It has certainly been an unusual and challenging year. The COVID pandemic has impacted our lives in many ways, and as we gear up for tax season, you need to be aware of how it will impact your 2020 taxes that will be filed early next year. For real estate owners and developers, below are some changes to keep in mind as you prepare to file your 2020 taxes and plan for the coming year.
Net operating losses
Congress passed the Tax Cuts and Jobs Act (TCJA) in 2017, and one of the key changes in that legislation was the dis-allowance of carrying back net operating losses to prior years as well as a limitation in the amount of loss carryforwards that can be taken in future years, where the losses can be used to offset no more than 80% of taxable income. However, the Corona Virus Aid, Relief, and Economic Security (CARES) Act postponed the 80% carryforward limitation, and it will now only apply for years beginning on or after January 1, 2021. In addition, taxpayers can also carry back any NOLs that arise in tax years beginning after December 31, 2017, and before January 1, 2021, over a 5-year period.
Corporate Alternative Minimum Tax (AMT) Credit
The TCJA of 2017 eliminated the 20% corporation AMT that principally impacts C corporations, and provided that only 50% of the AMT credits carried forward could be refundable in tax years after December 31, 2017 and before January 1, 2021. After December 31,2020, 100% of any excess AMT credits could then be refunded. However, the CARES Act permits corporations to claim a refund for 2018 equal to the full amount of their excess AMT credit carryforwards. For corporations that do not elect to take this refund, the CARES Act eliminates the 50% limitation on AMT credits for taxable years beginning in 2019.
Business Interest Expense Deduction
The TCJA limited the amount of business interest expense that a taxpayer can deduct. Under IRC Section 163(j), taxpayers may deduct business interest expense only up to 30% of their adjusted taxable income. However, the CARES Act increases the limitation to 50% for taxable years beginning in 2019 and 2020, and it also allows taxpayers to elect to use their 2019 adjusted taxable income for their 2020 taxable year, benefitting taxpayers that have had their income impacted by COVID-19.
For partnerships, the IRC Section 163(j) limitation still applies at the partnership level. the 30% limitation will continue to apply to partnership interest expense in 2019. However, 50% of any excess business interest allocated to a partner and carried over from 2019 will be treated as business interest paid by the partner in 2020 and will not be limited to the partner’s business interest income for 2020. The remaining 50% will continue to be subject to such limitations.
Bonus Depreciation for Qualified Improvement Property
Probably the most important change impacting the taxation of real estate involves bonus depreciation involving qualified improvement property. The TCJA permitted taxpayers to deduct the full cost of certain depreciable property placed in service by the taxpayer in a taxable year before January 1,2027. This is commonly referred to as bonus depreciation. Property eligible for bonus depreciation included property with a depreciable life of 20 years or less. While these rules permit immediate expensing for various types of personal property (i.e. equipment, furniture & fixtures, etc.), it was also intended to apply to structural improvements made to commercial properties, including (but not limited to) hotels, restaurants, and retail establishments. However, the general 39-year recovery period for these improvements prevented them from being eligible for immediate expensing.
The CARES Act corrects this “error” by assigning a 15-year depreciable life to “qualified improvement property,” thereby permitting such improvements to be eligible for bonus depreciation. The provision is effective retroactively to property placed in service in 2018 and beyond. This provision may allow taxpayers to file amended returns and claim refunds for 2018 and 2019 tax years if they placed qualified improvement property into service during those years, and it may also encourage taxpayers to make needed improvements in the coming years as the economy recovers from the pandemic.
The CARES Act also revises the definition of “qualified improvement property” to limit that concept to “improvements made by the taxpayer,” thereby eliminating the possibility of the taxpayer getting bonus depreciation for “used” property that was purchased by the taxpayer.
If you invest in real estate, please keep these CARES Act changes in mind as you review your tax planning for the coming years. If you need assistance in better understanding how these changes apply to your investments or real estate business, feel free to contact me at Brent@seaycpas.com or (479) 329-5862.