New Tax Considerations for Real Estate Businesses
By David A. Adams, Bingham Greenebaum Doll LLP
Since the Tax Cuts and Jobs Act of 2017 (TCJA) was signed into law on December 22, 2017, professionals of all industries have been trying to understand how the new law impacts their business. The real estate industry has been particularly impacted by the changes of the TCJA. While we expect guidance from the IRS to come in the near future, this blog series seeks to provide a manageable understanding of how the TCJA impacts real estate businesses.
Business Interest Expense Limitation – EXCEPTION!
A new expense limitation introduced by the TCJA limits business interest deductions to 30% of a taxpayer’s (business or individual) adjusted taxable income. This limit applies to any interest paid or accrued on debt that is attributable to a trade or business. Business interest does not include investment interest that may be paid to the business. However, those in the real estate business have the option to elect out of the limitation. If a real estate business has, on average over the past three years, $25 million or less in annual gross receipts, the business may choose to elect out. This election will impact depreciation and expensing changes as discussed below and is irrevocable. The limitation is in effect for taxable years after December 31, 2017.
Real Property Depreciation
The recovery period for a variety of property types has been modified. For properties using the Modified Accelerated Cost Recovery System (MACRS), depreciation has been extended to 39 years where it was previously 15 years. Depreciation for residential rental property and nonresidential real property remains the same, at 27.5 years and 39 years respectively. Under the Alternative Depreciation System (ADS), the useful life of qualified improvement property and residential rental property has been reduced to 20 years and 30 years respectively. The useful life of nonresidential real property under ADS remains 40 years.
The TCJA also expands the scope of the definition of qualified improvement property. Now, in addition to previously permitted qualified leasehold improvements, qualified restaurant improvements and qualified retail improvements, such property includes nearly all improvements to the interior of nonresidential real property. This does not include expenses for enlarging a building, installing elevators or escalators, or improving or repairing a building’s structural framework.
While a business may typically choose which depreciation system to use, those businesses that chose to elect out of the business interest expense limitation described above are required to use the alternative depreciation system. Assuming the rates remain as drafted, this could create a sizeable discrepancy in depreciation of qualified improvement property in particular.
Business Asset Expensing
A 100% bonus depreciation deduction is now available for particular assets placed in service after September 27, 2018. This depreciation, while subject to conditions, is now available for used property or non-first owner property as well. Assets eligible for the bonus depreciation are those with a useful life of 20 years or less under MACRS, water utility property and computer software. Thus, those real estate businesses that chose to elect out of the business expense interest limitation will not be eligible for the bonus depreciation. The bonus depreciation will be reduced by 10% each year, beginning in 2023.
The TCJA also increased the permissible expensing limit of qualifying tangible personal property to $1,000,000. It further expands this expensing to allow for improvements to roofs, heating, air-conditioning, ventilation, fire protection and alarm systems and security systems after the property is placed in service. The phase-out limit for these expenses is also increased to $2,500,000. These increases are in effect beginning after December 31, 2017.
Like-kind exchanges occurring after December 31, 2017 are now limited to real property. If a like-kind exchange was in process on December 31, 2017, it may still be eligible for nonrecognition.
Rehabilitation Tax Credit
The general rehabilitation tax credit is appealed under the TCJA. The historic tax credit has been retained but must now be claimed over a 5-year period. The credit remains at 20%.
Net Operating Loss Limitations
Net operating losses (NOLs) are now limited to 80% of a taxpayer’s taxable income. The TCJA also eliminates the ability to carryback NOLs. However, NOLs may now be carried forward indefinitely. These limitations are in effect as of December 31, 2017.
Additional guidance from the IRS, including technical corrections, are expected regarding these and other provisions of the TCJA. Please stay tuned for updates and the next part of the series.
If you have any questions about the TCJA and its implications on your real estate business, or tax or real estate law questions in general, please reach out to David Adams directly.
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