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ready to put on the stockpile for use as a raw material in the production of phosphorus. There is no chemical change involved and it is merely a physical operation.
This amendment to the act, if it can be put in, would greatly simplify our problems in reporting our tax returns.
The CHAIRMAN. Thank you very much, indeed.
STATEMENT OF JOHN C. WILLIAMSON, NATIONAL ASSOCIATION OF
REAL ESTATE BOARDS, WASHINGTON, D. C. Mr. WILLIAMSON. Mr. Chairman, my name is John Williamson. I am secretary counsel for the Realtors Washington Committee, National Association of Real Estate Boards. I have here a statement I would like to insert for the record. It covers four points, one relating to capital gains treatment of gain derived from sale of real estate held by real-estate dealers for investment. Another relating to depreciation, and a third relating to tax exemption of income placed in a retirement fund by self-employed persons, and the fourth relating to accrual of real property taxes.
Because of the importance of the capital gains section which is section 1237, I would like to devote the principal portion of my time to that section and read a brief summary of that part of the statement relating to capital gains.
The CHAIRMAN. The statement will be includedd in the record.
STATEMENT OF JOHN C. WILLIAMSON, SECRETARY-COUNSEL, REALTORS' WASHINGTON
COMMITTEE OF THE NATIONAL ASSOCIATION OF REAL ESTATE BOARDS WITH RESPECT TO H. R. 8300, INTERNAL REVENUE CODE OF 1954
CAPITAL GAINS TREATMENT FOR DEALERS IN REAL ESTATE Mr. Chairman and members of the committee, I am John C. Williamson, secretary-counsel of the Realtors' Washington Committee of the National Association of Real Estate Boards. This committee is the legislative committee of the National Association of Real Estate Boards. Our association consists of more than 51,500 realtors and realtor firms which include niore than 300,000 persons actively engaged in the business of selling real estate as well as all other phases of the real-estate industry. These realtors and realtor firms are members of 1,151 local real estate boards in all 48 States.
Section 1237 of H. R. 8300, the pending Internal Revenue Code of 1954, prescribes rules under which an unincorporated dealer in real estate will be recognized to have an investment in real property and, upon sale or exchange, to have any loss and that part of any gain in excess of 5 percent of the selling price subject to the general provisions of subchapter P of the new code, relating to capital gains and losses.
Section 1237 seems to be responsive to the suggestions received by the staff of the Joint Committee on Internal Revenue Taxation from the survey conducted by the staff prior to the general revenue revision hearings before the Committee on Ways and Means and to the apparently convincing testimony presented at the hearings that existing law, at least in its administration, is discriminatory against investments in real estate. The criticism expressed may, perhaps, be briefly summarized as follows:
1 Preliminary Digest of Suggestions for Internal Revenue Revision, prepared by the staff of the Joint Committee on Internal Revenue Taxation. Anril 21, 1953, pp. 89-90.
2 Hearings, pt. 2, 1013-1015, 1028–1032, 1038, 1061-1063, 1115–1124, 1164–1167.
(1) While dealers in other types of property, including dealers in securities,' may make investments in property like that which they hold for sale or for use in their business, dealers in real estate are subjected to an ever-increasing burden of administrative controversy with the Internal Revenue Service and litigation in the courts to establish their claim to capital gain treatment for real property held by them for investment.
(2) Taxpayers engaged in another trade, business, or profession who may never have been in the business of bu ng selling real estate and who may have held a tract for a long term of years during which the value of the property gradually increased, may find it advisable in liquidating their investment to sell it in smaller parcels with the hazard of being charged by the examining internal revenue agent with engaging in the real estate business and receiving gain fully taxable as ordinary income.
Both problems arise out of the difficulties in determining under existing law and Treasury Regulations whether real estate sold by the taxpayer was a bona fide investment or was property held primarily for sale to customers in the ordinary course of his trade or business. The regulations (Regulations 118, sec. 39, 117 (a)-1) have accentuated the first problem by giving the case of a dealer in real estate as an example of a taxpayer which may be in realization of “gain or loss upon the sale or exchange of land primarily for sale to customers in the ordinary course of his business." This language has doubtless led some internal revenue agents to the erroneous conclusion that a dealer in real estate can never simultaneously be an investor in real estate. The courts have held to the contrary, but the heavy volume of litigation continues. There are now pending in the Tax Court alone approximately 35 docketed cases in which the issue is whether real property sold by the taxpayer was a capital asset.
