On Wednesday, the House Ways and Means Committee completed consideration of tax provisions to potentially pay for some of the proposed $3.5 trillion reconciliation bill designed to address “human infrastructure.”
The legislation as passed by the committee includes significant tax increases that would affect the multifamily industry. Specifically, it would raise ordinary income, capital gains and carried interest tax rates. It is important to remember that these proposals are just one step in a long process and subject to further change.
In a win for the industry, the measure did not include provisions to restrict the use of Section 1031 like-kind exchanges or to eliminate “stepped up basis,” which would have taxed unrealized capital gains at death. Both of those proposals were endorsed by the Biden Administration.
It also includes expansions of the Low-Income Housing Tax Credit (LIHTC), as well as the rehabilitation tax credit. Modifications are also proposed to energy efficiency tax incentives utilized by the multifamily industry.
State of Play
Before explaining the House Ways and Means Committee’s proposal in more detail (see below), it is worth noting that its prospects of passing in the Senate are uncertain. As has been widely reported, Senator Joe Manchin (D-W-Va.) has suggested that he will not support a $3.5 trillion package. To gain his support any final legislation may need to be significantly trimmed, which would diminish the size and possibly the scope of necessary offsets.
In addition, as House leaders negotiate with the Senate on a reconciliation package that can pass both chambers, the Senate may bring other revenue raisers into the discussion, including a proposal targeting partnerships offered by Senate Finance Committee Chair Ron Wyden (D-OR). In other words, this is an opening salvo in a complicated multi-step process and the mix and scope of revenue raisers could well change as the legislative process moves forward.
Use the drop down features below to access a detailed analysis of the tax provisions of interest to the multifamily industry as well as a description of Senator Wyden’s partnership tax proposals follows.
Ordinary Income Tax Proposals
Marginal Tax Rates on Ordinary Income (Raises $170.5 billion): The proposal would increase the top marginal income tax rate to 39.6 percent from 37 percent. The rate would apply to single filers earning over $400,000 and joint filers earning over $450,000. The provision is applicable to taxable years beginning after December 31, 2021.
20 Percent Pass-Through Deduction (Raises $78 billion): The 2017 Tax Cuts and Jobs Act provided a 20 percent deduction for qualifying pass-through income, which was designed to minimize the disparate tax treatment between C corporations and pass-through entities. While the Tax Cuts and Jobs Act provided a 21 percent tax rate for corporations, it set the top marginal income tax rate applicable to pass-through entities at 37 percent. By providing a 20 percent deduction for qualifying pass-through income, the 2017 bill reduced the top tax rate to 29.6 percent. The pending House Ways and Means Committee proposal would limit the maximum allowable 20 percent pass-through deduction to $400,000 for single filers and $500,000 for married filers. The proposal would be effective for taxable years beginning after December 31, 2021.
Surcharge on High-Income Taxpayers (Raises $127.3 billion): The proposal would impose a three percent tax surcharge on a taxpayer’s income exceeding $5 million. Affected taxpayers would, therefore, see a top marginal income tax rate of 42.6 percent (or a top marginal capital gains tax rate of 31.8 percent). The proposal is effective for taxable years beginning after December 31, 2021.
Capital Gains Tax Changes (Raises $123.4 billion): The House Ways and Means Committee measure would increase the capital gains tax rate from 20 percent to 25 percent (and the total top capital gains tax rate to 28.8 percent when combined with proposal below). While proposed transition rules would permit a 20 percent tax rate for gains and losses recognized prior to introduction of the bill, the provision is applicable to taxable years ending after the date of introduction of the proposal. Additionally, gains recognized later in the same taxable year that arise from transactions entered into before the date of introduction pursuant to a written binding contract are treated as occurring prior to the date of introduction.
Net Investment Income Tax Imposed on Active Trade or Business Investment Income (Raises $252.2 billion): The Ways and Means Committee is also separately proposing to impose the 3.8 percent Net Investment Income Tax on net investment income (i.e., interest, dividends, annuities, royalties, and rents) earned in the ordinary course of a trade or business by single filers earning over $400,000 and married couples earning over $500,000. While such active trade or business income is excluded from the net investment income tax under current law, its inclusion would have the effect of taking the maximum capital gains tax rate for active trade or business investment income to 28.8 percent and the maximum rate on income taxed at ordinary rates to 43.4 percent (assuming no three percent surcharge on high-income taxpayers as described above is applicable). Notably, the provision would not apply to any wages on which FICA is currently imposed. The provision is effective for taxable years beginning after December 31, 2021.
Carried Interest (Raises $14.1 billion): The proposal would generally extend the three-year holding period required for carried interest to be taxed as a capital gain (as opposed to ordinary income) to five years. However, carried interest attributable to a real property trade or business would retain a three-year holding period requirement. Under this proposal, 1231 real estate gains that are currently accorded long-term capital gains treatment if held for at least a year would be subject to the three-year holding period. Notably, the three-year holding period will remain in effect for taxpayers with an adjusted gross income of less than $400,000.
Excess Business Losses (Raises $166.8 billion): The proposal makes permanent a provision limiting excess business losses that was otherwise set to expire at the end of 2026. Under current law, a non-corporate taxpayer is considered to have an excess business loss if their total business deductions exceed business income plus $250,000 for single filers and $500,000 for joint filers.
