Legislation introduced this week by Senate Finance Chairman Ron Wyden, above, would repeal tax rules applicable to foreign governments and their investment arms (“sovereign wealth funds”) if that government has more than $100 billion invested globally and does not qualify for an exception. (Wyden’s news release and one-page summary, July 26)  Section 892 

• Citing specific concerns related to the recent merger between the Professional Golf Association (PGA) Tour and the Saudi Public Investment Fund, Chairman Wyden’s expansive bill—the Ending Tax Breaks for Massive Sovereign Wealth Funds Act—would deny application of the tax code’s long-standing section 892, which exempts certain passive income earned by foreign governments from U.S. income taxation.
• Countries that have a free trade agreement or tax treaty with the United States could continue to qualify for section 892, provided they are not listed as a "foreign country of concern"by the U.S. State Department. According to Chairman Wyden, the legislation would apply to China, Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, and Russia. (PoliticoPro, July 26) 

Foreign Investment & CRE 

• Some of the listed countries are large investors in U.S. commercial real estate and represent a key source of capital for job-creating U.S. real estate investment. 
• “Section 892 is nearly as old as the tax code itself, and the tax principle it represents—sovereign immunity for foreign governments—is older than the tax code. Disrupting and rewriting these rules on a whim because of a single transaction is risky and unwarranted. The consequences for U.S. real estate, jobs, and the economy could be severe,” said Real Estate Roundtable President and CEO Jeffrey DeBoer, above.
• “The United States is able to attract foreign capital for jobs and productive real estate investment because foreign investors have confidence in our rule of law. They believe the USA is a safe place to invest,” continued DeBoer. “When leading lawmakers threaten to overturn 100-year-old tax policies because of a single, unpopular transaction, it raises legitimate concerns. Congress should tread carefully in this area and fully understand the potential implications of its action.”
• CBRE’s Global Head of Capital Markets Christopher Ludeman stated, “Sovereign wealth funds are among the largest and most important investors in global real estate, especially in the U.S. where, by conservative estimates, they have invested over $25 billion since 2021. At a time when capital flows into real estate are scarce, transaction volume is down by 53% in the first half of 2023 compared to the first half of 2022. In this environment, SWFs are an important source of capital, investing close to $9.7 billion this year alone. This is the wrong time to put any new restrictions on capital flows into real estate, which this bill would do.”   

Established Law 

• The section 892 tax exemption for foreign governments does not extend to commercial activities or active ownership of U.S. real estate. Income from an interest in a U.S. real property-holding corporation that a foreign sovereign does not control is generally exempt from U.S. tax as income from an investment in a U.S. security—consistent with the general rule that section 892 is limited to passive investments.
• Over the years, Treasury guidance and IRS rulings have further defined the scope of the provision and its interaction with other tax provisions, such as section 897 and the Foreign Investment in Real Property Tax Act (FIRPTA).
• The original version of section 892 was enacted in 1917 and is based on Supreme Court case law that dates to 1812. Similar foreign government tax exemption regimes apply in other countries, such as the United Kingdom, Canada, Australia, and Japan. See JCT, Economic and U.S. Income Tax Issues Raised by Sovereign Wealth Fund Investment in the United States (2008). 

The Wyden bill includes grandfathering rules that would apply to certain investments through 2025. The rules would cover capital deployed or committed prior to enactment and investments in publicly traded companies, provided the investment is less than 10 percent. Any grandfathering benefits would expire beginning in 2026. (Wyden’s one-page summary of the bill, July 26)  #   #   # 

The Real Estate Roundtable submitted comments today on proposed and temporary tax regulations regarding the transferability and direct payment of clean energy credits under the Inflation Reduction Act (IRA) of 2022. (Roundtable comments, July 28)

 IRA Incentives 

• Congress passed the IRA last August. The law significantly increases the size of existing tax incentives for energy-saving improvements to commercial real estate. Perhaps even more importantly, the legislation contained key reforms related to the transferability and direct payment of energy tax credits.
  