Section 1237 of the bill obviously represents an earnest effort to study and evaluate the impact of the existing discrimination against investment in real property. The report of the Committee on Ways and Means stresses the divergence in treatment between securities investments by dealers in securities and real-estate investments by dealers in real estate.' Section 1236 of the bill, however (relating to dealers in securities), which corresponds to section 117 (n) of the existing code, is in sharp contrast with section 1237. Section 1236 recognizes that a dealer in securities can invest, subject to requirements of clear identification as an investment on his records, in securities and can obtain capital-gain treatment if he keeps the investment for more than 6 months.
A dealer in real estate, however, under section 1237 must not only clearly identify real property as held by him for investment, but must hold it for more than 5 years—10 times as long as other investments must be held to receive capital-gain treatment. It may be suggested that investment in real estate is different, yet a dealer in real estate who forms a corporation to hold title to his property would be subject only to the 6-month holding period upon the sale of the stock in the corporation. Moreover, even under present law, taxpayers have been repeatedly successful in establishing their right to capital-gain treatment in cases in which the holding period was less than 5 years.
3 Sec. 1-17 (n) of the Internal Revenue Code of 1939.
* See statement of Hon. Edgar W. Hiestand, hearings before Committee on Ways and Means on general revenue revision (1953), pr. 1013–1014: John C. Wi'liamson, counsel, Realtors' Washington Committee, pp. 1164-1167. Examples of court decisions in which real-estate dealers have been forced to litigation to establish their right to capital-gain treatment of investments in real property are the following: Nelson A. Farry et ux. (13 T. C. 8 (1949)); R. H. Hutchinson (8 T. C. M. 597 (1949)); S. Franklyn Woodcock (9 T. C. M. 981 (1950)); Malouf et al. v. Riddell (52–1 U. S. T. c., par. 9296 (D. C., S. D. Calif., 1952)); Walter R. Crabtree (20 T. C. No. 120 (1953)); Gabriel Lee! (12 T. C. M. 256 (1953)) ; Victory Housing No. 2, Inc., v. Commissioner (205 F. 21 371 (C. A. 10, 1953)). In the Crabtree case, supra, Judge Rice observed : "The evidence is clear in this case that the nature and extent of petitioner's business puts him in the dual role of both a dealer and an investor in real estate."
• See statement, Hugh M. Bennett, hearings, Committee on Ways and Means, pp. 1115– 1124.
* Commerce Clearing House Tax Court Reporter, Petitions Index, p. 7004. ? H. Rept. No. 1337, n. 94.
8 Nelson A. Farry, 13 T. C. 8 (1949), Acg. 1950–1 C. B. 2. (In 1944 taxpayer sold 19 of his rental properties, 17 of which were held for 2 years or less, yet the court held on the evidence that he was entitled to capital-gain treatment although a dealer in respect of other real estate); $. Franklyn Woodcock, 9 T. C. M. 981 (1950). (Property purchased by a real-estate dealer for rental but held approximately 8 months was held taxable as capital gain.)
A further requirement under section 1237 is that no substantial improvement may have been made during the period it was held by the taxpayer. Such a prohibition would place a premium upon slothfulness and irresponsibility in the ownership and maintenance of large tracts of real property and discourage additional capital investment over a long period of time when such improvements can be made at greatest civic and economic advantage. For example, an investor in real estate may wish to embark upon a program of clearing, leveling, or drainage in a period of declining prices. Or such an investor may find it desirable to install a sewerage system at a time when a municipality is extending its sewer lines. Or, without effort on his part, a new State highway or paved road might be constructed across his land. Section 1237 (b) (2) would appear to prohibit such improvements, however, if the benefit of section 1237 (a) is to be obtained.
Section 1237 is inapplicable to investments by incorporated dealers in real property. It is difficult to understand this exclusion of corporations, since corporations and other taxpayers are generally accorded similar treatment with respect to gains and losses from the sale or exchange of capital assets, or from the sale or exchange of property used in the trade or business. This is true both under existing law and under H. R. 8300. Moreover, the most closely comparable provision with section 1237 is section 1236, relating to dealers in securities, which contains no prohibition against corporations. The corporate exclusion is perhaps less justified in cases of dealers in real property than in the case of dealers in securities, for the corporate form is especially adaptable to long-range investment in relatively large tracts of real estate. This is true because of the amount of capital frequently required both for acquisition of such an investment and for the payment of local real-estate taxes and other charges pending utilization of the property.
