To help businesses deal with the financial fallout caused by the COVID-19 pandemic, several changes in tax incentives have been implemented by Congress and the federal government. This article identifies those changes so that real estate businesses can act on them in time to meet the extended tax filing deadlines. Of significance for real estate companies are certain modifications brought about by the Coronavirus Aid, Relief and Economic Security (CARES) Act, which was signed into law on March 27, 2020.
Qualified Improvement Property
One of the items of relevance is a correction (the so-called “Retail Glitch”) to the Tax Cuts and Jobs Act of 2017 (TCJA), changing the depreciation period for qualified improvement property (QIP) from 39 years to 15 years and allowing for accelerated bonus depreciation, currently at 100% of qualified cost. This concept generally includes improvements made by the taxpayer to the interior of a nonresidential building after it starts being used.
As the change is retroactive to January 1, 2018, real estate businesses should consider amending their 2018 tax return to take the depreciation bonus. They should also consider having a change in accounting method under Form 3115 prepared to ensure this fix is incorporated in 2019 tax returns and beyond. Revenue Procedure 2020-25 provides additional detailed instructions related to these changes.
Increased Limits for Business Interest Expense Deductions
Taxpayers that operate a real estate business can now potentially benefit from increased deductions under Section 163(j) as well. This section of the Internal Revenue Code created a limitation on the deduction of business interest expenses for tax years beginning after December 31, 2017. Now, as a result of an amendment made by the CARES Act, the following modifications are applicable for the 2019 and 2020 tax years:
- The adjusted taxable income (ATI) limit for 2019 and 2020 has been increased from 30% to 50%. However, that increase does not apply to partnerships in 2019.
- Taxpayers can use the 2019 ATI for 2020 limits. This assumes income for the business will be lower in 2020 as a result of the COVID-19 pandemic, and the higher 2019 income therefore provides a higher deduction threshold.
- For business partnerships, the limit increases to 50% for 2020 only. However, partners who had excess business interest (EBI) allocated to them in 2019 can deduct 50% of that amount in 2020, regardless of any other Section 163(j) limits.
Additionally, taxpayers can choose to elect out of the above changes if so desired. The general deadline for making or revoking this election is October 15, 2021. For more information, please refer to our recent article on interest expense deductions, which can be found here.
Undoing Real Property Trade or Business Elections
On April 10, 2020, the Internal Revenue Service (IRS) published Revenue Procedure 2020-22, providing guidance on real property trade or business elections under Section 163(j). It allows an extension of time not only to file an election for the 2018, 2019 and 2020 taxable years but also to withdraw prior elections. Previously, electing real property trade or business was an irrevocable situation. Real estate businesses should therefore consider using this opportunity to amend their 2018 tax returns in order to make late elections or undo elections to take advantage of the taxpayer friendly changes to the QIP rules addressed earlier.
Section 1031 Exchanges
IRC Section 1031 gives taxpayers the opportunity to defer tax on gains they make from the sale of certain property, as long as they use the money from that sale to purchase similar property. To meet the terms of the Section 1031 exchange and deferral, the taxpayer must choose the replacement property within 45 days and purchase it within 180 days of the sale of the existing property. Details about the replacement property must (i) appear in a written document, (ii) be signed by the taxpayer and (iii) be delivered to the replacement property seller or their legal representative.
On April 9, 2020, the IRS published IRS Notice 2020-23, which stated that if the deadline for either of these transactions was scheduled to end after March 31, 2020, those deadlines are now automatically extended to July 15, 2020.
If you would like more information or want to take advantage of these tax opportunities, please contact your Smith & Howard tax advisor or fill in the form below.