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Three Big Tax Breaks to Provide Liquidity to CRE Investors in The Current Environment
There are several significant tax opportunities that can accelerate tax savings for investors right now. Wading through the tax legislation implications of the 2017 tax reform and 2020 CARES Act can be overwhelming for many real estate companies.
But there’s no doubt that the industry should pay attention as there are several significant tax opportunities that can accelerate tax savings to provide liquidity now for real estate investors.
First-year depreciation deduction
The 2017 tax reform bill increased the first-year depreciation deduction from 50 percent to 100 percent for qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
This is significant as it allows real estate companies to deduct the full cost of qualified property in the year of purchase and reduce the after-tax cost of your investment. This deduction will phase down after 2022, so time is of the essence. It is recommended that a cost segregation study be performed to identify the portion of the purchase price that can be written off in the first year.
Faster write-offs for interior building improvements
The 2020’s CARES Act made a technical correction to the 2017 tax law which made qualified improvement property “QIP” eligible for the 100 percent bonus depreciation. The CARES Act specifically designates that QIP has a 15-year recovery period for depreciation, which makes it eligible for the 100 percent bonus depreciation.
QIP is defined as any improvement to an interior portion of a building which is non-residential real property, if such improvement is placed in service after the date the building was first placed in service (expenditures attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building are excluded).
The technical correction is effective for property placed in service after December 31, 2017. Taxpayers or their advisors should review their 2018, 2019 and 2020 fixed asset additions and determine if they are QIP. Once identified, the taxpayer can then either elect to file an amended tax return to correct the depreciation deduction in the year acquired, or elect to file a change in the method of accounting and recompute the missed deductions, bring them forward to the current year and deduct them on their 2019 or 2020 return.
This correction provides unprecedented tax savings for commercial real estate companies.
Utilize net operating losses to create liquidity
The added deductions described above can be very substantial, which can create a net operating loss (NOL) or substantially increase an NOL which did not consider these provisions. The NOL can be used now to obtain immediate tax refunds.
The tax law in place before the changes by the 2020 CARES Act limited business losses to $500,000 and did not allow NOL carrybacks. In addition, the NOL carryforward was limited to 80 percent of the taxpayer’s income in future years.
But now, under the provisions of the CARES Act, businesses have the choice of recalculating the depreciation that should have been allowed in those prior years and then deciding to either amend those years or bring the added deductions forward and catch it all up in their extended 2019 or in the 2020 returns.
If those deductions are large enough to create net operating losses, taxpayers, including investors in and owners of commercial and multifamily real estate, can carryback those losses and obtain immediate tax refunds for tax paid at any time during the last five years.
Modeling of the potential loss carryback and refund opportunities becomes essential and is highly recommended to determine the highest and best use of the losses. Your losses, if carried forward, might only offset income otherwise taxed at 29.6 percent versus if carried back they might reduce income that was taxed at 39.6 percent to provide a refund right now.
These provisions together create a great opportunity for real estate companies to review their past fixed asset additions, plan for current and future asset additions through 2022, and take advantage of the full write-offs allowed by these new and expanded legislative provisions to provide liquidity in the current environment for real estate investors.