Other provisions of section 1237 which concern real-estate dealers are the following:
1. Even though all the restrictive requirements of section 1237 (b) are satisfied to demonstrate beyond a shadow of doubt that real property of a real-estate dealer is a bona fide investment, he can never receive capital-gain treatment for that part of the gain which is 5 percent of the selling price. If property is a capital asset, the entire amount of the gain or loss should be capital gain or loss. Furthermore, the 5-percent rule seems hardly to conform with a program of simplification.
2. If a dealer in real estate, in order to fortify his position that real property is held by him for investment under present law, has identified the property as held for investment, it is not clear whether such identification, even though accomplished long before consideration began on the current revenue revision, might subject him to the limitations of section 1237.
Although real-estate dealers with investments in real estate are appreciative of the time which has already been devoted to their request for fair and equitable tax treatment, we believe that section 1237 of the bill would create many new problems without actually solving the problems under existing law. While the burdens of potential controversy and litigation are now very substantial, they are at least balanced, if not outweighed, by those which are presented by section 1237. The best solution, in our opinion, if taxation of gains and losses from realestate investments comparable with treatment of gains and losses from investments by dealers in other property is to be attained, is a flat holding period of 6 months. If the enactment of such a provision cannot be favorably considered by your committee, we urge that section 1237 be deleted from the bill in order that the entire subject may be given further study by the staffs of the joint committee and the Treasury Department, with further opportunity for consultation wih the taxpayers so vitally affected.
If the committee should conclude, nevertheless, that some legislation in the pattern of section 1237 is desirable, we respectfully submit the attached draft of amendments to make clear that the section does not adversely affect the rights of real-estate dealers now available to them. It is our considered opinion that section 1237, if enacted in its present form, would increase the uncertainties in the tax treatment which real-estate dealers now are experiencing, would accentuate the discrimination against bona fide investments in real estate by real-estate dealers under existing law, and would not only fail to correct any existing inequity in the law but would go far toward compounding and aggravating the existing one.
PROPOSED AMENDMENTS TO SECTION 1237 OF H. R. 8300
(New language is italicized and language deleted is in brackets)
1. Amend subsection (b) (1) to read as follows:
* * *
Subsection (a) shall apply to real property if
“(1) After the date of enactment of this act, but before the expiration of the 30th day after the date of its acquisition or before the expiration of the 90th day after the date of enactment of this title, whichever is the later, the taxpayer has elected to have the gain taxed in accordance with the "provisions of this section and such real property has been clearly identified (such election and identification to be made in the manner prescribed by the Secretary or his delegate or, in the absence thereof, in the taxpayer's records)
as real property held for investment; and” 2. Add as subsection (f) the following:
“(f) EFFECT OF FAILURE TO ELECT AND IDENTIFY. In case of the sale or exchange of property as to which the taxpayer has not made the election and identification prescribed by the provisions of subsection (b) (1), none of the provisions of this section shall apply to the determination of taxable gain or deductible 1088."
3. Redesignate subsection (f) as subsection (g) and amend it to read as follows:
"(g) EFFECTIVE DATE. This section shall apply only with respect to sales of property occuring after [March 15, 1954] the date of enactment of this Act.”
CHANGE IN TAX DEPRECIATION RATES
Section 167 provides for a liberalization of depreciation policy with respect to both the estimate of the useful life of property and the method of allocating the depreciable cost over the years of service. We believe that the application of the double-rate declining-balance depreciation method on property constructed after December 31, 1953, on new property acquired by the taxpayers after that date, will provide a fair measure of incentive for the replacement generally of obsolete structures which will inure to the benefit of the economy.
TREATMENT OF USED REAL ESTATE
While we appreciate the motivations which limit the application of the double-rate declining-balance formula to new construction, we respectfully submit that the exception of used real estate from this formula is most unfortunate and fails to take fully into account the peculiar characteristics of real estate, which over the period of its long useful life changes hands several times, and the continual necessity for maintenance of the property over its useful life by its successive owners-a degree of maintenance which is not comparable to that of machinery and equipment because of the latter's much shorter life.
Our association estimates that at least 80 percent of existing income prop erty, rental, commercial, and industrial, was acquired by its present holders as used property. The denial of the double-rate declining-balance depreciation method to used real estate represents therefore a substantial discrimination.
