Tax Reform Manifesto for the Real Estate Industry – Part 2
This posting is a part of a 3-part series. The full article will be available in the coming weeks. Click here to read previous post.
By Alexander J. Narcise, CPA and contributions from the entire Wiss and Company LLP Real Estate Team:
- Michael Kroll, CPA
- Larry DiPasquale, CPA
- Steve Warholak, CPA
- Michael Bodrato, CPA
- Kyle Pennacchia, CPA
- James Jenco, CPA
- Ken Trainor, CPA
- Phil London, CPA
- Chris Gati, CPA
- Charlie Komack, CPA
The Internal Revenue Code has historically provided many planning opportunities for real estate investors and developers. In our practice, we have been able to save real estate clients a significant amount of tax staff about so we can deliver the highest quality service to our real estate clients and the industry as a whole.
The Internal Revenue Code has always been favorable to real estate investors and developers to help drive the overall contribution to the economy. Wiss is in a great position to advise the real estate industry on all the new changes. If you or anyone ever has any questions, don’t hesitate to contact someone on the team.
Below are highlights of the new tax policy that will affect real estate the most.
- Like-Kind Exchanges (1031) are now limited to Real Property only. Yay for the real estate industry! This has been a big opportunity for clients to defer and reinvest tax free.
- We had 100% expensing previously before becoming a part of the new tax policy. From September 2010 through December 31, 2011, 100% bonus depreciation applied. This came about to jump start the US economy after the Great Recession. This provision allows for 100% expensing of assets other than real estate (qualifying property) after September 27, 2017 through December 31, 2022. This means these benefits will kick in for the 2017 tax year. After this date, the percentage that will be allowed to be deducted will be decreased by 20% each year until 2027. Qualifying property will be assets with a recovery period of 20 years or less. In theory, this sounds amazing but we will need to be aware that there is now a business loss limitation. One important fact to point out is that bonus depreciation used to only apply to new property and was really only beneficial to real estate developers, but now it applies to existing properties as well. This is a big difference with the new tax policy. Remember recapture could also come into play here where less of the gain recognized on a sale is subject to capital gain. Lastly most states have historically decoupled from bonus depreciation in the past like New Jersey and New York. This creates a significant difference between Federal and State depreciation. As a result, Plan, Plan, Plan.
- If you are married filing joint the business loss limitations is 500,000 and if you are single it is $250,000. What this means is the days of “blowing it out” could be over. In the past, if you qualified as a real estate professional we would take huge amounts of depreciation which would create large overall losses that were used against a client’s other income (such as Wages, portfolio income, capital gains, and other income). If there was enough left over it would create a Net Operating Loss (NOL)that we could either carryforward to future years or carryback 2 years. We were able to utilize 100% of the NOL. However, we have been researching this issue and it is not clear on the mechanics of this. The IRS will continually be coming out with guidance that will help us navigate and understand this important provision of the new tax law.
- In the past, we could either carryforward or carryback and use 100% of the loss. The carryback was especially important as, from time to time, clients would not have income for many years because of new developments and the depreciation they were throwing off. Instead of carrying the loss forward and waiting to use the NOLs we elected to carryback and get tax dollars previously paid. It was a great planning tool and it worked great for our clients. Under the new tax policy NOLswill not be able to be carried back and will be limited going forward. The deduction going forward will be limited to 80% of the taxpayer’s current taxable income. So, what this means is that it might take longer to use the NOLs under the new tax policy. Instead of taking 100% expensing we might want to be more calculated on whether we elect out of 100% expensing and properly match losses with income. There will be many different situations but this is something that has me thinking taking 100% expensing for real estate developers and investors in certain situations might not be the best strategy. Plus, if we take all the deductions up front that could lead to higher risk of phantom income (Having income with no cash) for certain clients, especially if a client is going to be active for some time and then stop or slow down investing activities. In this situation, more of the cash flow from properties will go towards paying taxes because the future income will not be sheltered. This could be a bad result.