Real estate

Deferred interest loophole will be closed in new Manchin inflation deal, effects on real estate investments

  • Sen. Joe Manchin reached a surprise deal with Senate Majority Leader Chuck Schumer on Wednesday.
  • The deal, which would dedicate billions to climate spending, is offset by targeted taxes.
  • One of these tax changes closes a loophole available to real estate investors.

A surprise spending deal by Democrats could lead to heavier tax bills for some ultra-wealthy real estate investors.

On Wednesday night, leading centrist Democratic Senator Joe Manchin released a statement that reverberated through the halls of Congress — and into the pockets of high-income investors: He had struck a deal with Senate Majority Leader Chuck Schumer, and part of it involved closing the interest loophole.

Deferred profit sharing essentially allows investors, especially private equity managers, to pay a lower rate of tax on their income. This is because when they invest in a business, they can receive their share of the profits in the form of assets, rather than in the form of a check. When a long-held asset, such as a stock or real estate, is eventually sold, it is taxed at what is known as the capital gains rate – a rate well below the simple tax rate.

Some property managers “pay a much lower rate of tax than others who live off bonuses and salaries,” according to Steve Rosenthal, senior fellow at the Tax Policy Center, because their compensation is structured with carried interest.

While closing the rule won’t have a negative impact on the entire property industry, Bobby Fijan, property developer and founder of FORM, says it could transform the way property investors structure their businesses.

“What I expect is that it will discourage risk-taking or reduce developer bottom lines,” he told Insider. “I anticipate this will have a significant impact on how property developers structure their fees.”

Fijan says the interest shown has been invaluable to property developers as it is a profitable escape – but he doesn’t think Manchin’s proposal is unfair.

“I don’t think it’s a horrible thing to do,” he said. “Real estate has been granted special status, so it’s not an unreasonable loophole to close.”

The deal Manchin reached — called the Cut Inflation Act of 2022 — would extend the holding period for deferred interest by five years. In simpler terms, this means that you cannot benefit from the preferential tax rate unless you wait at least five years to sell your assets.

The law on the reduction of inflation is however far from being concluded. While most Democrats seem to be on board, the specter of Arizona Sen. Kyrsten Sinema looms. Sinema, the other key centrist vote in the razor-thin majority of Democrats, has repeatedly pushed back against any tax hikes. So far, Sinema has dodged inquiries about whether the package has his approval.

“I know this is something that Senator Sinema is concerned about,” Senate Finance Committee member and GOP whip John Cornyn of Texas told Warren Rojas. “And I don’t think they checked with her first,”