April 29, 2010

How Will the U.S. Jobs Bill Affect Local Real Estate Development?

On May 28, 2010, the House of Representatives approved legislation that extends unemployment benefits until November 30. It also raises tax rates on real estate developers, investment fund managers, and venture capitalists, which could mean that fewer new construction projects will happen in the Greater Baltimore region. That's because the bill treats a portion of carried interest as ordinary income. Normally, carried interest is taxed at lower capital gains rates. Carried interest is the share of profits paid to a manager of a fund or real estate project as a form of compensation. It is paid as an incentive to maximize performance. Those opposed to the bill say higher tax rates will increase the cost of projects.

Maryland democrats support the bill. Majority leader Steny Hoyer said, "It's a good bill for jobs, it's a good bill for closing tax loopholes, it's a good bill for dissuading people from taking jobs overseas." Although the legislation is aimed at increasing jobs, real estate experts argue it will have a negative effect on real estate financing and construction and development jobs for architects, engineers, and contractors.

Currently, carried interest compensation is taxed at the lower capital gains tax rate of 15%. But in the new legislation, that would change. According to the House Ways and Means Committee, here's what's involved:

"Taxation of carried interest. The bill would prevent investment fund managers from paying taxes at capital gains rates on investment management services income received as carried interest in an investment fund. To the extent that carried interest reflects a return on invested capital, the bill would continue to tax carried interest at capital gain tax rates. However, to the extent that carried interest does not reflect a return on invested capital, the bill would require investment fund managers to treat seventy-five percent (75%) of the remaining carried interest as ordinary income (50% for taxable years beginning before January 1, 2013). The provision will be effective for taxable years ending on or after January 1, 2011. This proposal is estimated to raise $17.697 billion over 10 years."

Proponents of the legislation argue that it closes a loophole that provides an undeserved tax break to fund managers. I suppose that's why the name of the bill is, "The American Jobs and Closing Tax Loopholes Act of 2010." (Not exactly subtle).

Business lobbyists hope to stick a fork in this bill before the Senate considers it. They are concerned that if developers have to pay taxes at the higher ordinary income tax rates, they will be discouraged from investing in new construction projects or likely will want a higher percentage of project profits. Either way, they believe there will be a decline of investment in the long term.

The question is, will investors stop investing because they are not getting the desired tax shelter? The answer is, only time will tell.

Until next time.

Be well.

Posted by: shana@lakeviewtitle.com