2020 Year-End Tax Guide

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Property, Pandemic and Politics: “PPP” for the Real Estate Industry

As with every segment of the global economy, the U.S. real estate market was not immune to the pandemic. In fact, there are four great forces at play in the determination of tax policy as it pertains to the real estate industry: 1. The Tax Cuts and Jobs Act of 2017 (TCJA), as augmented by the CARES Act in 2020; 2. The economics of the pandemic; 3. The Presidential election; and 4. The Congressional elections. Below are some of the key developments in these areas during 2020 that may affect real estate businesses for investors, developers, builders and owners, and what to look for in 2021. RETROACTIVE BONUS DEPRECIATION FOR QUALIFIED IMPROVEMENT PROPERTY (“QIP”) It took a pandemic to persuade legislators to correct a “technical glitch” in the TCJA. The CARES Act, signed into law in March 2020, corrects a drafting error in the TCJA, which failed to provide that certain improvement property (QIP) would be treated as having a recovery period of 15 years. The TCJA, as originally issued, erroneously provided for a recovery period of 39 years, thus making it ineligible for bonus depreciation of 100% in 2018 and later years. The CARES Act corrects this error, reducing the recovery period of QIP to 15 years and making the QIP eligible for 100% bonus depreciation. The correction is retroactive to January 1, 2018. This allows taxpayers to amend their 2018 returns to benefit from bonus depreciation and reduce taxable income.

A complicating factor in the QIP windfall in the CARES Act is that bonus depreciation generally is unavailable to taxpayers in a real estate business that elects out of certain interest expense limitations under Internal Revenue Code Section 163(j). Taxpayers that elect as real estate trades or businesses would still benefit from a shorter 15-year recovery period versus the former 39 year recovery period. INTEREST LIMITATION CHANGES AND THE CARES ACT. The TCJA modified Internal Revenue Code Section 163(j) to limit the deductibility of business interest expenses, generally capping the interest expense deduction at 30% of adjusted taxable income (ATI). ATI is defined as earnings before interest, tax, depreciation, and amortization (EBITDA), with a few adjustments for tax years beginning before January 1, 2022. Any interest expense in excess of the 30% limit is disallowed in the current tax year and carried forward to future tax years as “excess business interest.” As discussed above, not all real estate businesses are impacted by this limitation, as some will have elected out in exchange for longer depreciation periods on certain real property. The CARES Act temporarily modifies Section 163(j) in three important ways: X It increases the Section 163(j) limitation to 50% of ATI for the 2020 tax year, allowing taxpayers to deduct a larger amount of interest expense. X Taxpayers may (but are not required to) use their 2019 ATI to calculate the Section 163(j) limitation on their 2020 returns, which will create a more favorable limitation for taxpayers with higher ATI in 2019 than in 2020 (a highly likely scenario given the recent, sharp economic downturn). X In the case of a partnership with excess business interest from 2019, 50% of the excess business interest of each of its partners (unless a partner elects out) will generally be deductible against their tax year 2020 income without regard to the limitations under Section 163(j).