, included in the House but not the Senate version, also became part of the final bill. Permitting tax due on forgiven income to be deferred, according to Beck, this provision will assist workouts and prevent more owners from losing their buildings.

According to Coopers & Lybrand analysts, the passive loss and debt restructuring provisions of the bill can work together to facilitate workouts for the nation's estimated $50 to $70 million in troubled commercial real estate loans because they help to alleviate the adverse tax consequences of cancellation of debt (COD).

"It allows you to keep more of the reduction of indebtedness, more of the benefit," said John Schmalz of Coopers & Lybrand.

Previously, indebtedness canceled by a lending institution was considered income for the owner. This COD-income or "phantom income," as it has become known, was taxed during the first year the workout was finalized.

Many already-strapped owners could not handle the tax burden and, as a result, rejected the principal-reducing bailout out plans that lenders were offering.

Now, under the new tax measure, Schmalz said, borrowers may defer the impact of canceled debt by reducing the appreciable basis by the same amount of the canceled debt. The borrower will then pay the tax over time via lower depreciation deductions and a greater gain on sale when the property is sold.

Also, under the passive loss reform, the borrower may use passive losses to offset "active" real estate income, which may include the canceled debt from a loan restructuring.

"There are situations where you can use the benefits of both," said Schmalz.

The tax deferral option, according to Schmalz, is enhanced by another change in the Clinton tax plan. The plan increases the differential between income and capital gains tax rates. Therefore, borrowers can defer COD-income and have it taxed as capital gains.

According to Schmalz, the less money an investor has to pay to the government at one time, the more he has for other investments.

Housing and Other Victories

Another provision expands investment opportunities for pension funds by allowing them to put funds into real estate investment trusts (REITs), which are now comprised of nearly every property type. Previously, pension funds were prohibited from such activity because they are considered a single investor and REITs have a "five or fewer" rule, which prohibits five or fewer investors from owning 50 percent of a REIT. The bill lifts that restriction for pension funds.

Pension funds are somewhat "behind the learning curve" in real estate investment, said Mark Decker, president of the National Association of Real Estate Investment Trusts (NAREIT), and this should serve as a "catalyst."

In the area of housing construction, the permanent renewal of the low-income tax credit and the mortgage revenue bond were critical components of the plan.

Jay Shackford, spokesperson for the National Association of Home Builders of the United States (NAHB), said those two programs together have been responsible for 100,000 housing starts per year and 175,000 full-time jobs. While some units already underway have kept the programs active, they had both expired in June of 1992.

The pension fund expansion, passive-loss changes and the debt restructuring provisions, Shackford said, will also be helpful. And, reducing the deficit, he said, will help keep interest rates down.

As well as being happy about what was included in the bill, industry members were also relieved about certain provisions that did not survive conference negotiations, such as: An increase in the capital gains rate, an acceleration of non-residential depreciation from 31 to 41 years -- it was increased to 39 years, and an onerous recapture provision.

"In a sense one can breathe a sigh of relief," said Beck.

But whether these provisions will work with the bills' others provisions to serve their ultimate purpose -- create jobs and expand the economy while ensuring those with dependent needs are properly served, Beck said, remains to be seen.

"It really is a situation where the jury is still out," Beck said.

While much of the bill's success can be attributed to tireless lobbying, the package also includes a provision that disallows tax deductions for lobbying contributions on the federal level, but permits deductions for state and local levels. Brazeman said the dues of National Realty Club members would be affected but they are not yet sure to what extent.