For these economic reasons, federal tax policy debates in 2009 will be necessarily related to the depth of the recession and the prospects for an economic recovery, as well as the policy priorities of the new Obama administration. Issues under discussion include temporary enhancements for the Low-Income Housing Tax Credit [LIHTC] program, as well as continued debate concerning the taxation of carried interest in the context of Alternative Minimum Tax [AMT] reform.

Multifamily Housing Market Background

Being both a cause and an effect of the foreclosure crisis, the credit crunch has significantly reduced housing demand and generated historic levels of for-sale inventory of new and existing homes in all sectors of the housing market, including multifamily. These levels of inventory have the ability to generate – or have already produced – stagnant or reduced property prices and rents, thereby hurting multifamily business profits.

The following figures, which employ Census data, show how the crisis is affecting the condominium market. Figure 1 illustrates the runup in new condominium inventories and months-supply since the middle of 2005.

Figure 2 demonstrates that declining condominium sales have pushed the months-supply measure of existing condominiums to more than a one year-supply.  This months-supply measure for existing condominiums, which currently stands at approximately 14 months, is greater than the comparable single-family existing measure (11.2-months for November 2008, according to NAR data).

The inventory and price impacts generated by the housing crisis have created a vicious cycle in the finance industry, with homebuyers facing increasing difficulty obtaining mortgages, which in turn places greater pressure on property prices and inventories due to declining housing demand.  This, in turn, produces negative spillover effects in the affordable housing sector, where access to credit is very challenging because of the financial crisis, thereby impairing the ability of programs like the LIHTC to operate efficiently. This last effect is particularly painful in a period of economic downturn and increased need for affordable housing.

Looking Back: Tax Legislation in 2008

Against this backdrop, Congressional tax policy efforts have focused on general economic stimulus and specific housing tax-related initiatives. In February 2008, Congress enacted the Economic Stimulus Act of 2008. The legislation provided more than $100 billion in individual income tax rebates, equal to $600 per taxpayer ($1200 for married taxpayers) plus an additional $300 per qualifying child. The rebates were intended to provide a boost to economic growth, and while GDP growth was measured at a relatively strong 2.8% rate in the second quarter of 2008, the rebates were ultimately unsuccessful in providing a permanent stimulus to the economy.  Indeed, third-quarter GDP declined by 0.5%, and the National Bureau of Economic Research officially dated the recession as beginning after December 2007, when national economic activity peaked.

February’s stimulus legislation also increased certain investment incentives, including section 179 small business expensing, and additional bonus depreciation allowances. However, these incentives were ultimately unsuccessful because they benefited only industries that possessed substantial consumer demand and current period tax liability. Indeed, these policies had almost no impact on the housing sector, in part because with the exception of certain existing GO-Zone incentives, residential structures are not eligible for bonus depreciation. Thus, these business tax incentives targeted industries not needing stimulus, and generated little macroeconomic feedback effects on jobs, incomes, and state and local taxes.

Moving ahead to July 2008, we saw Congress enact the NAHB-supported Housing and Economic Recovery Act of 2008. Hailed at the time as the most significant housing legislation in a generation, the impacts of the legislation on the housing sector have been mixed, in large part due to the growing economic crisis.

With respect to multifamily developers, the legislation included many important provisions.  The most important set constituted changes to the LIHTC program, the nation’s most important affordable housing production program. Among these changes are the ability to claim the tax credit against the Alternative Minimum Tax; a temporary increase in the LIHTC allocation cap; a temporary rule that fixes the 70% present-value credits at a minimum 9% credit rate; reforms to the income limit rules (including codification of the HUD hold-harmless rules for data changes); modifications to the income limit rules for rural areas; and changes to the income treatment of base housing allowances for military installations in certain areas for LIHTC income eligibility. The changes, totaling more than $4 billion in program enhancements, made substantial improvements to the LIHTC program.

