CARES Act Provides Needed Tax Relief to the Real Estate Industry
On March 27, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) into law, giving the real estate industry much-needed tax relief. The economy is currently taking a hit from the SARS-CoV-2 virus and the incidence of COVID-19, and the surge in unemployment and required business closures are adding additional strain to real estate owners. Property owners are concerned about the ability of their tenants to pay rents timely, if at all, and the potential increase in bankruptcy and business closures that will apply pressure to occupancy rates.
The CARES Act intends to provide additional stimulus to the economy through individual provisions such as recovery checks, relaxed retirement plan distribution rules and additional unemployment assistance. The CARES Act also includes several key business provisions that should be considered with your past, current and future tax returns.
Correction for Qualified Improvement Property
The CARES Act includes a highly anticipated technical correction to the Tax Cuts and Jobs Act (TCJA) that would allow taxpayers to apply the accelerated bonus depreciation rules to qualified improvement property (QIP). QIP is generally any improvement to an interior portion of a building that’s nonresidential real property if it was placed in service after the building was placed in service. Due to the error in the TCJA (commonly referred to as the retail glitch), QIP was required to be depreciated over 39 years with no accelerated depreciation. With the change, QIP can now be depreciated over 15 years and is eligible for 100 percent bonus depreciation.
The effective date of this amendment is retroactive to the TCJA’s enactment, thus creating refund opportunities for taxpayers as the change potentially converts an asset depreciated over 39 years to an immediate deduction. Refunds could be achieved by filing either an amended 2018 return or possibly an accounting method change with the taxpayer’s 2019 return, depending on whether the IRS considers this an automatic change.
Many taxpayers may be concerned about the effect this change may have on the real property trade or business election, which allows an exemption from the business interest expense limitations (examined later in this article). In exchange for making the election, taxpayers are required to depreciate QIP, residential property and nonresidential property over a longer period and without bonus depreciation. For taxpayers who previously made the real property trade or business election, additional guidance on how the correction may affect them is expected to be provided.
Changes to Excess Business Losses & Net Operating Losses
The TCJA also enacted an excess business loss (EBL) limitation, which limits EBLs on all noncorporate taxpayers, e.g., individuals, trusts and estates. The basic calculation of the EBL is the aggregate of business deductions over the sum of the aggregate gross income attributed to trades or businesses of the taxpayer, limited to a $250,000 loss ($500,000 if married filing jointly). This reduced the tax benefit generated by large real estate losses as they were limited, and any excess would be carried forward like a net operating loss (NOL). The CARES Act removed this limitation for 2018, 2019 and 2020 tax years. Taxpayers subject to the EBL limitation on their 2018 income tax returns (or 2019 if the return was already filed) should consider amending to obtain income tax refunds or create NOLs.
Under the CARES Act, the current NOL rules under the TCJA are temporarily revised to allow losses arising in tax years 2018, 2019 or 2020 to be carried back five years. In addition, the provision limiting NOLs to only 80 percent of a taxpayer’s taxable income is suspended for taxable years beginning before January 1, 2021, allowing companies to fully offset taxable income by such carrybacks or carryforwards.
The coupling of the changes in the EBL and NOL rules may allow taxpayers to recoup income taxes paid in prior years. The QIP correction also can be combined with a cost segregation study to accelerate additional deductions and provide access to key cash flow.
Modifications of Limitation on Business Interest Expense
The TCJA created a new limitation on business interest expense deductions for tax years beginning after December 31, 2017. The CARES Act temporarily modifies the 30 percent of adjusted taxable income (ATI) limitation (as initially provided in the TCJA) to 50 percent of ATI. While taxpayers may elect to use the 30 percent limitation instead, this provision would affect taxable years beginning in 2019 or 2020 and allow businesses to increase liquidity with a reduced cost of capital. Also, businesses may elect to use their 2019 ATI to calculate the 50 percent of ATI limitation for 2020. Leverage is a critical factor in most real estate developments; the increase in the limitation can provide additional benefit, as operating income is expected to be lower in 2020 for many developments.
The CARES Act provides additional updates not covered in this article, including modifications to the 7(a) loan program, administered by the U.S. Small Business Administration, amendments to the Families First Coronavirus Response Act and more. We encourage you to visit the BKD COVID-19 Resource Center for access to relevant information for you and your business. If you have questions, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below.