ATRA: DIGGING INTO THE NEW TAX LAW

The American Taxpayer Relief Act of 2012 (ATRA) not only has an effect on individual tax rates, but also can have a significant effect on the bottom lines of real estate developers and investors. This article looks at ATRA’s implications for depreciation, Section 179expensing and energy-related incentives. This article also discusses tax credits available for hiring people from certain target groups that have faced significant barriers to employment. When Congress avoided the so-called “fiscal cliff” with the passage of the American Taxpayer Relief Act of 2012 (ATRA) in early January, much of the attention focused on the effect on individual tax rates. But ATRA also contains several provisions that can have a significant effect on the bottom lines of real estate developers and investors. Bonus depreciation ATRA generally extends 50% first-year bonus depreciation on qualified property through 2013 (through 2014 for certain longer-lived and transportation property). Qualified property includes new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), as well as qualified leasehold improvement property. You can write off 50% of the cost basis of qualified property in the year the property is placed in service,depreciating the remaining basis over the applicable recovery period. Bonus depreciation applies automatically unless you elect not to apply it. The law also extends the provision allowing corporate taxpayers to accelerate certain credits instead of claiming bonus depreciation. Section 179 expensing Internal Revenue Code Sec. 179 allows you to write off the full expense of qualifying property purchases in the year they are made rather than depreciating the purchases over several years. The deduction is reduced by $1 for every $1 of expenses in excess of a phaseout threshold and can be claimed only to offset net income — it can’t be used to reduce net income below zero. ATRA extends the 2011 expensing limit of $500,000 (with a phaseout threshold of $2 million) through 2013. Although Sec. 179 expensing is generally limited to tangible personal property, ATRA allows you to expense up to $250,000 (of your $500,000 maximum) for qualified real property, which includes leasehold improvements, restaurant property and retail improvement property. The amounts had been scheduled to fall to $25,000 and $200,000 for 2013. Absent further legislation, they will drop to those levels in 2014. Sec. 179 expensing may provide you a greater tax benefit than bonus depreciation because it allows you to deduct 100% of a new asset’s cost and, unlike bonus depreciation, is available for used property. But bonus depreciation might apply to more taxpayers because it isn’t subject to a purchase limit or net income requirement. Accelerated depreciation The new law extends through 2013 your ability to depreciate qualified leasehold improvement, restaurant and retail improvement property over a shortened recovery period of 15 years, as opposed to the normal 39-year period. Energy-related incentives ATRA also includes several energy-related provisions. For example, it makes it easier to qualify for a production tax credit (PTC) or investment tax credit (ITC) on certain renewable energy facilities, including wind, geothermal that generates electricity, biomass, landfill gas, municipal solid waste, hydroelectric, and marine and hydrokinetic energy. Previously, such facilities generally were eligible for the credits only if they were placed in service in 2013. Under ATRA, the availability of the credits hinges on when the facility begins construction. As long as construction begins in 2013, the facility will be eligible for the applicable PTC or 30% ITC even if it isn’t ultimately placed in service until after 2013. ATRA also extends the energy-efficient home credit (Sec. 45L) to 2012 and 2013. Qualified taxpayers can earn a tax credit of $1,000 or $2,000 for each new dwelling unit, depending on whether the unit achieves 30% or 50% savings in the annual level of heating and cooling energy consumption. Finally, the act extends the credit for alternative fuel vehicle refueling property (Sec. 30c). The 30% credit had expired on Dec. 31, 2011, but now runs through Dec. 31, 2013. The credit for refueling property brought into service before then may not exceed $30,000. What’s next? In addition to the passage of ATRA, tax reform remains on Congress’s agenda for 2013 and could bring major changes for future years. Consult with your financial advisor to chart the best course toward minimizing your business and personal taxes. Could you earn tax credits for hiring? The American Taxpayer Relief Act of 2012 (ATRA) extends the Work Opportunity tax credit. The credit, which originally expired Dec. 31, 2011 (Dec. 31, 2012, for qualified veterans), is intended to encourage hiring from certain target groups that have faced significant barriers to employment. Under ATRA, the credit is extended for most target groups through 2013. In addition to certain veterans, target groups include food stamp recipients, ex-felons and certain individuals with disabilities who’ve been unemployed for four weeks or more but less than six months. Employers can earn a tax credit equal to 25% or 40% of a new employee’s first-year wages, up to the maximum for the target group to which the employee belongs; the maximums generally range from $2,400 to $9,600. The credit is 25% if the employee works at least 120 hours and 40% if the employee works at least 400 hours. There’s no limit on the number of qualified individuals an employer can hire.

