On March 27, 2020, President Trump signed into law the CARES Act to provide relief to millions of American taxpayers and businesses impacted by the COVID-19 pandemic. Below are the key provisions of the legislation and its applicability to the commercial real estate industry:
Bonus Depreciation on Qualified Improvement Property (QIP): Previously, a drafting error in the Tax Cuts and Jobs Act (TCJA) resulted in qualified improvement property to be ineligible for 100% bonus depreciation under the Modified Accelerated Depreciation System (MACRS). The CARES Act corrects to that error, making QIP eligible for 100% bonus depreciation. The legislation also assigns a 20-year class life to QIP under the Alternative Depreciation System (ADS). Previously, QIP was assigned a 40-year ADS class life.
Assuming bonus is taken on QIP under MACRS, real estate entities cannot opt to be an electing real property trade or business since ADS is required to do so. In turn, this results in a limitation in business interest deductibility under Sec. 163(j)(1) as discussed below. Given the significant QIP put in place by real estate entities, businesses will need to consider the benefits gained and lost as a result of bonus depreciation, interest expense limitations, and the effects on the qualified business income deduction. One key factor to consider is the debt level of the entity; if little or no debt exists, it’s highly likely the entity should take advantage of bonus depreciation.
163(j) Business Interest limitation: As a result of TCJA, businesses were subject to limitations on the deductibility of interest expense, which was equal to 30% of a taxpayer’s adjusted taxable income. For partnerships, the CARES Act temporarily increases that threshold to 50% for tax years beginning in 2020. However, since real estate entities typically opt to be an electing real property trade or business, whereby interest limitation rules are not applicable, the modification that the CARES Act provides may not create a significant benefit. An analysis should be performed to consider the potential benefits that accelerated depreciation and changes in the qualified business income deduction that the CARES Act may provide.
Payroll Tax Credits and Deferrals: While a significant number of real estate entities do not have employees due to the utilization of management companies, those that do may be able to obtain payroll tax related relief. The CARES Act includes two major provisions:
- Employee retention credits: Provides for a refundable payroll tax credit for 50% of eligible wages paid by eligible employers.
- Deferral of Employer Payroll Tax Payments: Permits the deferral of the employer potion of certain payroll taxes through the end of 2020.
Net Operating Losses: Previously, Net Operating Losses (NOL) were limited to 80% of taxable income and did not allow for NOLs to be carried back. Under the CARES Act, the 80% limitation applies to tax years beginning after December 31, 2017, as well as to tax years beginning on or before December 31, 2017, to which NOLs arising in those tax years. Additionally, NOLs arising after the December 31, 2018 tax year and before January 1, 2021 can be carried back to each of the five preceding years.
Excess Business Loss Limitations: Business loss limitation rules previously disallowed excess losses, which became part of a taxpayer’s net operating loss to be carried forward. The CARES Act repeals the excess business loss limitations for the 2018, 2019 and 2020 tax year, thereby repealing the provisions put in place by TCJA.
Forbearance for Multifamily Properties with Federally Backed Loans: This provision provides up to 90 days of forbearance on multifamily properties that have federally backed loans. In exchange for this forbearance, landlords cannot evict their tenants, nor assess late changes during the forbearance period.
Temporary Moratorium on Evictions: From the date of enactment of the CARES Act through 120 days, landlords are prohibited from initiating legal action to evict or charge fees related to non-payments, assuming the landlord’s mortgage is insured, supplemented, guaranteed, or protected by HUD, Freddie Mac, Fannie Mae, the rural housing voucher program, or the Violence Against Women Act of 1994.
Forgivable Loans for Businesses: Qualified businesses can obtain loans, which were designed to keep personnel employed. The loans also allow for qualifying costs to be paid such as rent, mortgage interest, and utilities. These loans not only provide funds to landlords in order to pay their operating costs, they also provide tenants funds to pay their rents to landlords.
Given the various components of the CARES Act, multiple analyses will need to be performed in order to consider the interrelationships between interest deductions, NOLs, bonus depreciation and qualified business income tax deductions. The ultimate benefits of the CARES Act remain to be seen at this point; however, the legislation provides real estate entities with more flexibility to maximize deductions and provides non-tax economic relief to assist with the impending economic downturn.
For more information on the CARES Act and how this impacts your real estate business, contact Chris Vasquez at 301.231.6244.