From our study of the House report on the general tax revision bill we conclude that the principal basis for the exclusion of used real estate is the desire to minimize transitional revenue losses but still obtain maximum incentive effort; hence, the impropriety of permitting the doubling of the remaining life straight-line rate on such acquisitions. While we recognize to a degree the valid reasoning behind the exclusion of used real estate, we nevertheless believe that the remedy is altogether too harsh. Why not permit the declining balance depreciation, at the option of the subsequent purchaser, at twice the full-life straight-line rate (the rate computed on the sum of the expired life and remaining life)? We believe that this meets the principal objections to the inclusion of used buildings and used rental property, yet provides the incentive to maintenance of the property which is at least equally if not more important to our economy as is the stimulus for new construction, the avowed purpose of the House-approved change which we believe falls short of its target.
LIBERALIZED DEPRECIATION METHODS AS AN AID TO SLUM CLEARANCE
The committee is aware of the housing message of the President early this year which underscored the tremendous problem faced by the cities of our
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country in eliminating slums and preventing the spread of blight and urban decay which are having telling effect on the health, morals, and safety of millions of our people. Millions of dollars have been expended by Federal, city, and State governments on this program, yet, according to the President's Advisory Committee on Housing Policies and Programs, it will take at least 200 years to do the job at the present rate. New methods, new techniques, new incentives, and broader vision are required to cope with this problem, and we note with satisfaction that the President in his housing message and the Congress in the housing bill now pending in the Senate are preparing to meet to a substantial degree this growing challenge.
Our association, too, in its build America better program is reaching down into the neighborhoods of our cities to meet the problem of slum prevention and neighborhood conservation with such tools as may be brought to bear against this problem by State and local governments and civic groups.
The President's Advisory Committee made one recommendation similar to one that is part of our build America better program, which we believe will materially assist in bringing about the demolition of slum dwellings. The Advisory Committee (p. 125) said:
“Under present rules when an obsolete property is demolished, the residual value ascribed to the building and the cost of demolition is considered to be part of land value and cannot be depreciated for tax purposes. This policy obviously deters the removal of obsolete structures."
Recommendation No. 14 (b) of the President's committee is as follows:
“Code enforcement should be employed to the fullest extent possible to achieve without compensation, compulsory demolition of dwellings unfit for human habitation and too far gone to be rehabilitated. This opportunity would be enhanced if, in the event of such demolition, the residual value ascribed to the building and the cost of demolition were, for tax purposes, allowed as depreciation instead of being added to land value.” [Emphasis supplied.]
We recommend therefore the approval of an amendment to the proposed bill as follows:
“Sec. Amortization deduction for demolished structures. Every person, at his election, shall be entitled to a deduction with respect to the amortization of the residual appraised value of any structure demolished within an urban renewal area. so certified as such by the Administrator of the Housing and Home Finance Agency, plus the cost of demolition of such structure, based on a period of 60 months. The 60-month period shall begin as to any such demolished structure, with the month following the month in which the facility was demolished.”
LIBERALIZED DEPRECIATION ALLOWANCES AS AN AID TO URBAN RENEWAL
The problem of replacing blighted or obsolete structures is as important to the renewal of our urban areas as is the demolition of the structures themselves.
The Blueprint for Neighborhood Conservation, which is the working manual of our Build America Better Council, recognizes the problem in the following recommendation which appears on page 24 of the manual :
“In order to encourage maximum investment in new construction and capital improvement of existing structures in conservation programs, it is proposed that Federal revenue laws be amended to provide that when a neighborhood conservation area is legally created, thereafter the total cost of any new capital improvement made or erected in such an area may be depreciated for incometax purposes, at the option of the taxpayer, at a rate of not to exceed 20 percent in any 1 year."
We wish to emphasize that the spread of urban decay and urban blight, while basically a local problem, has reached such grave proportions that the Federal Government since 1949 has found it necessary to assume the greater part (twothirds) of the financial cost involved. The pending housing bill reemphasizes and redirects this program and outlines the basis for deeper commitments which will inevitably increase Federal financial participation.
The question properly arises as to the extent of future Federal involvement in programs which are essentially local in character, and our association as well as the Congress has from time to time earnestly set itself to the task of devising nieans whereby the local responsibility might be increased and the Federal responsibility decreased.
We seriously doubt that a formula could readily be devised to completely eliminate the Federal Government's role in this problem. However, we see in a change in the tax structure relating to depreciation the basis for an incentive