Estate Tax Unified Credit (Raises $54.3 billion): The 2017 Tax Cuts and Jobs Act doubled the estate tax exemption amount through 2025. The proposal terminates this temporary increase after December 31, 2021. Thus, the $11.7 million (single filer) and $23.4 million (married couple) exemption will be cut in half in 2022 after an inflation adjustment.
- It would increase the availability of 9 percent LIHTCs by 50 percent, phased in over five years, and adjust credit amounts for inflation in 2026-2028. The 12.5 percent addition to credit authority available in 2018-2021 is included in the baseline prior to the increase, making the total increase approximately 60 percent. The cap increase sunsets after 2028. NMHC has long advocated for this proposal.
- It would reduce the amount of a property that must be financed with private activity bonds to utilize 4 percent LIHTCs from 50 percent to 25 percent. The provision would be effective for buildings placed in service in taxable years beginning after December 31, 2021 and financed by bonds issued in 2022-2028. NMHC strongly supports this proposal.
- It would provide a 50 percent basis boost for LIHTC projects that provide at least 20 percent of units to extremely low-income households.
- It would enable housing credit agencies to designate bond-financed buildings as requiring additional tax credits meaning buildings designated as such would be treated as being located in difficult-to-develop areas and would receive additional basis for purposes of the LIHTC.
- It would increase the credit percentage from 20 percent to 30 percent for 2020–2025. It would then phase it down to 26 percent in 2026, 23 percent in 2027, and 20 percent in 2028 and thereafter. Notably, smaller projects would be provided a permanent 30 percent credit.
- It would modify the definition of substantially rehabilitated so qualified rehabilitation expenditures must exceed the greater of: (1) 50 percent (instead of 100 percent) of the adjusted basis of the building or (2) $5,000.
- The historic tax credit would no longer have to be deducted from the building’s basis, which is designed to make the credit more compatible with other incentives including the LIHTC.
Low-Income Housing Tax Credit (Costs $29.2 billion): The proposal includes a number of provisions to increase the scope and effectiveness of the LITHC.
Rehabilitation Tax Credit (Costs $26.5 billion): The proposal would enhance the historic rehabilitation tax credit.
Energy Tax Incentives (Costs $3.4 billion): The proposal would modify energy tax incentives available to the multifamily industry. Firms meeting baseline requirements would receive a base credit, but they would have to meet prevailing wages and apprenticeship requirements to receive a bonus credit.
Specifically, firms can quintuple the base credit if they pay all contractors and subcontractors prevailing wages. Projects would also have to be staffed by apprentices (5 percent of labor hours must be performed by apprentices for projects commencing construction in 2022, 10 percent in 2023, and 15 percent thereafter, with a minimum of one apprentice for each contractor or subcontractor employing at least four workers. Exemptions would be permitted if apprentices are unavailable.
Energy Efficient Commercial Buildings Deduction: Beginning in 2022, the base credit for buildings with four or more stories that exceed 25 percent of ASHRAE standards in effect three years before a building is placed into service would be $0.50 per square foot for energy savings. It would increase by $0.02 per square foot for every percentage point by which energy savings exceed the 25 percent baseline threshold, up to $1.00 per square foot. Bonus amounts, as described above, are available for taxpayers meeting applicable labor requirements.
Additionally, taxpayers would be able to take a deduction for energy efficient lighting, HVAC and building envelope costs placed in service as part of a retrofit. The value of the deduction would be based upon how much energy savings is achieved. A minimum 25 percent reduction would be required to realize a $0.50 per square foot gain in the base credit.
The base credit would be increased by $0.02 per square foot for each additional percentage point in energy savings, up to $1.00 per square foot. Bonus amounts, as described above, are available for taxpayers meeting applicable labor requirements. NMHC has long called for retrofits with energy savings measured against an existing building’s baseline energy usage to be eligible for the credit. The provision would be effective through 2031.
New Energy Efficient Home Credit: The proposal would extend the New Energy Efficient Home Credit (which applies to buildings of three or fewer stories) through 2031. For multifamily units acquired after 2022, a base credit of $500 is provided for units that participate in the ENERGY STAR Multifamily New Construction Program while meeting both national and regional program requirements. It is, however, unclear whether units will decide to participate in this program. Finally, a base credit of $1,000 is available to multifamily homes certified as zero energy ready under the Department of Energy Zero Energy Ready Home Program. Bonus amounts, as described above, are available for taxpayers meeting applicable labor requirements.
- Allocation of Partnership Items: It would generally require allocations in accordance with a partner’s interest in the partnership.
- Tax Attributes of Contributed Property: It would require the use of the remedial method for allocating tax attributes of contributed property to partners.
- Built-in Gains: It would require a partner contributing property to a partnership to recognize built-in gain if the property is subsequently distributed to another party (current law requires recognition only if property is distributed within seven years).
- Rules for Determining Whether a Partner Has Recourse Debt: It would require all debt be shared between partners in proportion to profits (with an exception in cases in which a partner is a lender). Tax liability arising out of enactment of the provision could be paid over eight years.
- Mandatory Basis Adjustments: It would require basis adjustments that are currently elective in most cases to address differences between inside and outside basis. These adjustments are made mandatory in cases in which partnership assets are either distributed or transferred.
Wyden Proposal Targeting Partnerships
As mentioned above, the Senate will also have an opportunity to propose revenue offsets. Senate Finance Committee Chairman Ron Wyden (D-OR) on September 10 released a discussion draft targeting partnerships that would adversely impact multifamily partnerships. Key provisions include: