In the Internal Revenue Code of 1954 additional accelerated depreciation was extended by statute to new property, including buildings, # up to a maximum of 200% declining balance. The Committee Report / Regulations and a published ruling recognize that 150% declining balance had been available under prior law. In 1964, in response to Treasury criticism that there was a tax abuse where taxpayers took accelerated depreciation and then disposed of the property in a relatively short time, the Congress enacted $1250 which provides recapture of all or some real estate depreciation, varying with the holding period of the asset. §1245 provides total recapture of depreciation for machinery and equipment, unrelated to holding period. Unlike machinery and equipment, real estate is (A) long-lived, not short-lived and (B) owned to a significant extent by individuals subject to sharply progressive income tax rates (14 to 70% without the surcharge). Thus, the $1245 treatment which applies to relatively short-lived assets substantially owned by corporations is inappropriate for real estate. 0/ "Under this method [the declining balance method] a uniform rate is applied to unrecovered basis of the asset. Since the basis is always reduced by prior depreciation, the rate is applied to a constantly declining basis. The salvage value is not deducted from the basis prior to applying the rate, since under this method at the expiration of useful life there remains an undepreciated balance which represents salvage value. The rate to be used under this paragraph may never exceed twice the rate which would have been used had the deduction been computed under the method described in paragraph (1). Under section 23(1) of the 1939 Code the declining balance method was allowed in certain instances but the rate was generally limited to one and one-half times of the rate used under the straight-line method. If this method has been used for property acquired prior to December 31, 1953, it may continue to be used but the rate provided for in paragraph (2) will not be presumed to be reasonable with respect to such property. . . ." H. Rept. No. 1337, 83d Cong., 2d Sess. (1954), p. A48. (As is noted, accelerated depreciation also avoids the salvage value controversy and never results in deductions in excess of basis, which is generally cost). #/ See H. Rept. No. 1337, 83d Cong., 2d Sess. (1954), p. 23; The 200% declining balance method was provided by the 1954 Code for "rental housing and industrial and commercial building" as well as machinery and equipment. The Treasury Study contains no information on what the experience has been under §1250, which has now been in effect over five years. The term accelerated depreciation is often used to refer to any depreciation in excess of straight line. In the interest of clarity of thinking, two different kinds of accelerated depreciation need to be distinguished, the accelerated depreciation up to 150% declining balance administratively recognized by the Internal Revenue Service for 23 years as being a reasonable allowance for depreciation and the special accelerated depreciation added by statute in the Internal Revenue Code of 1954 for new property up to 200% declining balance. An apartment is never worth more physically than on the day it opens its door. Thereafter, its equipment is old and it is subjected to falling behind in the development of the art. Refrigerator sizes become larger, air conditioning is introduced, swimming pools are added, new types of carpet come in. The constant changes in equipment and furnishings for an apartment are such that any apartment in the first few years of its life suffers substantially more than straight line depreciation as a matter of economics. This can be illustrated many ways. For example, new apartments tend to have dishwashers; older apartments do not. The cubic foot area of refrigerators has expanded substantially over the years. Projects which are ten years old may have 6 cubic foot refrigerators whereas projects which are being done now have 12 or 15 cubic foot refrigerators. A person looking for a new apartment will naturally tend to prefer one which has the larger capacity refrigerator and a dishwasher. The older apartment project is at a significant competitive disadvantage as compared to the new project. In the current economy depreciable real property which has been held for many years is often sold at a gain. It is incorrect to assume that this gain demonstrates that the depreciation was excessive. To the contrary, the gain is generally the product of either or both inflation* of the price level and increase in the value of non-depreciable land which is a clear capital gains. The Treasury Study argues that present tax laws encourage frequent turnover of properties and, therefore, cause inadequate maintenance. (page 443) This conclusion appears to rest on two assumptions: (1) the owner who is holding the property for a longer period will maintain the property well; and (2) the owner who is holding the property for a shorter period will not maintain his property well. Both assumptions are incorrect. The ultimate test of the quality of a property is how it fares on sale in the market place. It is precisely the owner who is going to sell who must maintain his property; if he does not, he will either be unable to sell or he will have to take a substantial discount because of poor maintenance. It is precisely the owner who is going to hold for a long time who can skimp on maintenance, doing only enough to keep tenants minimally satisfied. For these reasons we urge the Committee to amend H. R. 13270 to retain the 150% method for existing apartments, and to modify the harsh recapture provision in accordance with the recommendation made on pages 1-2 of this statement. It was for this reason that this Committee, in 1962, decided not to act on a Treasury recommendation for full recapture of real estate depreciation ". . . Your Committee decided not to apply this treatment to buildings or structural components of buildings at this time because testimony before your Committee indicated that this treatment presents problems where there is an appreciable rise in the value of real property attributable to a rise in the general price level over a long period. . ." H. Rept. No. 1447, 87th Cong., 2d Sess. (1962), p. 67. STATEMENT CARTER L. BURGESS NATIONAL CORPORATION FOR HOUSING PARTNERSHIPS Summary Private investment in the development of low and moderate income housing currently depends upon aid provided through both the existing federal income tax treatment of real estate and the federal housing subsidy programs. The changes in present tax law contained in H. R. 13270 will eliminate much of the incentive for equity investment in low and moderate income housing and substantially reduce entrepreneurial interest in this housing. Although the bill recognizes a distinction between new housing and other real estate development, it jeopardizes the Congress's efforts to promote the private development of publicly assisted housing and the sale of such housing to low and moderate income tenants and tenantoriented organizations. Significantly, this comes at a time when the nation faces its greatest housing shortage since the immediate post-war years and when the demand for housing by lower income families is particularly acute. In the Housing Act of 1968 Congress established the goal of the construction or rehabilitation of 26 million housing units, including 6 million publicly assisted units, by 1978. If Congress wishes to achieve these goals, it must not eliminate these tax incentives -- at least until it provides a suitable substitute. Since the existing incentives have barely been effective, if private, rather than direct governmental action is to produce decent low and moderate income housing in volume, Congress should, at a minimum, create a new stimulus to development. It is suggested that H. R. 13270 be amended to provide that upon the sale of a publicly assisted low or moderate income housing project to or for the benefit of persons of low and moderate income, the seller would recognize gain for federal income tax purposes only to the extent that the amount realized on such sale exceeds the cost as determined under Section 1012 of the Internal Revenue Code. Such action by the Committee would maintain or increase the continued interest of private enterprise in the development of low and moderate income housing without any significant loss of revenue and without disturbing the other goals sought to be achieved by the Tax Reform Act of 1969. |