CARES Act: Summary of Real Estate-Related Tax ProvisionsBy Steve Brodsky | Alan M. Blecher | April 21, 2020
The Coronavirus Aid, Relief and Economic Security (CARES) Act became law on March 27, 2020. Included within the CARES Act are a few tax-related provisions that may assist businesses operating in the real estate industry. Although most of these tax provisions represent temporary, and in some cases retroactive, relaxation of certain amendments made by the Tax Cuts and Jobs Act of 2017 (TCJA), they promise to mitigate the adverse economic effects of the health crisis for many businesses by reducing tax burdens and getting cash into the hands of taxpayers sooner, when it is really needed.
Following is a brief description of certain provisions of the CARES Act that may be of interest to the real estate industry.
Net Operating Losses (NOLs)
The CARES Act temporarily reinstates and expands the NOL carryback that had been eliminated by the TCJA. Specifically, the new law allows a business or individual that incurs an NOL during a taxable year beginning after December 31, 2017 and before January 1, 2021 to carry its NOL back to each of the five taxable years preceding the year of the loss.
The new law also suspends the TCJA’s 80% of taxable income limitation for NOL carryovers arising in taxable years beginning prior to January 1, 2021. Thus, for a taxable year beginning in 2018-2020, an NOL carryover may be utilized to offset 100% of the taxpayer’s taxable income for that year, without limitation. The elimination of the NOL carryback and 80% NOL limitation on carryovers is reinstated for taxable years beginning after December 31, 2020.
Excess Business Loss
For taxable years beginning after December 31, 2017 and before January 1, 2026, Section 461(l) limited the ability of individuals to offset their nonbusiness income with losses arising from their business, above a threshold amount. Instead, such “excess business losses” are required to be treated as part of the taxpayer’s NOL carryforward to subsequent taxable years. Section 461(l) disallows a deduction for the amount of business losses in excess of $250K ($500K for joint filers), attributable to a trade or business in which the taxpayer actively participates.
The CARES Act retroactively defers the effective date of these “excess business loss” rules. Specifically, the rules will now apply only to taxable years beginning after December 31, 2020 and before January 1, 2026. Consequently, an individual taxpayer who incurred a loss from an operating business in a taxable year beginning before January 1, 2021 will be allowed to apply such losses against their other income for such taxable year, including salary and investment income, without limit (as was the case prior to the TCJA). This change may afford those taxpayers, to whom the excess business loss rules have already been applied, an opportunity to claim a refund with respect to their taxable years beginning in 2018 and 2019. However, when Section 461(l) goes into effect in 2021, the rules will be slightly different. In 2021 and after, wages will no longer be considered business income, capital losses are not considered in the calculation and trade or business capital gains are factored into the calculation, capped at net capital gain.
163(j) Business Interest Expense Limitation
Starting in 2018, new Section 163(j) limited a taxpayer’s deduction for business interest expense to the sum of the taxpayer’s business interest income for that year plus 30% of the taxpayer’s “adjusted taxable income” (ATI) for that year. Any excess business interest expense was carried forward to succeeding taxable years, where it could be utilized if sufficient taxable income was generated in the future by the business.
The CARES Act reduced the impact of this rule for taxable years beginning in 2019 and 2020, by increasing the ATI limitation to 50% from 30%. In the context of partnerships, the rules are more complicated for 2019. For a partnership’s 2019 tax year, the limitation on the deductible business interest deduction remains at 30%. However, each partner in the partnership may treat 50% of that partner’s share of the disallowed business interest expense as a deductible expense incurred in 2020, without limitation. The remaining 50% of disallowed 2019 interest expense remains suspended at the partner level until the partner has enough income from that partnership to free it up in 2020 or in a subsequent year. A partnership’s business interest expense for 2020 is subject to a 50% ATI limitation at the partnership level and the special partner-level rules are not applicable. Taxpayers have the option to elect out of these new rules.
Additionally, to benefit from these changes, a taxpayer can elect to treat its 2020 ATI as equivalent to its 2019 ATI for purposes of calculating its 2020 business interest expense limitation. This election will make practical sense for those taxpayers whose ATI decreased from 2019 to 2020. The 30% limitation will be reinstated in 2021.
Bonus Depreciation on Qualified Improvement Property (QIP)
The CARES Act corrected an error in the TCJA, commonly referred to as the “glitch,” which prevented QIP from being eligible for a 15-year depreciable life and qualifying for bonus depreciation, even though that was not the intended purpose. QIP is generally defined as any improvement to the interior portion of a nonresidential building. The CARES Act retroactively corrected the “glitch,” effective for property placed in service after December 31, 2017, to treat such property as 15-year property rather than 39-year property, making it eligible for 100% bonus depreciation.
The CARES Act neglected to address the impact of some of these changes on taxpayers who decided to elect to be treated as real property trades or businesses under 163(j). Electing taxpayers are not subject to the Section 163(j) limitation on interest expense but are required to use less favorable depreciation methods. Under 163(j) the election is irrevocable. The IRS recognized that a taxpayer who previously made an election to exclude their real property business from the 30% interest limitation may have approached the limitation differently had the 50% limitation been in effect. In addition, a taxpayer may have also approached the limitation differently along with the option to elect real property trade or business status if it were permitted to take bonus depreciation on QIP. Prior to the CARES Act, QIP was required to be depreciated using a 40-year ADS life when the real property trade or business election was made and was not eligible for bonus depreciation.