The legislation also created a temporary first-time home buyer tax credit for the purchase of a principal residence, including multifamily units.[1] The provision was intended to reduce the stock of for-sale inventory of housing units, thereby reducing the downward pressure on owner-occupied and rental housing prices. Given the growing inventory, in particular, of existing condominium units, a robust homebuyer tax credit would have reduced inventories and taken some pressure off declining property prices.

Unfortunately, market-level evidence from builders indicates that the tax credit has been unsuccessful in significantly stimulating housing demand. The primary reason for this disappointment is that the credit is really a no-interest loan; that is, the credit must be repaid over 17 years, thereby significantly reducing the value of the housing tax incentive.[2]  The loan has a real monetary value to qualified homebuyers (about $4,000 in net present value terms), but builders and realtors have reported that it is too complicated and too weak to entice potential homebuyers waiting on the sidelines. Moreover, shocks to the financial system in September and October of 2008, including the placement of Fannie Mae and Freddie Mac into conservatorship, significantly reduced consumer confidence and home buying demand, thereby overwhelming any stimulative impact from the summer’s housing legislation.

These negative shocks to the economy were so great that in October, the President signed into law the Emergency Economic Stabilization Act of 2008.  The primary feature of the legislation was the appropriation of $700 billion for the purchase of troubled financial assets {the TARP program). The program has evolved over time to constitute a recapitalization fund for troubled financial institutions, to the disappointment of many in Congress, given the original intent of the law. Indeed, the last amount of the initially approved $350 billion of TARP funds was used as a loan to the struggling automobile sector.

The Act also contained numerous tax provisions. In particular, the law extended for three years (until the beginning of 2013) the temporary income tax exclusion for forgiven mortgage debt allocable to a principal residence, which was enacted in late 2007. The exclusion eliminates any tax consequences that otherwise would result from mortgage workouts in an effort to prevent foreclosures. While many of the benefits from the provision fall in the single-family market, the expansion of debt relief will help reduce the excess inventory of existing condominiums in the for-sale multifamily market.

The legislation also extended a number of energy tax incentives, including those that affect the multifamily sector. The section 179D energy efficient commercial buildings deduction (which includes most multifamily properties) was extended for five years (through the end of 2013). The section 48 solar credit was extended for eight years. Other extended tax incentives include the section 45L $2,000 new energy efficient home tax credit (which includes properties intended for lease and sale), the section 25D home solar credit, and the section 25C existing homes energy tax credit.

The law also extended a number of important and expensive expiring tax provisions, the most important of which is a one-year patch of the AMT. Among other effects, patching the AMT involves increasing the exemption amount, thus reducing the number of individual and business taxpayers that face increased tax liability due to potential AMT liability. This is particularly important in the construction industry, which is dominated by pass-through entities, such as partnerships, for which business taxes are paid on a pass-through basis on individual income tax returns. Other extended tax incentives of interest to the multifamily industry include a two-year extension of the brownfields expensing provision and a one-year extension of New Markets Tax Credit allocating authority. The Act also made a number of beneficial changes for multifamily affordable housing developers, including increased tax-exempt housing bond and LIHTC authority for the areas of the Midwest affected by floods and Hurricane Ike.

Notably – and fortunately – missing from this discussion of tax extenders is mention of a provision requiring a change to the taxation of carried interest. Under present law, carried interest is taxed – correctly according to NAHB – as a capital gain at a 15% rate. Previous discussions of patching the AMT and tax extenders had suggested that Congress might change the taxation of carried interest to that of ordinary income, at rates as high as 35%, and use the increase in tax revenue to offset the lost tax receipts from extending the aforementioned expiring tax provisions.  Due to the advocacy efforts of groups like NAHB, as well as the effects of the current economic crisis, no such pay-for provision was included in the legislation.