WARD OFF REALLY BIG PROBLEMS: REGULARLY PERFORM PREVENTIVE MAINTENANCE

Just one poorly maintained property can result in a myriad of headaches and possible lawsuits. That’s why it’s important to stay on top of repairs and maintenance on all buildings, whether they be residential or commercial. This article shows how to create a formal schedule for fixed asset repair and maintenance, taking into account labor requirements and tax considerations. If just one of your properties is poorly maintained, you could face a myriad of headaches and possible lawsuits. That’s why you must stay on top of repairs and maintenance on all your buildings, whether they be residential or commercial. Scheduling tasks Some maintenance items must be checked weekly, while others may be inspected less often. The property manager, along with the maintenance supervisor, should develop a realistic schedule for each task. Moreover, it’s critical to create checklists that facilitate daily, weekly, monthly or even seasonal reports. Make sure you have a system for issuing work orders and monitoring task completion. Accounting for all systems To cover all the bases, regularly take stock of every piece of equipment on each property, including elevators, HVAC systems, pumps and motors. Be sure to include structural components, such as roofs and supports. For the exterior of a building check the:

• Foundation walls and waterproofing,
• Fascia and soffits,
• Grading and drainage,
• Exterior painting, and
• Window seal repair and replacement.

And don’t forget the interior. Some “hotspots” that deserve attention are moisture control systems, drywall installation and repair, and interior painting. Other focal points are carpet replacement, mechanical system repair, and plumbing and electrical repair. Create a formal schedule for fixed asset repair and maintenance, and assign someone to update this schedule (usually the property manager). Describe each item fully, including the manufacturer, operating procedures (if applicable), location within the property, and any details of purchase and existing warranties. The inventory should also state where to obtain needed parts and service. This schedule can help management quickly assess the condition of fixed assets and helps transition the task if a new person is put in charge of repairs and maintenance. Handling inspections and preventive maintenance Another task: Determine the types of inspections and preventive maintenance that should be performed on each piece of equipment and structural component. Note how frequently these tasks should be done. Often the property manager programs routine maintenance reminders into his or her smart phone calendar — or writes it in his or her day planner — to stay atop the schedule. For equipment items, develop a schedule that outlines when each item needs to be cleaned, lubricated, serviced or overhauled. Also list spare parts that should be kept readily on hand. For structural items, add a to-do list for periodic inspections related to painting, patching or similar maintenance issues. Estimating labor requirements The property manager should estimate how much time, labor and money the preventive maintenance program will require and develop cost estimates that are realistic for both the budget and level of work involved. In some cases, it may be cheaper to replace an outdated asset, rather than maintain it. For example, many older buildings use old air conditioning systems which might be expensive to maintain. Consider reducing monthly utility bills by replacing the entire system. Moreover, new equipment will likely last longer, deferring replacement costs, and major equipment breakdowns will be less frequent. The building owner could also benefit from a tax credit for energy-saving equipment, together with Section 179 expensing or other increased depreciation write-offs. But before you start upgrading at random, make sure you evaluate whether the financial benefits of the renovations, over the long term, outweigh the costs. Recording all activities will pay off … eventually Maintaining accurate records will help you determine whether time, money — or both — can be saved by simply performing certain maintenance activities less frequently, or whether certain items should be inspected more often. Keeping good records can also help verify whether your maintenance personnel are performing needed tasks to your satisfaction. Plan ahead Maintaining your buildings’ equipment and infrastructure shouldn’t be just an occasional occurrence. To ensure your properties are always in “tip top” shape, performing regular inspections and maintenance is critical.

