actions. Where an installment obligation is received in ex-
The Tax Reform Act of 1984 Effects on Real Estate Transactions
By Michael O. Parker On June 27. 1984, Congress passed the Tax Reform Act of 1984 (the "Act") as part of a larger body of legislation designated the Deficit Reduction Act of 1984. It is clear that a primary theme of the Act is to narrow the beneficial tax
rules previously contained in Internal Revenue Code ยง483 and applicable regulations. Under these rules, most real estate purchased on an installment basis over a period in excess of six months needed to carry a mini-
treatment given many real estate
mum "safe harhor" interest rate
transactions, and reduce the attractiveness of real estate as a tax advantaged investment. However. not all of the changes affecting real estate transactions are unfavorable. The reduction in the capital gains holding period from a year to six months and the changes in the tax treatment of property divisions on divorce are two examples of helpful revisions. However. these provisions do not relate primarily to real estate as an investment. The change in the capital gains holding period is more beneficial to securities transactions than real estate, while the tax treatment of property divisions on divorce (which will be discussed in an upcoming issue of The Arkansas Lawyer) does not directly involve investment decisions. This article will address the provisions of the Act which come into play at the various stages of com-
(usually nine percent') in order to avoid having interest imputed. or assumed by the Internal Revenue
mon real estate transactions: pro-
visions affecting acquisition and
holding; construction and rehabilitation; rental and leasing; and disposition of realty.' Provisions Affecting Acquisition and Holding of Real Estate Deferred Payment Transactions. Most business clients are familiar with the imputed interest
Service to be present. at a one per-
cent higher rate. Congress was concerned that this minimum interest rate was too low and did not react to market changes and that the timing of interest deductions taken by purchasers did not correspond to interest income recognized by sellers, due to differences in the taxpayers' accounting methods. Therefore. Congress developed new sets of rules which will relate the safe harbor and imputation rates to an "Applicable Federal Rate'" and will require matching of expense and income treatment between taxpayers in many instances. The Applicable Federal Rate will be determined by the Treasury at six month intervals for short term, mid-term and long term obligations.' A recent article in The Arkansas Lawyer discussed how the Applicable Federal Rate applies to loans between related taxpayers.~ Certain loans must carry interest at 100"10 of the Applicable Federal Rate in order to avoid gift or compensation treatment. The rule is somewhat different with respect to sales trans-
change for property, the installment obligation must bear interest at 110"10 of the Applicable Federal Rate to avoid unstated interest treatment.' If the interest being charged is less than 110"10 of the Applicable Rate. unstated interest will be present and interest will be imputed at 120"10 of the Applicable Federal Rate.' Congress carved out a few exceptions to the new rule when the Act was passed, and then passed additional legislation which tinkered with the concept further. First. the Act continues the 7% maximum imputed interest rate for land transactions between related individuals involving $500,000 or less.' Second. in the case of sale of a farm for less than $1.000.000. the safe harbor and imputed interest rates under prior law continue to apply.' Third, in the case of a sale of a principle residence. the rates under prior law continue to apply to the extent the purchase price does not exceed $250,000." Where the purchase price exceeds $250,000, a combination of old and new rates applies. After the Act was passed. the new deferred payment rules received a tremendous amount of criticism. and their future is now subject to some doubt. Late in the Congressional session an interim Editor's Note: Michaela. Parker is a partner in the Davidson. Horne. Hollingsworth Law Firm in Little Rock. He is a graduate of Vanderbilt University in Nashville. Tennessee IBA-Economics. 197J) and a 1973 honors graduate of the University of Arkansas School of Law in Fayetteville. where he served on the Board of Editors of the Arkansas Law Review. He presently serves as vice-chair of the Section of Taxation of the Arkansas Bar Association and on the Southeast Regional Internal Revenue Service-Bar Association Liaison Committee. This artlcJe is one of a continuing series by members of the Section of Taxation in its effort to keep the membership informed and up to date on important developments in tax law.
April 19a5/Arkansas Lawyer/a9