In tumultuous economic conditions, cash is king—and companies could have a lot of it sitting in their real estate portfolios and depreciation schedules waiting to be unleashed.
Taxpayers that own real estate, tenants that make improvements to their spaces, and companies with significant fixed assets can currently receive benefits and much-needed tax relief from COVID-19-related initiatives as well as tax laws that existed prior to the pandemic.
These benefits span across multiple industry types, including professional services, industrial, retail and restaurants, hotels and hospitality, healthcare, and multifamily. In general, any recent asset purchase, newly constructed building, renovation, or improvement project should be looked at for a potential cash flow infusion.
Many of these opportunities can generally be implemented on a lookback basis and applied on a current-year tax filing through an automatic accounting method change filed on a Form 3115. In some cases, amended returns can be filed, which could provide greater cash flow benefits if losses can be carried back to earlier years in which taxes were paid.
To increase their benefit from these opportunities, companies should carefully evaluate their options and review all related tax requirements. Modeling may be required, particularly for real estate businesses that elected out of the business interest limitation requirements at the cost of accelerated depreciation. The Coronavirus Aid, Relief, and Economic Security (CARES) Act may also cause these businesses to revisit prior elections to benefit from cash flow benefits now available.
Below are six key tax relief opportunities real estate owners should know about as well as related implementation and filing requirements.
Qualified Improvement Property
The CARES Act provides numerous favorable provisions as a way to generate an immediate cash infusion to taxpayers across all industries.
Many taxpayers have waited for a technical correction to qualified improvement property (QIP) since the passing of the 2017 tax reform reconciliation act—commonly referred to as the Tax Cuts and Job Act (TCJA)—and the correction to QIP has finally arrived through the CARES Act.
QIP is any improvement a taxpayer makes to the interior of nonresidential real property after the building was initially placed in service, excluding:
- Improvements to enlarge the building
- Elevator or escalator enhancements or additions
- Improvements to the internal structural framework of the building
The QIP technical correction is applied retroactively. That means taxpayers that placed QIP in service after 2017 are generally able to treat this property as 15-year property eligible for bonus deprecation. For alternative depreciative system (ADS) purposes, QIP is recovered over 20 years, not eligible for bonus depreciation.
To learn more about these QIP changes and potential impacts, watch our webcast.
Cost segregation is a tax-deferral strategy that frontloads depreciation deductions into a taxpayer’s early years of owning real estate.
This strategy is attractive because segregating real estate costs into the correct asset classifications and recovery periods for federal and state income tax purposes can result in a property having a significantly shorter tax life—typically five, seven, or 15 years, rather than the standard 27.5- or 39-year depreciation periods. These accelerated tax lives allow property owners to increase deductions and reduce their federal and state income tax liability.
Cost segregation has become increasingly valuable after changes to bonus depreciation were enacted in the TCJA. These changes increased bonus depreciation to 100% for property acquired and placed in service after September 27, 2017, and before January 1, 2023. The TCJA also made used property eligible for bonus depreciation, but only if it’s acquired in an arm’s-length transaction—the same requirement that applies for new property.
Visit our Cost Segregation Services page for more information about this approach and potential benefits.
Fixed Asset Study
A review of depreciation schedules, or a fixed asset study, is designed to reduce federal and state tax liabilities by applying tax laws to a company’s fixed assets.
Aside from standard tax depreciation lives provided in Revenue Procedure 87–56, taxpayers often miss beneficial accelerated depreciation methods and lives, bonus depreciation, asset retirements, as well as qualified property classifications that are afforded favorable treatment.
If a fixed asset study reveals that a taxpayer can accelerate deductions on assets previously placed in service with improper tax lives or methods, this can lead to immediate tax deductions for the owners.
Visit our Fixed Asset Consulting page to learn more about this opportunity.
Tangible Property Regulations
The tangible property regulations (TPR) became effective for tax years beginning on or after January 1, 2014. For tax purposes, these regulations provide a framework for determining if an expenditure to existing tangible property is treated as a deductible repair expense or a capital improvement subject to cost recovery through depreciation.
Many taxpayers filed accounting method changes when the TPR rules first became effective in 2014. Once a method change is made, taxpayers are generally precluded from requesting another method change for the same item for five years. Taxpayers that made changes in 2014 can now once again use the automatic change procedures to request a change if they haven’t correctly applied the regulations to their treatment of repairs and improvements.
This could provide a timely opportunity for many taxpayers to revisit overcapitalized expenditures beginning with their 2019 tax return. Real estate or building operators may have missed savings opportunities related to tax-deductible maintenance and repair expenses that were treated as capital improvements on a previous tax return.
Performing a review of a company’s existing asset holdings can reveal improvement projects from prior tax years that could’ve been classified and expensed as repair expenditures. These changes can then be reported on the taxpayer’s upcoming tax return.
It’s important to note that partial dispositions of an asset, which generally occur when a business undergoes an improvement project, can also be identified and included in the taxpayer’s return during the tax year in which the disposal occurs.
For more information about the tangible property regulations, read our article.
Energy Efficient Commercial Building Deduction
Legislation that was signed into law in December 2019 extended tax deductions for energy efficient commercial buildings and improvements through December 31, 2020, under the Section 179D Energy Efficient Commercial Building Deduction.
The Section 179D provision grants a tax deduction of up to $1.80 per square foot for certain energy efficient property in three distinct categories:
- Interior lighting
- HVAC systems
- Building envelopes
These benefits apply to owners and tenants of commercial properties that built newly constructed buildings or leasehold improvements after 2006.
Learn more about the extension and potential impacts in our article.
Net Operating Loss Carrybacks
As a result of the previous five strategies, companies may find themselves in a loss position. The CARES Act included a taxpayer-friendly provision by restoring the five-year net operating loss (NOL) carryback for losses arising in any taxable year beginning after 2017 and before 2021. It also allows 100% offset of taxable income, suspending the 80% limitation put in place by the TCJA in 2017.
The CARES Act also allows a taxpayer to decide to carry losses backward or forward, an election that can be made for each separate tax year in 2018, 2019, and 2020. Companies generally can benefit from choosing to carry losses back prior to 2018 because the TCJA lowered the corporate tax rate from 35% to 21%, and the pass-through rate from 39.6% to 29.6%—assuming the new 20% pass-through deduction for eligible businesses is applied.
For eligible businesses, these changes could result in a permanent cash savings on any NOLs of up to 14% for C corporations and 10% for eligible pass-through businesses.
Given this change, taxpayers may also want to revisit their prior year depreciation elections as well. Some taxpayers may have elected out of accelerated depreciation provisions, but, with the ability to now carry back losses, these elections may be revisited to increase deductions.
To learn more about the potential benefits of leveraging NOLs, read our article.
We’re Here to Help
If you have questions about how any of these opportunities could apply to your business and potentially decrease its tax liability, visit our tangible asset incentive services web page or contact your Moss Adams professional.