In response, the IRS issued guidance in the form of Rev. Proc. 2020-22, allowing a taxpayer to withdraw the otherwise irrevocable election or to make a late election. Subject to certain limitations for certain partnerships, for the 2018 and 2019 taxable years, Rev Proc 2020-23 permits taxpayers to file amended federal tax returns for the year in which the election was made along with an election withdrawal statement or amend a return to file a late election. The details of these two Rev. Procs. were covered in earlier Marks Paneth alerts:
Additionally, as a way of providing guidance on the reporting requirements and implementation of the glitch fix, the IRS issued Rev. Proc. 2020-25, which is applicable to the 2018, 2019 and 2020 tax years. This additional Rev. Proc. does not apply to taxpayers who are either revoking or making a late real property trade or business election. Those taxpayers must follow Rev. Proc. 2020-22. Taxpayers who are subject to Rev. Proc. 2020-25 and who have filed only one return using the now “incorrect method” may either amend that one return or file for an automatic change in accounting method utilizing Form 3115 with the succeeding year’s return, under the automatic method change rules. A taxpayer who has filed two “incorrect” returns must file Form 3115.
Rev. Proc. 2020-25 also provides relief for taxpayers seeking to either make a late election or revoke a late election in certain instances with respect to returns timely filed before April 17, 2020. Of relevance to real estate, this relief is available with respect to the ADS election, the election out of bonus depreciation for a class of property, and the election to claim bonus depreciation at 50% rather than 100% for a tax year that includes September 28, 2017. Additionally, Rev. Proc. 2020-25 suspended certain eligibility rules such as the 5-Year Rule and created a new designated change number to include with any Form 3115 filing.
The TCJA repealed Like-Kind Exchanges (Section 1031) for all other types of property that are not real property. The basic mechanics of a Section 1031 exchange haven’t changed. A taxpayer must still identify their replacement within 45 days and exchange within 180 days.
When President Trump declared a national emergency resulting from the COVID-19 outbreak, the IRS postponed the time to perform specified “time-sensitive actions” for taxpayers who were affected by the crisis, which included taxpayers who may have been in the process of identifying or replacing property as part of a 1031 transaction.
As a result of the postponement, the IRS issued Notice 2020-23, affording taxpayers an extension to July 15, 2020 to perform certain “Specified Time-Sensitive Acts” that are due to be performed on or after April 1, 2020 and before July 15, 2020. Rev. Proc. 2018-58 lists these specific acts. Among these specified time-sensitive acts are the time periods associated with 1031 exchanges. Under Notice 2020-23, if the 45-day identification period or the 180-day exchange period ends between April 1, 2020 and July 15, 2020, the deadline is automatically extended to July 15, 2020. If the taxpayer’s 180-day exchange period for acquiring the replacement property would normally end within the relief period of April 1, 2020 to July 15, 2020, the end of the replacement period is extended to July 15, 2020. The Notice does not provide relief if a deadline arose prior to April 1, 2020.
Nevertheless, although the IRS extended deadlines for the identification and purchase of properties in 1031 exchanges, it is still uncertain whether the deadlines are extended until July 15 or for an additional 120 days pursuant to Rev. Proc. 2018-58. Under that Rev. Proc. the IRS has expanded authority to extend certain deadlines for an additional 120 days.
On one hand it appears that Notice 2020-23 limits the extended due dates to specified time-sensitive actions that have a deadline between April 1 and July 15, until July 15. Alternatively, another interpretation of Notice 2020-23 is that it extends both the 45-day and 180-day deadlines for an additional 120 days under the theory that Rev. Proc. 2018-58, which says if the IRS issues guidance for a specified federally declared disaster and authorizes the postponement of certain acts, then affected taxpayers may use the postponement rules provided in Section 17 of Rev. Proc. 2018-58, to extend all actions by 120 days. Until the IRS weighs in on this issue and clarifies, the questions will remain open to interpretation.
Qualified Opportunity Funds (QOF)
The 180-day investment period to invest gains into a QOF is also extended by Notice 2020-23. Taxpayers electing to invest gains into a QOF within a 180-day period that would have ended between April 1, 2020 and July 15, 2020, will now have until July 15, 2020 to invest in a QOF and elect to defer the eligible gain.
About Steve Brodsky
Steve D. Brodsky, CPA, JD, LL.M., is a director in the Real Estate Group at Marks Paneth LLP. To this role, Mr. Brodsky brings 20 years of accounting experience, with a focus on advising clients on complex tax matters related to the real estate industry. Mr. Brodsky’s areas of specialization include Real Estate Investment Trust (REIT) planning and compliance, tax consulting, and filing of federal and state returns for partnerships/limited liability companies, C and S-Corps,... READ MORE +
About Alan M. Blecher
Alan M. Blecher, JD, is a Principal at Marks Paneth LLP. Mr. Blecher has considerable experience serving high-income and high-net-worth individuals and their closely held businesses. He focuses especially on partnerships, limited liability companies and S corporations. He has been in public accounting since 1985 and has been involved in tax planning for numerous transactions. These include transactions involving public debt offerings, sales of family businesses and restructurings of distressed entities, among others. Mr. Blecher... READ MORE +