COURT ACCEPTS REDUCTIONS IN VALUE TO REFLECT CARRYING COSTS AND LACK OF CONTROL

When real-estate-related assets undergo valuation, their value may be reduced for lack of marketability. But, as the wife in a divorce case recently learned the hard way, the value of ownership interests in companies holding such real estate assets may be further reduced to reflect carrying costs and lack of control. This article warns that interests in real-estate-related entities could be subject to sizable discounts in a variety of contexts. When real-estate-related assets undergo valuation, their value may be reduced for lack of marketability. But, as the wife in a divorce case recently learned the hard way, the value of ownership interests in companies holding such real estate assets may be further reduced to reflect carrying costs and lack of control. Experts weigh in In Barth v. Barth, a married couple owned minority interests in numerous real estate development companies that owned land held primarily for the purpose of residential subdivision development. In the two years leading up to their divorce trial, the companies suffered substantial losses in a poor real estate market. At trial, a neutral expert, charged with valuing the real estate owned by the companies, testified that he assumed a six- to 12-month timeframe for selling the residential lots in a bulk sale. Therefore, he applied a 50% bulk, or marketability, discount to the value of the real estate. To value the spouses’ interests in the companies, the husband’s expert discounted the values by a 30- month carrying cost for real estate taxes and mortgage interest payments the company owners would pay out of their own pockets. She assumed they would carry the lots for 30 months until the market improved enough that the entities could sustain themselves by selling individual lots. She also applied a 45% minority interest discount to reflect the lack of control the couple, as minority owners, had over the entities’ decision making. The trial court adopted the husband’s expert’s opinions about the carrying costs and their effect on the value of the parties’ ownership interests in the companies. The wife appealed, arguing that the court shouldn’t have discounted the value of the ownership interests by carrying costs because those costs had already been accounted for when the neutral appraiser valued the real estate. The wife also argued that a 45% minority interest was excessive, but she didn’t provide any rebuttal evidence supporting a lower amount. The appeals court weighs in The appeals court began its analysis by pointing out the difference between valuing the real estate owned at the company level and valuing the husband and wife’s ownership interest in each of the companies. It conceded, though, that the appraised value of a company’s assets generally serves as the “rough” starting point for valuing an ownership interest in the company. The wife was correct, therefore, in asserting that specific discounts applied to the value of the companies’ assets shouldn’t be applied again when valuing ownership interests in the companies. But, the court said, the marketability discount that had been applied to the value of the real estate was distinguishable from the discount applied to the value of the ownership interests in the companies to reflect the carrying costs. The wife was correct, therefore, in asserting that specific discounts applied to the value of the companies’ assets shouldn’t be applied again when valuing ownership interests in the companies. But, the court said, the marketability discount that had been applied to the value of the real estate was distinguishable from the discount applied to the value of the ownership interests in the companies to reflect the carrying costs. The court also upheld the 45% minority interest discount. All three adjustments — the marketability, carrying cost and minority interest discounts combined — reflected a 91% reduction from the initial equity value of the interests at the asset level. But the court found that the size of the collective discounts was not enough to indicate that the trial court abused its discretion. Plan accordingly The potential application of significant discounts isn’t limited to the divorce arena. Interests in real-estaterelated entities could be subject to sizable discounts in a variety of contexts — including bankruptcy, estate taxes, and mergers and acquisitions — to varying effect. Your financial advisor can help you determine how discounts could affect your valuations.

