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Real Estate, Taxes and COVID-19

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.

IRS final regulations regarding Section 1031 like-kind exchanges

On November 23, 2020, the IRS posted final regulations (TD 9935) on its website in regards to changes in the the rules for like-kind exchanges of real estate under IRS Code Section 1031.

Background

Under the Tax Cuts and Jobs Act (TCJA), several amendments were made to Section 1031 rules for the like-kind exchange of real property, as follows:

  • Limited the exchange rules to include only exchanges of real property
  • The deferral rules are no longer allowed for an exchange of property that is held primarily for sale
  • Stated that real property located in the United States is not considered to be like-kind to real property located outside the United States

New guidance

The new release that came out last month provides additional clarification to these new rules. Below are the key clarifications included in the final regulations:

  • Elimination of the purpose or use test in the regulations
  • Adding a definition of real property
  • List of intangible property that is considered real property
  • Adapt an existing incidental property exception to apply to a taxpayer’s receipt of personal property that is incidental to real property the taxpayer receives in the exchange.

Elimination of purpose or use test

Real property includes land and improvements to land, both permanent structures and structural components of inherently permanent structures. The earlier prpoosed regulations also took into consideration the function of the property in determining whether it is real property per section 1031. Tangible property, such as machinery or equipment, nor intangible property were classified as real property if the property contributes to the production of income unrelated to the use or occupancy of the space. The following example was included in the earlier guidance:

For example, a gas line installed for the sole purpose of providing fuel to fryers and ovens in a restaurant is not a constituent part of an inherently permanent structure and therefore not real property under the proposed regulations.

IRS Publication TD 9935

Based on feedback from commenters on the proposed regulations challenging the need for the purpose or use test and the cost of cost segregation studies that would be required, the Treasury Department and the IRS agreed and have eliminated the purpose or use test.

Definition of real property

Per the new guidance, “..property is classified as real property for section 1031 purposes if, on the date it is transferred in an exchange, the property is real property under the law of the State or local jurisdiction in which that property is located.” The final regulations also eliminate, with regard to both tangible and intangible properties, any consideration whether the property contributes to the production of income (i.e. purpose or use test). Finally, although the IRS is following state or local definitions of real property, the regulations do exclude from the definition intangible assets listed in section 1031(a)(2) prior to its amendment of TCJA, regardless of state or local law.

Intangible property as real property

The final regulations include the following intangible assets as real property defined in section 1031:

  • Fee ownership interests
  • Co-ownership interests
  • Leasehold interests
  • Option to acquire real property
  • Easements
  • Stock held by a person as a tenant-stockholder in a cooperative housing corporation
  • Rights to develop land
  • Licenses, permits, or other similar rights that are solely for the use, enjoyment, or occupation of land or an inherently permanent structure

Incidental property exception

The proposed regulations issued earlier this year provided for the receipt of personal property that is incidental to the taxpayer’s replacement real property. Personal property is considered to be incidental to real property acquired in an exchange if both of the following are true:

  • In standard commercial transactions, the personal property is typically transferred together with the real property.
  • The aggregate fair market value of the incidental personal property transferred with real property does not exceed 15% of the aggregate fair market value of the replacement real property.

The final regulations clarified that the 15% limitation is to be applied in the aggregate for the transaction and not on a property-by-property basis.

Summary

The final regulations on like-kind exchanges are a reflection of the Treasury Department and the IRS accepting constructive feedback on the changes in the TCJA, with the final regulations reflecting feedback received after the preliminary regulations were issued. The full 75-page regulations can be found at the following link: https://www.irs.gov/pub/irs-drop/td_9935.pdf

Tax regulations related to real estate are complex. If you need assistance working through these types of issues, give The Seay Firm CPAs a call. We specialize in real estate, and we can help you figure out the best tax strategy for your situation.

The Seay Firm CPAs was officially launched today!

I am excited today to announce the launch of The Seay Firm CPAs in northwest Arkansas. You can read the press release below.

A New Virtual CPA Firm Opens in Northwest Arkansas

The Seay Firm CPAs will leverage technology to interact and serve new clients

November 30, 2020

Brent A. Seay, CPA has recently relocated back to northwest Arkansas and has opened The Seay Firm CPAs PLLC.  And because of the pandemic and need to limit face-to-face contact, the firm will initially operate virtually to serve clients.  “With today’s technology and tools such as remote access and web conferencing tools such as whiteboards, webcams, and chat, I am confident The Seay Firm can provide excellent client service while working remotely in these challenging times,” said Seay.

A native of Arkansas, Brent has spent most of the past 30 years in northwest Arkansas.  He began his career in public accounting, including two years at the former Barclay, Yarborough & Scott in Rogers, before beginning a 25-year career at Walmart.  At Walmart, Brent held numerous management and executive roles in internal audit, accounting, corporate finance, and international real estate.  Brent has spent the past 2 ½ years as Vice President Financial Accounting and Business Processes for Smartcentres Real Estate Investment Trust, one of the largest REITs in Canada.

The Seay Firm will focus on tax planning and preparation for individuals and small businesses, accounting and bookkeeping services, and virtual/part-time CFO services.  The firm has also recently entered into an agreement with Stone Financial & Tax Centers to assist that firm in managing its Eureka Springs office, including responsibility for providing CFO services to the Eureka Springs Hospital.

With Seay’s extensive background in real estate development, he will also be providing more in-depth services to real estate and construction firms in northwest Arkansas.  “Taxes for real estate owners and developers are very complex, and I believe I can bring a unique perspective as someone who has spent a considerable portion of my career working through these types of challenging issues,” said Seay.

Brent, his wife Bella, and their son Finlay live in Pea Ridge.

About The Seay Firm CPAs PLLC

Founded in 2020 by Brent A. Seay, CPA, The Seay Firm is a full-service accounting firm, providing tax planning and preparation, accounting, bookkeeping and payroll services.  Please visit www.seaycpas.com for more information.