Tax plan a mixed bag to investors Key change affects property managers

August 09, 1993|By New York Times News Service

The new tax measure passed by Congress last week has good news for some real estate investors, but many other investors will find bad news in it. The value of some municipal and corporate bonds may go down, but not nearly as much as if the bill had been passed a few years ago. And investing in bankrupt companies will become even more hazardous than it was before.

The most important real estate change affects investors actively involved in managing a property. They will be permitted to deduct losses from the property against ordinary income. Losses from other real estate investments, like limited partnerships, will remain deductible only from income earned on similar investments, known as passive income.

Other real estate changes make it easier for pension funds to buy into real estate investment trusts, without jeopardizing the trusts' special tax benefits.

While President Clinton emphasized that workers in families with incomes of less than $180,000 a year are unlikely to pay higher taxes, that is not true for many investors. A variety of measures could wind up costing them money, even if they are not making really big bucks.

One such change concerns the way that interest on margin accounts at brokerage houses is deducted from taxable income. The change will have the effect of making the deduction less valuable for those whose investment income consists largely of long-term capital gains. Under the new law, to use the deduction, investors will in effect have to agree to have some or all of their capital gains taxed at the higher rates that apply to ordinary income like salaries.

Those with large capital losses will also find reason to moan about the new tax measure. Such losses can generally be used to offset a maximum of $3,000 a year of ordinary income, but can offset capital gains on a dollar-for-dollar basis with no ceiling. That is not changed.

What is changed is that the new law bars a number of strategies that have enabled investors to realize short-term capital gains with little risk. Effectively, those strategies, some of which involve complicated options transactions, converted interest income on borrowed money into capital gains, said Robert Willens of Lehman Brothers. Not any more.

Provisions of the tax bill deal with so-called "market discount" bonds. These sell below par value because interest rates have risen, or perhaps because the credit quality of the issuer has declined since the bond came out. There are relatively few such bonds right now, but there will be more around if interest rates rise.

The new law worsens the tax treatment of such bonds, something that could depress their value. But because interest rates are at their lowest level in years, few bonds will be immediately affected.

Under current law, those who buy a market-discount municipal bond, or any discounted corporate or Treasury bond issued before July 18, 1984, have an advantage: profits on sale or redemption are taxed at the capital gains rate, typically lower than rates on ordinary income.

The new measure changes that. With bonds bought after April 30, that part of a gain attributable to amortizing a market discount will be taxed as ordinary income.

Many bankrupt companies will lose what has been their most valuable asset -- the tax-loss carry-forward that shelters future income. Beginning in 1995, when a lender to a bankrupt company is given stock to replace bonds or other debt, the value of the canceled debt will be taxable income for the bankrupt company.

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