ASK THE ADVISOR

IS WRAP-UP INSURANCE RIGHT FOR MY PROJECT? The expense of construction litigation and insurance has prompted developers to seek cost-efficient ways to limit their liability. One option, known as wrap-up insurance, can provide comprehensive coverage while cutting costs. It’s worth considering for multimillion-dollar, labor-intensive projects when permitted under state law. Please click here to read more. How it works With wrap-up insurance, a developer provides a single source for project-specific liability insurance. The policy covers the developer, general contractor, subcontractors, construction managers and possibly design professionals. The developer is designated as the named insured, and the other parties become additional insureds. The insurance typically comprises workers’ compensation, general, excess, pollution and construction defects liability. It also may include builder’s risk and errors and omissions coverage. The defects liability coverage usually runs for an extended period after the project’s completion, corresponding to the relevant state’s statute of limitations or repose. Advantages for developers Wrap-up insurance can reduce problems associated with obtaining adequate liability coverage for a construction project. Many trade contractors, for example, rely on insurance policies that carry exclusions for new residential attached housing construction. Wrap-up insurance provides coverage they might be unable to purchase on an individual basis, allowing you to hire contractors and subcontractors based on their qualifications, not their insurance coverage. You can use wrap-up insurance to secure consistent coverage and speedy, coordinated claims handling. Because you’ll deal with a single insurer, there won’t be coverage gaps and disputes between multiple insurers. And litigation between the parties is less likely, since the policies provide ways of resolving disputes. In exchange for wrap-up insurance, you should receive bid credits from contractors, thereby cutting construction costs. You also can reduce insurance costs by instituting requisite on-site job safety programs and avoiding the need for tail coverage. If a case goes to trial, the parties can forge a unified defense. Further, wrap-up insurance carries a smaller risk of depleting liability limits. The defense costs usually come out of the deductible or selfinsurance retention, so you have policy limit amounts available to cover judgments or settlements. Coverage also imposes fewer administrative burdens. For example, you’ll no longer need to collect certificates of insurance and endorsements from contractors. But wrap-up insurance does shift the burden of insurance policy and job safety administration from the individual contractors to the developer. Worth considering Wrap-up insurance programs are attractive in today’s litigious environment. Your financial advisor can help you determine the best insurance option based on your specific costs and benefits.

SPOTLIGHT ON Marks Paneth

FEAR OF FLOODING: HURRICANE SANDY STILL WASHING AWAY LUSTER OF LOWER MANHATTAN REAL ESTATE A majority – 63% – of New York commercial property executives said in our survey they think the potential for flooding in lower Manhattan will increase interest in commercial properties in other parts of Manhattan less prone to flooding. Fewer than a quarter of the executives disagreed with that view and only 43% said they are somewhat confident government efforts will minimize the potential for future flooding in lower Manhattan. Read these and other results from our Spring 2013 Gotham Commercial Real Estate Monitor. FORMER IRS COMMISSIONER DESCRIBES PERFECT STORM AT THE IRS Mark W. Everson, IRS commissioner from 2003 through 2007, recently spoke at our headquarters. He applauded a lot of what’s been accomplished at the agency over the past few years. He also painted a picture of the “perfect storm” the agency must navigate now. It was a provocative talk, so much so that CSPAN ran it in its entirety. If you’d like to watch and listen, please click here. A summary of the presentation can also be found here. JEWISH NATIONAL FUND HONORING Marks Paneth REAL ESTATE GROUP LEADER William H. Jennings, the Partner-in-Charge of the Real Estate Group at Marks Paneth, will be honored by the Jewish National Fund (JNF) at its annual Golf and Tennis Classic on Monday, August 5. The event will take place at the North Shore Country Club in Glen Head, New York. For more information or to register, please contact Howard Ingram of the JNF directly by phone at 516.678.6805 ext. 110 or by email at hingram@jnf.org. IDENTITY THEFT: THE TAX AND FINANCIAL IMPLICATIONS Everyone is familiar with identity theft, one of the fastest growing crimes in America. Laura LaForgia, Tax Partner, outlines areas where people are vulnerable, techniques thieves use to steal identities and tips people should be aware of to protect themselves. Click here to read the full article. DOING BUSINESS GUIDES Doing business around the world presents a variety of challenges. Morison International (MI), the association of independent accounting and consulting firms of which we are a member, has added Costa Rica and Spain to its series of Doing Business Guides. These guides can be found in the Library on the Marks Paneth website. Each guide is written by the MI member firm in the country that is being profiled and provides an introduction to foreign investors on the various aspects of doing business.

About William H. Jennings