The Debt Debate and Commercial Real Estate

Nov. 9, 2011
How the debt debate can help – or hinder – commercial real estate.

With a mounting national debt and a struggling economy, Congress and President Obama continue to debate how to solve the unrelenting economic crisis. But the critical role the commercial real estate industry must play in the country’s economic recovery seems to be lost in the debate.

What’s important to understand is that building operations alone support more than 1 million jobs, according to BOMA International’s Economic Impact Study.

Some believe the commercial real estate industry is not paying its fair share. Whether enacted through the president’s proposed jobs plan or through the bipartisan “super committee” tasked with reducing the debt, many are pushing for a tax increase on commercial development. Instead, Congress and the president should empower the commercial real estate industry to be a stronger partner in stabilizing the economy by reducing its tax burden, not increasing it.

Late last summer, Congress enacted legislation that appointed a super committee to address the nation’s debt crisis. With 12 members of Congress, evenly divided between both chambers and both parties, the super committee must find a minimum savings of at least $1.2 trillion over 10 years by the end of 2011. If Congress fails to enact significant savings by the end of the year, budget cuts to defense and Medicare will go into effect starting in 2013.

President Obama laid the groundwork for the super committee by proposing the American Jobs Act. In this plan is a provision to increase the current carried interest tax rate from a capital gain (15%) to ordinary income (nearly 40%). Commercial development is among the industries affected by this change. The proposed tax increase would disproportionately impact small- to medium-sized real estate partnerships that rely on carried interest to make up for the substantial risks and liabilities associated with long-term real estate ownership and development.

Consequently, when carried interest is discussed, you probably won’t hear about the benefits buildings bring to the economy, such as millions of construction and manufacturing jobs and the millions generated in tax revenue.

Rather than hamstring the industry, President Obama and Congress could help create jobs in every congressional district by reducing the burden the current tax code places on commercial real estate. One way Congress could do this is by making the 15-year timeline for depreciation of leasehold improvements permanent. This tax change would more closely align the tax code with current market realities and provide the certainty needed to move forward with building renovations in the short and long term.

While building owners, retailers and restaurants are able to depreciate improvements on a 15-year schedule in 2011, this provision expires at the end of the year, providing additional uncertainty and less incentive to move forward with future projects. Owners are making long-term decisions and could make a stronger case for investment if the 15-year timeline is made permanent.

Congress could also create jobs by enacting pending legislation that reduces the timeline for depreciating certain energy-efficient commercial roofs from 39 years to 20 years. With the average life of a commercial roof estimated at 17 years, the current tax code only incentivizes building owners to delay the replacement of older, failing roofs with new energy-efficient technology.

Such a simple change to the tax code would help create 40,000 new jobs among roofing contractors and manufacturers and add $1 billion of taxable annual revenue in the construction sector. Similar bills that shorten the depreciation schedules for fire sprinklers and mechanical insulation have also been introduced and would help create additional jobs and tax revenue.

Commercial real estate is also urging Congress to amend the Foreign Investment in Real Property Tax Act (FIRPTA) to encourage foreign investment in real estate. FIRPTA discourages the investment of foreign capital in U.S. real estate by treating a gain or loss from a foreign investor’s real estate sale as if the gain or loss were tied to a U.S. business.

A foreign investor currently faces no tax liability for income realized from investments, such as stocks and bonds. With an average of $300 billion in commercial real estate loans maturing each year for the next decade, a change in the tax code to reduce the tax burden on foreign investment in commercial real estate would go a long way toward stabilizing the industry and the economy. Pending legislation would increase a foreign investor’s ownership stake in a publicly traded Real Estate Investment Trust (REIT) without being subjected to FIRPTA from 5% to 10%.

To effectively tackle the mounting debt and struggling economy, Congress and the president must welcome the commercial real estate industry as a powerful partner in our nation’s recovery. To achieve this, they must enact policies that will create jobs, help stabilize the industry, and provide much-needed tax revenue.

Boyd Zoccola is chair and chief-elected officer of the Building Owners and Managers Association (BOMA) International and executive vice president of Hokanson Companies, Inc. Learn more about BOMA International at www.boma.org.

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