Senate Passes $740B Reconciliation Package; Drops MBA-Opposed Carried Interest Provision

(Summary by the MBA Government Affairs Department)

After hours of procedural debate on Saturday afternoon, followed by a marathon overnight “vote-a-rama” (a series of amendment votes – none of which pertained directly to real estate finance), the Senate on Sunday passed an amendment in the nature of a substitute to H.R. 5376, now known as the Inflation Reduction Act, by a 51-50 vote (Vice President Kamala Harris breaking the tie). 

This revised budget reconciliation and tax package (over 18 months in the making) is designed to address climate change, healthcare costs, and deficit reduction — principally through corporate tax increases. It is estimated to raise approximately $740 billion in revenue over 10 years by: (1) implementing a 15 percent corporate “minimum book tax” on GAAP income (for firms with declared net income over $1 billion); (2) increasing IRS tax enforcement funding; (3) allowing Medicare to negotiate lower prescription drug prices; and (4) imposing a 1 percent excise tax on stock buybacks.    

  • Why it matters: After months of persistent MBA advocacy, the Senate substitute to H.R. 5376 incorporates language to preserve the deferred tax treatment of MSRs and excludes mortgage servicing-derived income (both residential and multifamily) from the corporate minimum book tax’s coverage. The book tax language was also altered to exclude private equity subsidiary firms from its coverage, as offset by extending pass-through loss limitations (from the American Rescue Plan) for two additional years.
  • The agreement does not include a host of harmful revenue raisers considered in prior reconciliation proposals, including: other broad changes to the tax treatment of pass-through entities, such as an expansion of the 3.8 percent Net Investment Income Tax (NIIT) or limits to the current Section 199(a) 20 percent deduction against Qualified Business Income; a cap on 1031 Like-Kind Exchanges; changes to capital gains treatment/”stepped-up” basis; broad changes to the deductibility of business interest; an enhanced FICA tax regime; altered treatment of the gain on sale from a home; and, changes to the capital gains treatment of “carried interest.”
  • What’s next: MBA will also continue to push for targeted housing investments/credits (e.g., a workable Down Payment Assistance program, enhancing/expanding the Low Income Housing Tax Credit, a new single-family rehabilitation credit targeted at LMI census tracts, a new repurposing/refurbishment affordable housing credit, etc.) excluded by the Congress (and/or Senate Parliamentarian) from the Inflation Reduction Act.

For more information, please contact Ethan Saxon at (202) 557-2913 or Tallman Johnson at (202) 557-2866

Earlier in the week, Senate Democrats dropped a controversial carried interest provision in a reconciliation bill that the Mortgage Bankers Association and other industry trade groups said would “cripple the housing recovery.”

On July 27, Senate Majority Leader Chuck Schumer, D-N.Y., and Sen. Joe Manchin, D-W.Va., announced an agreement to add the Inflation Reduction Act of 2022 to the FY2022 budget reconciliation bill and vote in the Senate. The proposed legislation would have expanded the scope of Section 1061.1 which outlines taxation of carried interests and other partnership interests.

However, Sen. Kyrsten Sinema, D-Ariz., objected to the carried interest provisions of the bill, leading to intensive negotiations on Thursday, news sources reported. With Democrats holding a razor-thin 50-50 edge in the Senate (Vice President Kamala Harris serves as tiebreaker), Sinema’s objections threatened to derail the overall reconciliation bill. Late Thursday, after discussions with Sinema, Schumer and Manchin agreed to drop the the carried interest provision from the bill.

“We have agreed to remove the carried interest tax provision, protect advanced manufacturing, and boost our clean energy economy in the Senate’s budget reconciliation legislation,” Sinema told The Hill. She said she would vote to begin debate on the bill, subject to the Senate parliamentarian’s review.

Earlier on Thursday, MBA and more than a dozen industry trade groups sent a letter to the Senate, opposing the carried interest provision. The MBA/trade group letter said the carried interest provisions of the Inflation Reduction Act of 2022 which would “harm the residential and commercial real estate industries to the overall detriment of job creation and the economy. The carried interest proposal would slow housing production, discourage the capital needed to reimagine buildings to meet post-pandemic business needs, hamper job creation and create an additional unknown in an already confusing economic environment. The small amount of revenue associated with the proposal is not needed in this inflation-fighting legislation and we respectfully urge that it be dropped.”

The letter cited three primary concerns:

–Holding period measurement. The legislation would unintentionally extend the holding period requirement well beyond the 3 or 5 years suggested in the bill’s description. “Some real estate assets that are held for 8 years, 10 years, or even longer would not qualify for long-term capital gains treatment,” the letter said. “This is because the holding period would not start until a partnership had acquired substantially all of its assets. In the case of an open-ended fund that has no predetermined end date, it may never meet the holding period’s ‘substantially all’ requirement.

As a result, the letter said, the bill would greatly distort and misalign the interests of general partners vis-vis limited partners who are not subject to these arbitrary rules. It would drive the potential for new and unnecessary conflicts between parties. In addition, the holding period changes would unfairly deny capital gains treatment to the income that arises from many productive, long-term investments simply because of the owners’ partnership structure. The fact that a partnership invests in more than one building or business should not distort the basic economic reality and longstanding principle that each asset is taxed ad its own capital investment with its own lifespan and holding period.

–Extension to section 1231 gain common in housing and other real estate projects. The pointes out the legislation, perhaps unintentionally, would extend the holding period requirement to other types of carried interest income common in the construction and improvement of housing and other real estate. Specifically, the expanded carried interest rules would pull in section 1231 gain —net gain from property used in a trade or business or held for the production of income.

The letter noted the Section 1231 gain was excluded from the regime when it was enacted in 2017. “Many real estate funds construct or rehabilitate housing and sell it within two years so they can finance the next housing project,” the letter said. “Extending the 3-year holding period will slow down their housing development as funds hold on to the property for another year, or it likely will drive up rents on the property to recuperate the additional tax liability. The proposed change is counterproductive to addressing the severe housing and crisis throughout the country.”

–Retroactivity. The legislation would apply retroactively to partnership agreements executed years earlier. In some cases, the result would be to change the tax rate for one partner to the agreement and not the others. “This could alter the basic and mutually agreed economics of the original deal between the parties, and further undermine the predictability of the tax system,” the letter said.

“Carried interest is a vital tool contributing to capital formation and new housing development, productive risk-taking and job creation,” the letter said. “Changes to carried interest could have profound, unintended consequences for the main streets of cities all across our country. Property taxes on real estate contribute 75 percent of local tax revenue and provide a stable and reliable source of funding for vital public services like education and law enforcement.

“Achieving tax fairness is complicated,” the letter noted. “Simple solutions often are not solutions at all. Now is not the time to impose a tax increase on the countless Americans who use partnerships to develop, own and operate housing and other commercial real estate. We urge you to preserve current tax law as it relates to carried interest.”

Joining MBA in the letter: American Resort Development Association; American Seniors Housing Association; Building Owners & Managers Association; CCIM Institute; CRE Finance Council; ICSC; Institute of Real Estate Management; NAIOP, the Commercial Real Estate Development Association; National Apartment Association; National Association of Home Builders; National Association of Realtors; National Multifamily Housing Council; The Real Estate Roundtable; and the Realtors Land Institute.