The COVID-19 pandemic is having a wide-ranging impact on businesses across most industry sectors, and the real estate industry is certainly no exception. In many states, projects already in development were deemed essential and were allowed to continue with safety protocols in place.
However, during the shutdown, it was difficult for developers to get the permits they needed, causing project delays and even cancellations. Developers are seeking ways to improve cash flow and find ways to respond to tenants who might be struggling to make lease payments — all while following new safety protocols.
The pandemic has not affected all industry subsectors the same way. For example, industrial real estate is flourishing due to the driving demand for data warehouses and fulfillment centers. Much has been made of the effect that a larger remote workforce will have on commercial real estate, but as employees return to their workplaces in many parts of the country, it’s too early to know what the long-term impact will be on the sector. In the meantime, people are still buying property and investing in buildings. Interest rates remain at historically low levels, and the demand for housing outweighs supply in many markets.
The retail sector has been severely affected by the COVID-19 shutdown, with malls, lodging/ hospitality and other high-human-density businesses closing.
Legislation enacted to address the pandemic, notably the Coronavirus Aid, Relief and Economic Security (CARES) Act, included provisions that benefit the real estate industry and provide a way for real estate investors to reduce tax liability and ease cash flow. With an eye toward the future, Engineered Tax Services takes a look back at 2020 and summarizes these opportunities.
Before the Crisis: TCJA Changes
It can be difficult for any of us to remember life before the pandemic. The Tax Cuts and Jobs Act (TCJA) of 2017 made sweeping changes that were extremely favorable to owners and operators of commercial real estate. In fact, the IRS recently provided final rules for bonus depreciation changes included in the TCJA. A significant provision in the TCJA is the ability to immediately depreciate new and used assets that have a useful life of less than 20 years through 2022. The TCJA also included the tax rate reduction of 20% for pass-through businesses, which provides extra cash flow to real estate developers that they can reinvest into additional projects.
The creation of Opportunity Zones allows investors who make qualifying investments in these designated areas to receive preferential tax treatment through a combination of tax deferment and reduced capital gains, depending on how long the investment is held.
Economic Pandemic Response
Congress enacted the CARES Act to provide critically needed assistance to businesses and individuals. As a national specialty tax service business, ETS closely monitored the legislation with an eye on tax-advantageous measures for real estate investors. The following information highlights these changes.
General Business Tax Provisions
Net Operating Losses: Five-Year Carryback
Before the CARES Act, net operating losses (NOLs) were limited to 80% of current year taxable income and could not be carried back. The CARES Act now permits a loss from taxable years 2018, 2019 and 2020 to be carried back five years prior to generate refunds. This change removes the taxable income limitation, which allows NOLs to fully offset income in current taxable years. It also removes excess business loss limitation applicable to pass-through business owners and sole proprietors so that they, too, can benefit from the modified NOL carryback.
Taxpayers can file amended returns to generate refunds where appropriate. Note: For any losses in 2020, they should file a Form 1145 as early as possible in January 2021.
Alternative Minimum Tax
The TCJA repealed the corporate AMT for tax years beginning after December 31, 2017. The CARES Act modified the AMT credits to be 100% refundable for tax years beginning after December 31, 2018.
The Act also provides that taxpayers may elect to claim the entire refundable amount in 2018 as a tentative refund by filing Form 1139, Corporate Application for Tentative Refund.
Bonus Depreciation
The CARES Act retained the 100% bonus depreciation mentioned above but added a new five-year carryback option.
Now that NOLs can be carried back, it’s worthwhile for taxpayers to review all cost segregation, 179 and 179D tax deduction opportunities to generate an NOL and possible refunds.
Interest Deductions
The TCJA had limited interest deduction to a portion of an entity’s taxable income. The CARES Act raised the limit on interest deduction from 30% of ATI to 50% for taxable years beginning in 2019 and 2020.
Taxpayers have more leeway in how they deduct the interest.
Tax Credits and Incentives
179D Energy-Efficient Commercial Buildings Deduction
Energy-efficient improvements made to your company’s building also may be a way to increase cash flow, thanks to the 179D Energy-Efficient Commercial Buildings Deduction. Building owners now have the five-year carryback option for energy deductions for commercial buildings and residential structures that are four stories or more for both new construction and improvements of new lighting, HVAC, roofs and windows. The CARES Act makes this tax incentive retroactive to January 1, 2018.
Now that NOLs can be carried back five years, taxpayers should review all 179D opportunities to generate immediate tax savings by December 31. To take full advantage of these tax-advantageous programs, now is the time to consult your specialty tax experts.
45L Energy Tax Credits
Lawmakers also extended the 45L Energy Efficient Tax Credit through the end of 2020. Developers of energy-efficient residential buildings can take advantage of this tax credit, which equals $2,000 per residential unit or dwelling on qualifying properties including apartments, townhomes, condominiums and single-family homes. In late 2019, the 45L Tax Credit was retroactively extended for 2018 and 2019. Additionally, unused credits can be carried over for up to 20 years.
Review all 45L opportunities to generate immediate tax savings and possible retroactive refunds by December 31.
The CARES Act made no direct changes to this permanent federal tax credit for qualified research and development (R&D) activities, but the five-year NOL carryback may allow taxpayers to carry recent losses back against taxable income that was taxed at higher rates.
Business owners can ease cash flow by capturing retroactive tax credits to generate cash refunds now against taxes paid or to be paid going forward.
Cost Segregation
Another way to increase your near-term cash flow is to undertake a cost segregation study to accelerate depreciation and gain a tax deferral. To correct a drafting error in the TCJA, the 39-year depreciable life for qualified improvement property (QIP) was changed to 15 years, allowing for the immediate expensing of these improvements, which are also eligible for 100% bonus depreciation. The shorter depreciation schedule allows building owners to decrease their tax liabilities.
The value of conducting a cost segregation study significantly increased for building owners. A cost segregation study will determine which components can be depreciated as 15-year property. This correction is retroactive, so taxpayers and CPAs will need to determine the best options for claiming these expenses.
Looking Ahead: Development Drivers
The CARES Act changes outlined above drive development through more advantageous bonus depreciation, the five-year carryback rule and reduced AMT limitations. In addition, we are seeing strong sales and property appreciation.
So, why are people still buying property and building? Let’s consider the following example: Let’s say you buy a $5 million building.
- Land is $1 million
- Building is $4 million
- Straight line depreciation is $102,500 per year (prorated depending on purchase date) OR
- Cost segregation could generate $1 million depreciation to offset current income, and it’s not prorated. If you buy by December 31, you can claim the full deduction!
These incentives, coupled with Opportunity Zones and other state and local incentives, motivate many taxpayers in top tax brackets to choose real estate investment rather than paying income tax. Many of these provisions will remain intact through 2022, unless a new tax law is passed in the meantime. These factors are likely driving the market in spite of COVID-19.
If you have any questions relating to this article, please feel free to contact Engineered Tax Services at 800-236-6519 or email hhenderson@engineeredtaxservices.com.
