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Real Estate Scores Loophole in Schumer-Manchin Plan

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Stephen Schwartzman, Senator Joe Manchin and Senate Majority Leader Charles Schumer (Illustration by The Real Deal with Getty Images)

Real estate is an industry that is always in trouble. But few things have angered private equity chiefs more than talk of removing tax breaks for carried interests.

When Barack Obama confided it, Blackstone head Stephen Schwartzman compared it to “when Hitler invaded Poland in 1939.” Schwartzman later apologized.

Last week, Senators Charles Schumer and Joe Manchin hammered out a surprise compromise on the appropriations bill that would again include a tax increase on interest income that was implemented.

In the world of real estate, this was no small matter. The portion of the profits a developer or fund manager makes from a project, “promoted,” is treated as net interest that is taxed as capital gains rather than regular income.

For higher earners, Uncle Sam would receive 23.8% instead of 37%.together depreciation When 1031 exchangesit is a major tax advantage that real estate has over other businesses.

But the effective interest tax loophole isn’t entirely eliminated by the Democrats’ new plan. Inflation control law Instead, Schumermanchin simply asks realtors to hold on to assets a little longer to continue enjoying lower interest rates — three years instead of one. extended from 3 to 5 years.

For real estate, three years is not a long time to own an asset.

“This is not the last nail in the real estate coffin,” said Holland & Knight real estate attorney Stuart Saft, understatement.

Republican tax legislation signed into law by President Donald Trump in December 2017 extended holding periods from one to three years to allow investors to enjoy lower tax rates, but offered a workaround for real estate. .than capital gains

According to real estate attorneys, the new plan treats these 1231 gains as short-term capital gains and could impose higher taxes.

Stephen Land, chairman of Duval & Stachenfeld’s tax department, said:

Another big change, according to Rand, is when the three-year holding period begins. Previous rules considered it to begin when a venture or fund was formed. But under the new bill, the count won’t start until the fund or venture has acquired nearly all of its assets. In the case of a real estate project from scratch, the developer may not be able to time the three-year term until the project is nearly finished.

“If you start a new venture, issue interest and start developing, it takes two years to complete the project, and that’s when the three-year holding period begins,” says Land. “If you add that to his two years of development, it’s effectively five years.”

Regarding real estate, I have another concern. Developers often pitch their projects to smaller investors, noting that they are funding their projects. Schumer and Manchin’s plan would weaken that alignment of interests. Developers and managers have an incentive to hold onto assets until the sale is subject to a lower tax rate, but investors may not be, pushing them to sell sooner.

Max Sharkansky of Miami-based Trion Properties said the tax hike could affect younger investors as well. Young investors tend to sell relatively quickly and invest the profits in new projects. Schumer-Manchin would discourage that by taxing short-term profits more.

“This is a big tax increase, not one percent or two percent,” Sharkansky said. “There will be higher tax rates and less capital to manage.”

Proposals are rarely closed. Democratic Senator Kirsten Sinema, who will exercise his 50th vote of importance in the Senate, remains undecided.

Private equity, the main target of the bill, is likely to aggressively lobby for change. The Wall Street Journal recently reported that 28 of the executives at the five largest publicly traded private equity firms earned about $760 million in carry interest last year.

“With our economy facing severe headwinds, Washington should not impose new taxes on private capital that helps local employers survive and grow,” said the Private Equity Lobby. Drew Maloney, president and CEO of the American Investment Council, an association, said. in a statement.

Bill AckmanHe is a prominent hedge fund manager.

“The carry interest loophole is a stain on tax law,” said Ackman. said in a tweet“It doesn’t work for small businesses, pension funds, hedge funds or other investors in private equity, and everyone in the industry knows that.”

“It’s embarrassing and should end now,” he added.

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