Looking Forward – Tax Legislation in 2009

However, the taxation of carried interest may reemerge in 2009 when a new Congress and a new administration take office. At the end of 2010, many of the 2001 and 2003 tax cuts expire, including the reduced rates of taxation on dividends and capital gains, the elimination of the estate tax, and the reduced rates of ordinary income. The expiration of these reduced rates could see the top individual income tax rate jump from 35% to 39.6%. Extending some or all of these tax policies may require increasing other taxes, such as that on carried interest, to make up the difference in federal revenues.

Nonetheless, President-elect Obama’s tax policies clearly will be determined in the context of addressing the recession as the top priority. Indeed, some observers believe a stimulus package of up to a trillion dollars may be enacted in the early part of 2009 in order to promote an economic recovery. To date, much of the debate concerning economic stimulus in 2009 has focused on block grants to state and local governments and infrastructure development. Nonetheless, as the housing sector is central to the ongoing economic weakness, policies targeted to the housing market, including the multifamily sector, are critical to economic recovery efforts.

Among NAHB’s priorities as part of the stimulus debate are stabilization policies for the LIHTC.  The exit of Fannie Mae and Freddie Mac from the LIHTC syndication markets has driven the price of LIHTCs down. Moreover along with other parts of the real estate industry, the LIHTC program is suffering due to the credit crisis.  In particular, it has been become increasingly difficult to put together LIHTC deals due to the high cost of financing and the lack of LIHTC credit demand in syndication markets. 

To increase demand for tax credits and to stabilize LIHTC prices, NAHB is recommending two changes to bring in more investors. These proposals are to temporarily accelerate the credit claim period from ten years to five (thereby raising the yield on LIHTC investments, but not materially affecting the government’s ten-year budget window estimate) and expanding the permitted carryback period on LIHTCs, as defined by the tax code’s general business credit rules, from one year to five. These changes are designed to make LIHTC investments more attractive, thus easing the current constraints on affordable housing development and attracting more investors. 

NAHB is also studying proposals that would allow for limited refundability for the LIHTC –  allowing the tax credit to be claimed by taxpayers who have no tax liability – as well as modifications to the tax code’s passive loss limitations for the LIHTC program. Substantially increasing the $25,000 deduction equivalent passive loss limitation on LIHTC credit claims would encourage individual taxpayers to participate in the program, thereby increasing demand and prices for LIHTC and injecting more equity into affordable housing projects.

NAHB also is reviewing certain tax policy proposals to help builders with operating losses due to declining sales and revenue.  NAHB has previously fought for an expansion of the section 172 net operating loss (NOL) deduction carryback from the present law – two years – to five years in order to accelerate when taxpayers can claim the tax benefit from current period business losses.  Making this change is especially important during a credit crunch because other sources of capital are difficult to obtain. NAHB also is studying the effects of expanding the mortgage debt tax relief established in 2007 and expanded in 2008 (for principal residence owners) to small business dealer-related debt – in particular ADC loans. Making this change would likely eliminate any possible tax consequences that could arise due to workout arrangements on troubled loans.  This would promote market-based solutions to loan issues arising as a result of today’s challenging economic environment.

Of course, after the economy recovers, the long-term tax policy agenda remains daunting as well.  AMT reform (or repeal) still remains high on the to-do list. And because of past Congressional debates, any AMT discussion will necessarily involve a debate over the taxation of carried interest. Certain tax proposals are likely to be part of future policy debates because they were either campaign issues during the Obama campaigned, or are linked to past advocacy by Senator Obama in Congress.  Among these are possible changes to the tax treatment and qualifying criteria of independent contractors, an important rule in the construction sector and other industries where workers may contract for multiple projects in a given tax year. Senator Obama introduced legislation in the last Congress severely restricting the tax rules associated with independent contractor status. NAHB has advocated that existing rules are economically practical but need clarification to protect against taxpayer mistakes. NAHB opposes restrictions on the legal use of independent contractor status. Finally, many of the Bush-era tax cuts are due to expire on January 1, 2011. The Obama campaign supported many of the tax cuts for middle class taxpayers. The extent to which extent these tax cuts will be curtailed or extended will be a major tax policy debate in 2009 and 2010.