The Unintended Consequences of the Tax Reform Act of 1986

by Linda Postorivo

Date: Early 1980s

What's Hot: Wham, Madonna, Frankie Goes to Hollywood, E.T. the Extra-Terrestrial, Raiders of the Lost Ark, The Chicago Bears, TAX SHELTERS.

Life was good...and then, TRA 86 (Tax Reform Act of 1986). It all came to a screeching halt. TRA 86 was given impetus by a detailed tax-simplification proposal from President Reagan's Treasury Department.

The top tax rate was lowered from 50% to 28% while the bottom rate was raised from 11% to 15%, and tax brackets were consolidated from fifteen to four levels of income. This would be the only time in our history when the top rate was reduced and the bottom rate increased. Capital gains faced the same tax rate as ordinary income and corporate tax rates increased. Until 2013, TRA 86 was the most recent major simplification of the tax code, which drastically reduced deductions as well as the number of tax brackets.

The "Reagan tax cuts" most notably took aim at eliminating many tax shelters as well as other preferences thought to benefit wealthy individuals. Prior to this tax reform, many investors taxed at the highest rates invested in limited partnerships in various areas such as commercial and residential real estate, oil & gas exploration and drilling, public storage facilities, cable television systems, movie productions, airplanes, etc. Their investments would not only fund these endeavors and provide growth for these industries, but also provide 2:1 or 3:1 tax write-offs for the investors.

TRA 86 changed all this. Once the tax advantages disappeared, so did the funding of the investments since passive investors had provided much of it. The domino effect caused an implosion in the real estate market. Since mortgage loans constituted a significant portion of S&Ls' asset portfolios, significant declines in the market value of real properties resulted in the erosion of the value of these institutions' major assets and contributed to the savings and loan crisis that took many years to resolve.

We are once again facing new tax changes. No one knows what the long-term consequences will be. The most important thing you can do as a responsible investor is to prepare yourself and your portfolio for multiple scenarios. Working with a highly qualified Investment Advisor is where you should begin. We've seen the landscape in Washington change many times. Although we can make ourselves heard through the voting process, out best advice is to be proactive rather than reactive whenever possible.

Talk to your Investment Advisor. Map out a plan. Take control.