An examination of the effect of the Tax Reform Act of 1986 on individual and corporate investment in residential rental realty

The purpose of this study is to examine the effect of the Tax Reform Act of 1986 (TRA 86) on the profitability of residential rental real estate investment to individual and corporate investors. Many real estate tax advisors propose corporate investment in income-producing real estate as a tax-planning response to the imposition of the passive activity loss limitations on individual investors. One objective of this study is to provide information useful in evaluating the preferable business form for post-TRA 86 investment in residential rental real estate, and, in particular, in evaluating proposals for corporate investment in response to the passive activity loss limitations. A second objective of the study is to provide information useful in evaluating the effectiveness of the legislation relative to stated Congressional policy goals. The third objective of the study is to provide information useful to investors in evaluating the effect of TRA 86 on alternative investment opportunities.; The study uses an after-tax internal rate of return model to simulate returns realized by hypothetical individual and corporate investors from direct investment in a hypothetical residential rental property. The model is also used to simulate returns to individuals from indirect investment in the hypothetical property as shareholders of corporate investors.; In general, the research results do not support the proposals for corporate investment in residential rental real estate as a tax-planning response to the passive loss limitations imposed on individual investors. The research results also suggest that the passive loss limitations have an insignificant effect on the profitability of residential rental investment by top marginal bracket individual investors.