  
• The reforms have made the incentives relevant to a large and previously untapped segment of real estate owners, including REITs, pension funds, and private foundations. The incentives include:
  
  
  • Tax-exempt real estate owners that invest in solar panels and other improvements can elect to receive direct payments from the Treasury in lieu of the expanded investment tax credit.
  • Taxable real estate owners, including REITs, can sell the credits to third parties for cash. 
  • The credit amount can range from 6% to 60% of the qualifying investment, depending on factors such as the size, location, domestic content, and wages paid to equipment contractors.

• Roundtable comments submitted last year included recommendations on the IRA’s transferability provisions. On June 14, the Treasury Department and IRS issued proposed regulations to implement the provisions, as well as temporary regulations establishing a pre-filing registration process.
  
  
• The IRS rules adopted certain Roundtable recommendations, such as the ability to divide and sell the credits from a single project to multiple transferees. Other recommendations, which would have maximized the value of the credits in mixed real estate partnerships involving taxable and tax-exempt partners, were rejected as contrary to the statute and difficult to administer.  

Energy Credits Monetization  

• Today’s letter from Real Estate Roundtable President and CEO Jeffrey DeBoer commends Treasury for providing greater clarity on its credit monetization mechanism and for laying out a rational process and timeline for property owners to claim and transfer credits or receive payments.
  
  
• The Roundtable’s July 28 letter—developed by a joint working group of the Roundtable’s Tax and Sustainability Policy Advisory Committees (TPAC and SPAC)—also encourages Treasury to revisit the issue of mixed partnerships and asks for clarification that the credits are not “bad assets” for purposes of the 75% REIT asset test.
  
  
• The credit monetization tools enacted in the IRA offer valuable new opportunities to access and raise capital for energy-saving improvements to commercial real estate. The deadline for comments to Treasury and the IRS is August 14, and final Treasury regulations are expected this year.  

The Roundtable’s Energy Credit Transferability Working Group will remain engaged with policymakers as the rules are finalized and implementation continues. 

#   #   #

Federal bank regulators this week approved a sweeping set of proposed changes that would increase capital requirements for the nation's largest banks by as much as 20%, which could significantly affect liquidity available for commercial real estate transactions, impact asset values, and influence economic growth. Dissenting votes on the proposed rulemaking revealed rare disagreement among regulators, and Fed Chairman Jerome Powell signaled a cautious approach to consideration of any final rule as a 120-day public comment period begins. (Axios and PoliticoPro, July 27) New Capital Framework

• The Fed, Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) jointly approved the proposal, which would substantially revise the regulatory capital framework for banking organizations with total assets of $100 billion or more. Stakeholder comments on the 1,100-page proposed rulemaking are due by Nov. 30. (See Interagency Overview of the Notice of Proposed Rulemaking for Amendments to the Regulatory Capital Rule, July 27)

• Fed Chairman Powell voted for the proposal, but noted a significant tone of caution, stating, “Raising capital requirements also increases the cost of, and reduces access to, credit … threatening a decline in liquidity in critical markets and a movement of some of these activities into the shadow banking sector.” He added, “While there could be benefits of still higher capital, as always we must also consider the potential costs. As the financial system evolves, it is important that regulation evolve with it. I look forward to hearing from all stakeholders on how best to strike that balance.” (Federal Reserve Board - Statement by Chair Jerome H. Powell)

• Statements were also issued by Fed Governors Michelle W. Bowman and Christopher J. Waller, who voted against the proposal. Extensive background information on the proposal is available on the Fed’s website, including a video of the Fed’s July 27 Open Board Meeting, Board memo, Fact Sheet, Statements and Federal Register Notices.

• The proposed changes to large bank capital requirements would implement the final components of international banking regulations known as the Basel III “endgame” following the U.S. banking turmoil in March 2023. The agencies’ proposal would have a long phase-in period and not impact community banks. (CNBC, July 27)

• Real Estate Roundtable President and CEO Jeffrey DeBoer stated in a March 2023 comment letter to Fed Vice Chair Michael Barr and other key regulators, "At this critical time, it is important that the Agencies do not engage in pro-cyclical policies such as requiring financial institutions to increase capital and liquidity levels to reflect current mark to market models. These policies would have the unintended consequence of further diminishing liquidity and creating additional downward pressure on asset values. A deflationary spiral must be avoided at all costs. As recent events are only amplifying the contraction of credit, it is important for the Agencies to take measures to maintain sufficient liquidity levels and support positive economic activity."

