5 Questions Every Property Owner Should Ask This Tax Season
- Mar 01, 2019
The last 13 months have been far from ordinary for commercial property owners. Following the passage and implementation of the Tax Cuts and Jobs Act, record property values began to cool in many markets, raising interest rates and a volatile regulatory environment. With the March 15 deadlines for tax returns for partnerships and S Corporations coming up, to be soon followed by the April 15 deadlines for C Corporations and individual income tax, property owners should be sure to evaluate the following considerations with tax advisors before submitting returns.
Extension or no extension?
There are a wide range of scenarios that make filing an extension to push your return deadline to the fall a wise decision for many property owners. With 2018 the first full tax year subject to the reforms specified by the Tax Cuts and Jobs Act, most tax practitioners will advise clients to not rush things and take the extension to allow more time to analyze changes to the tax code.
In the last year, IRS has confirmed several errors within the reforms that may be amended, including the recovery period and allowance for bonus depreciation on Qualified Improvement Property. IRS has also noted that additional guidelines will be released for aspects of the legislation, such as the Economic Opportunity Zones program and attribution rules related to the gross receipts test for Business Interest Limitation. With updates expected in the next few months—which can possibly be applied retroactively, as well as the slowing of the finalization of some 2018 forms by the federal government shutdown, extending the filing deadline will give property owners and their advisers more time to understand complexities of the updated tax.
2. Are you subject to business interest limitations?
Before the Tax Cuts and Jobs Act, interest paid or accrued by a business was generally fully deductable. Under the new law, property owners or entities such as S corporations, partnerships and LLCs with average annual gross receipts of $25 million or more (attribution rules apply) cannot deduct interest expense in excess of 30 percent.
Entities and individuals that own real estate can elect to use a slower depreciation method for real property and deduct 100 percent of their interest expense. However, this election could limit the amount of bonus depreciation the taxpayer may be eligible for in the future. Depending on the owner’s long-term plans for properties and partnership agreements, careful planning should be done before electing to take this deduction, since this election is permanent.
3. Should you take bonus depreciation for an improvement property?
Under the Tax Cuts and Jobs Act, bonus depreciation doubled to 100 percent. In addition, “used” property—that is, property placed in service by a previous owner—qualifies for bonus depreciation. This makes a cost segregation study even more valuable than before.
Assuming IRS amends the law relating to bonus depreciation for qualified improvement property, as has been indicated, an owner that made interior improvements in buildings that are nonresidential real property after Sept. 27, 2017 may expense 100 percent for the property’s improvement under bonus depreciation—up from 50% under previous tax law. Qualified Improvements would be depreciable over 15 years using half-year conventions; no longer need to be subject to a lease; and the property no longer has to have been placed in service for three years. An important consideration property owners should take before claiming bonus depreciation is analyzing if it will result in an excess loss.
4. Will you be impacted by the new excess loss limitation?
Under the Tax Cuts and Jobs Act, a new limitation applies to deductions for excess business losses incurred by non-corporate taxpayers. This limitation heavily impacts real estate businesses and has been met with near universal shock by owners when tax practitioners explain the effects of this aspect of the new tax law. Excess losses, which account for losses of over $250,000 for individual taxpayers and $500,000 if filed jointly with a spouse, now carry forward to later tax years and must be deducted under net operating loss rules.
This new limitation was meant to be a simplification for taxpayers. Instead it has made things much more complicated and greatly increased what will be subjected as taxable income for many owners. To address the negative impacts of this limitation, corporations with owners’ salaries and with flexibility around salaries may seek to reduce compensation to lower losses.
5. Have you claimed Section 179 and qualified business income deductions?
The Section 179 and qualified business income deductions have proven to be two of the most advantageous aspects of the Tax Cuts and Jobs Act for property owners. Beginning in 2018, the amount a business may claim as an immediate deduction under Section 179 increased from $500,000 to $1 million. The limit on property eligible for the Section 179 deduction is increased to $2.5 million. The new tax law also expanded the definition of Section 179 property to include roofs, HVAC property, fire protection and alarm systems and security systems, if these improvements are made to the nonresidential real property. In states that do not allow bonus depreciation, property owners should consider taking section 179 in lieu of bonus depreciation.
Additionally, the new deduction based on a non-corporate owner’s qualified business income is available to individuals, estates and trusts that own interests in pass-through business entities. The deduction can reach as much as 20 percent of QBI, subject to various calculations and limits. Final regulations and additional guidance on what qualifies as QBI is expected to be released by the IRS in early 2019. Owners should quickly review and analyze these updates with their tax practitioners once the updates become available.
While there are more than two dozen variable calculations that can be made in order to maximize the benefits or lessen the burden of the Tax Cuts and Jobs Act, it is important to remember tax strategy is a fluid process. Property owners need to carefully consider deciding whether to pursue an extension. Owners and their tax practitioners should consistently monitor for subsequent clarifications and legislative changes regarding tax law, as well as observing how others in the industry are reacting to recent reforms.
Robert Gilman and Marc Wieder are partners and co-leaders of the Real Estate Group at Anchin, Block & Anchin, LLP.