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Baucus Draft Hits Commercial Real Estate

November 21, 2013

Senate Finance Committee Chairman Max Baucus (D-MT) released a draft tax reform proposal today, which included several provisions that would affect current tax provisions for commercial real estate in a negative way.  This is a draft only, and has no support from any Republicans in the Senate.  Chairman Baucus is seeking comments on the draft.  NAR is planning to submit comments, and will be working with other real estate organizations to fight these proposed changes.

  1. Like-kind Exchanges.  The Baucus draft repeals section 1031, effective for tax years beginning after 2014.
  2. Depreciation.  Depreciation periods for real estate are extended from the present-law period of 27.5 years for residential rental property and 39 years for non-residential rental property to 43 years.  And, the change is retroactive in the sense that it applies to all real property being currently depreciated, but is subject to a transition rule that somewhat eases the pain.  The transition rule reduces the 43 years by the number of years for which the property has already been depreciated.  Thus, if a 4-plex had been purchased five years ago, it would have a new depreciable life of 38 years rather than 43.  But this is still way more than the current life of 27.5 years.  In addition, there appears to be no special shorter period for depreciating leasehold improvements.
  3. Recapture of depreciation for real property.  Under current law, gain on the sale of real property is treated as ordinary income only to the extent of the amount of accelerated depreciation over the straight-line amount.  Since there has been only straight-line depreciation for real estate since 1986, most depreciation of real property is not presently subject to recapture.  However, such gains are subject to a 25 percent capital gains rate.  The Baucus draft provides that any gain is treated as ordinary income to the extent of any claimed depreciation, even if it is straight-line.  Presumably, tax reform will bring down the top tax rate, but few think it will go as low as 25 percent.  Thus, this could be a bit hit to investors and owners of commercial real property.
  4. Section 179 real property (qualified leasehold improvements, qualified restaurant property, qualified retail improvement property).  The present-law provision that allows certain real property to be expensed in the year purchased is repealed in the Baucus draft.
  5. Section 179D.  The present-law provision under section 179D that provides a deduction for energy-efficient commercial building property expenditures of up to $1.80 per square foot is repealed in the Baucus draft.