CRE Challenges

• The Wall Street Journal this week quoted Roundtable Chair John Fish, above, (SUFFOLK Chairman and CEO) and Roundtable Board Member Scott Rechler, (RXR Chairman and CEO) on the influence of the agencies and their positive joint policy statement issued last month that granted flexibility for CRE workouts. Agencies’ joint statement, June 29 and Roundtable Weekly, June 30)
• Fish noted that the agencies’ recent policy statement “is a bridge to the other side. It’s what the real-estate industry was asking for.” Rechler also praised the new policy and added, “Since the failure of the regional banks, regulators have come on very hard.”
• Major refinancing pressures facing CRE are shown in new Trepp data released this week, which estimates $528.7 billion of commercial mortgages will mature this year—and increase to $532.8 billion next year. (TreppTalk, July 25)
• Trepp notes the data indicates “the market is facing a wall, if not a mountain, of maturities that would make the 2015-2017 wall of maturities look almost inconsequential. During that period, roughly $1.1 trillion of loans were scheduled to come due.”

The Roundtable’s Real Estate Capital Policy Advisory Committee (RECPAC) plans to work on industry comments in response to the agencies’ proposed rulemaking. #  #  #

The Biden administration announced a new initiative yesterday to increase the energy-efficient affordable housing supply, including a multi-agency working group to “develop and advance federal funding opportunities” for commercial-to-residential reuse. (Reuters and HousingWire, July 27) Support for Office Conversions

• White House Chief Domestic Policy Adviser Neera Tanden said, “With high rates of commercial vacancies across the country, we see a tremendous opportunity for conversions to residential housing.” (PoliticoPro, July 27)
• An administration statement listed a variety of new initiatives aimed at lowering housing costs and boosting supply that include:
  • Promoting commercial-to-residential conversion opportunities, particularly for affordable and zero emissions housing; 
  • Expanding financing for affordable, energy efficient and resilient housing; and,
  •  Reducing barriers to build housing such as restrictive and costly land use and zoning rules. 

Agency Actions 

• HUD: Yesterday’s announcement included opportunities for localities that develop high-density zoning rules to apply for grants from the Department of Housing and Urban Development (HUD) under a new “Pro-Housing” Program. This follows HUD’s release on Tuesday of new funds for research and policy guidance on economically viable office-to-residential conversions, with applications due by October 12. (HUD Press Release)
• DOT: A similar grant program run by the Department of Transportation (DOT), “Reconnecting Communities and Neighborhoods,” will provide funds for planning and construction projects (primarily in disadvantaged communities) for transit-oriented affordable housing.
• EPA: The White House also announced that the $27 billion Greenhouse Gas Reduction Fund, created by the Inflation Reduction Act (IRA) and administered by the U.S. Environmental Protection Agency (EPA), will be available for energy efficiency building retrofits and commercial-to-residential conversions.
• GSA: The White House statement advised that the General Services Administration (GSA) will launch an effort to identify under-utilized and surplus assets in the federal real estate portfolio that present the “best opportunities” for public-private partnership, commercial-to-residential projects.
• DOE: Yesterday, the Department of Energy (DOE) released program and legal documents for $8.8 billion in rebates authorized by the IRA. State-level energy agencies will dole out federal rebates that can be used for high-efficiency appliances and electrification equipment installed in single-family homes and multifamily units, including measures in adaptive reuse projects. 

This week’s announcements follow commitments made by the Biden-Harris administration in its Housing Supply Action Plan, released in May 2022. That month, The Real Estate Roundtable and 18 other real estate organizations urged Congress to work with the Biden administration, housing providers, lenders, and other stakeholders to pursue bipartisan solutions to increase the nation’s supply of housing. (Coalition letter, May 23 and Roundtable Weekly, May 22)  #  #  #