The COVID-19 outbreak will have a long-lasting impact on the commercial real estate industry, as many of their tenants are forced to contend with drastic and uncertain social changes. Business owners and partnerships that have certain types of tenants in their portfolio, such as professional office buildings, restaurants and retail establishments, will be most affected. But, every real estate company will be faced with economic challenges. The question for all becomes: what actions can you take now that will improve your position?
The good news is that the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), signed into law on March 27, 2020, provides much needed relief and tax planning opportunities to consider. In this article, we offer three practical considerations and highlight the most relevant tax and business changes.
3 Tax Planning Opportunities for Commercial Real Estate Businesses:
The CARES Act modified interest limitations under 163(j). With many real estate businesses being highly leveraged, the limitation on the amount of interest expense that was deductible under the Tax Cuts and Jobs Act (TCJA) was a major cause of concern. Although a limitation may still exist, the threshold has increased from 30% of adjusted taxable income to 50% of adjusted taxable income for tax years beginning in 2019 and 2020 (with a special rule for partnerships). This increased threshold could provide a sizable increase in deductions. A few elections are available for taxpayers during these years including keeping with the 30% threshold or substituting 2019’s adjusted taxable income for their 2020 calculation.
For partnership’s tax year beginning in 2019, the threshold remains 30% of adjusted taxable income. Partners may treat 50% of any excess business interest expense that they could not deduct in 2019 as automatically paid or accrued to them in the partner’s 2020 tax year without having to run that amount through 2020’s limitation calculation (i.e. they will get to expense 50% of the carryover interest in 2020, no matter their income level in 2020). The partner may elect out of this special rule if they choose.
The Impact: Additional deductions may be available to businesses in 2019 and partners of partnerships in 2020.
If you had leasehold improvements in 2018 and 2019, you recall that the TCJA eliminated the various 15-year recovery periods for qualified leasehold improvement, qualified restaurant, and qualified retail property; making these types of improvements recoverable over a 39-year life and not eligible for bonus depreciation (a cost segregation study may have been done to recover a portion of these improvements as short-lived property). The CARES Act has provided our highly anticipated fix; qualified improvement property (QIP) is to be recovered over 15-years and eligible for bonus depreciation and Section 179 expensing The ADS recovery period for QIP was also modified with the CARES Act from a 40-year life to 20-years.
QIP is defined as an improvement made by a taxpayer to an interior portion of a nonresidential building that is placed in service after the building was first placed in service and does not include the enlargement of the building, an elevator or escalator, or the internal structural framework of the building. The 15-year recovery period is for QIP placed-in-service after December 31, 2017.
The Impact: If you have made improvements to nonresidential properties in the past few years, reviewing those additions to determine if you can accelerate any depreciation may allow for full expensing of these components by utilizing the 15-year recovery period and 100% bonus depreciation or Section 179 expense. This could be done by amending returns or filing a Form 3115 – Change in Accounting Method.
The Interplay: If an election under 163(j) was made to slow down depreciation by utilizing the ADS recovery periods and not limiting the interest expense deduction, you have the option to modify this election by amending returns*. If you completed improvements to nonresidential buildings that would now qualify under the QIP definition and the accelerated recovery periods; you can now amend your return to claim these additional depreciation deductions but be subject to the interest limitation through Rev. Proc. 2020-22. If the accelerated depreciation isn’t sizeable enough to outweigh the benefit of not being subject to the interest limitations, you could still see some benefit from the depreciation fix for qualified improvement property as the ADS recovery period changed from a 40-year to 20-year life. This change in ADS lives will most likely be able to be made via an amended return or Form 3115 filing.
*Rev. Proc. 2020-22 was released on Friday, April 10th and provides taxpayers with flexibility to revisit determinations under 163(j) – the interest expense limitation – that may have been made in prior years. Taxpayers, through an amended return filing, can either choose to revoke elections made to slow down depreciation and not be subject to the interest expense limitations, or can choose to make a late election via the amended returns.
This is welcome relief as additional modifications to the CARES Act like the change in recovery periods for qualified improvement property to a 15-year MACRS life and eligible for either Section 179 or bonus depreciation may have a significant impact on the calculation of the cost/benefit of slowing down depreciation or being limited in the amount of interest expense that is deductible. These changes are to be made via amended return filings that incorporate the interest expense and depreciation modifications of the CARES Act provisions.
The limitation of net operating losses that can be used to offset current year income was removed temporarily with the CARES Act. In addition, the ability to carry back losses to prior years was temporarily put back in play. For NOL’s generated in 2018-2020; a five year carryback is allowed. For tax years prior to 2021, the 80% limitation is removed. The CARES Act also removed the loss limitations for individuals.
The Impact: The ability to carry back NOL’s presents a few interesting planning opportunities; especially when the carry back period includes years in which tax rates were higher. Carrying back a loss into a year with a higher tax rate represents an opportunity to generate permanent tax savings. It will be important to consider any ownership or entity structure changes as well as GILTI years that may have occurred during the carry-back provision to ensure that income tax attributes are not limited.
The Interplay: Increasing deductions, like accelerating depreciation due to the modification of QIP to a 15-year recovery period, can generate a higher loss. A loss being carried back to a year in which rates were higher can increase the amount of permanent tax savings available. If you have an NOL you are planning to carry back, it may be worthwhile to review any additional areas in which expenses can be accelerated to take advantage of this unique opportunity. It will be important to consider the impact an NOL carryback may make on your overall tax situation. Comprehensive modeling is recommended to ensure that inadvertent tax consequences are not generated.
- Financial Statement Considerations
Due to the current economic conditions, it will be important to review receivables as there is most likely a greater possibility that they will be unrecovered or at higher risk. In addition, waivers including rent and interest may also impact timing for financial statement purposes. Additional disclosures may need to be placed on financial statements and additional consideration given to going concern issues.
Proactive Tax Planning Begins Today
It is critical to evaluate all tax and refund opportunities as quickly as possible. Everyone is looking for ways to weather the economic impact by delaying payments or new investments, which also means increased pressure on commercial real estate companies. Talk to your CPA about your unique situation and how new provisions in the CARES Act can potentially be used in your favor.
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Julie has over 10 years of experience with fixed assets, specializing in cost segregation and expense vs. capital analyses. She has a unique approach and enjoys the complicated areas of the tax law where she can come up with creative solutions for her clients. Knowing the correct answer can look different for each client, Julie works with clients and their current systems and processes to find the best solution tailored for them. Julie has mastered the art of taking complicated tax concepts and translating them into understandable and implementable processes.
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