NCREIF. Real Estate Tax Update - Repair Regulation Update - Camp Proposal - State & Local Update

Transcription

1 NCREIF Real Estate Tax Update - Repair Regulation Update - Camp Proposal - State & Local Update Martin A. Griffiths KPMG LLP Principal Los Angeles (213) magriffiths@kpmg.com

2 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 1

3 The Final Tangible Property Regulations: Nailing Down the New Rules March 13, 2014

4 Long Journey to Here Time line January 20, 2004: Notice announces government s plan to develop tangibles regs August 21, 2006: Government issues first set of proposed regulations March 10, 2008: Government withdraws 2006 proposed regulations and issues new proposal December 27, 2011: 2008 proposed regulations withdrawn and replaced with third proposal (also issued as temporary regulations, so effective immediately) March 7, 2012: Transition guidance for filing automatic method changes issued November 20, 2012: Notice delays effective date of temporary regulations to tax years starting on or after January 1, 2014 March 22, 2013: LB&I stand down directive reissued September 19, 2013: Final regulations published 3

5 Summary of Significant Changes Acquisition Costs $5000 per item book-conformity safe harbor Materials and supplies definition includes $200 items (rather than $100) Repair and Maintenance Costs Election to follow book capitalization policy Routine maintenance safe harbor Extended to buildings (with a 10-year testing period) Network assets ineligible (pipelines) Casualty loss double dip rule relaxed Treatment of removal costs clarified Dispositions / GAAs Disposition rules significantly modified Losses allowable for MACRS partial dispositions but generally not permitted for GAAs 4

6 Acquisition costs

7 De minimis rule - safe harbor 2011 ceiling replaced with a safe harbor Requirements to use the safe harbor Taxpayer has written procedures at the beginning of the taxable year treating as an expense for non-tax purposes amounts paid for property: Costing less than a specified dollar amount; or Having an economic useful life of 12 months or less Taxpayer treats as an expense in AFS Amount eligible for safe harbor may not exceed $5,000 per invoice (or per item on invoice) Additional costs (e.g., delivery and installation) not included if not on the same invoice Requires annual, irrevocable election May amend for 2012 or 2013 unless no written policy Higher amounts allowed if clear reflection of income 6

8 De minimis rule - safe harbor election How to make the annual election Statement attached to the timely filed original income tax return (including extensions) The statement must be titled Section 1.263(a)-1(f) de minimis safe harbor election and include the following: taxpayer's name, address, taxpayer identification number, and a statement that the taxpayer is making the de minimis safe harbor election under 1.263(a)-1(f). Parent must list the name and identification number of each consolidated group member making the election. 7

9 Repair and maintenance or capital improvements?

10 The Second Bucket Repair and Maintenance Costs Compliance Book capitalization election Book typically over-capitalizes Prior method change / study Form 3115 with zero 481(a) Documentation Opportunity Accelerate tax deductions for previously capitalized improvements Requires 481(a) adjustment Statistical sample usually required Cost segregation at same time 9

11 Election to follow book capitalization policy Taxpayer may elect to capitalize otherwise deductible repairs If incurred in trade or business; and Capitalized in books and records regularly used in computing income. Must be applied to all amounts paid for repair and maintenance of tangible property that taxpayer treats as capital expenditures on its books and records in that taxable year. Note that this doesn t apply to amounts expensed for book purposes, including under the de minimis rule. The annual election is irrevocable 10

12 Book capitalization election How to make the annual election Statement attached to the timely filed original income tax return (including extensions) The statement must be titled Section 1.263(a)-3(n) election and include the following: taxpayer's name, address, taxpayer identification number, and a statement that the taxpayer is making the election to capitalize repair and maintenance costs under 1.263(a)-3(n). Parent must list the name and identification number of each consolidated group member making the election. 11

13 Unit of property Buildings Everything Else Single UOP Default Rule Plant Property Network Assets Functional Interdependence Discrete and major function Facts & circumstances - industry specific 12

14 Unit of property buildings Determine UOP Apply Capitalization Standards Capitalize Improvements to UOP Entire building Building structure Building systems Entire building HVAC Plumbing system Electrical system All escalators All elevators Fire protection Security system Gas distribution 13

15 Capitalization standards - detail Betterment 1. Material condition or defect at acquisition or production 2. Material addition, including a physical enlargement, expansion, extension, or addition of a major component; or a material increase in the capacity 3. Reasonably expected to materially increase the productivity, efficiency, strength, quality, or output Adaptation Restoration 1. Component loss 2. Gain/loss on sale of a component 3. Casualty loss 4. Return to former operating condition no longer functioning 5. Rebuild to like new condition after the class life 6. Replacement of a major component or substantial structural part Showroom to manufacturing Walk-in medical clinic Grocery - sushi Hospital emergency room 14

16 Exception to general capitalization standard Routine Maintenance Safe Harbor Routine maintenance expected to be performed more than once during property s ADS class life Expanded to include building property 10 year period used not ADS life Inapplicable to: Betterments Restoration standards 1 to 4 Network assets Distinguish repairs and maintenance expense under book min cap policy 15

17 481(a) calculations stat sampling permitted - Rev. Proc

18 Example 1 Invoice documentation of HVAC repair Acceptable documentation: Installed new compressor in Trane roof unit. Checked for leaks and changed unit 17

19 Example 2 Incomplete documentation - electrical Incomplete documentation: Per this invoice, the drawings or an interview with facilities would be required Begin installation of electrical as per drawings 18

20 Dispositions

21 Dispositions A disposition is a transfer of ownership of the asset or the permanent withdrawal of an asset from the trade or business. Includes: Sale or exchange Retirement Physical abandonment Destruction Transfer to a supplies, scrap, or similar account A portion of an asset Including elective treatment for building structural components Involuntary conversion 20

22 Partial Dispositions under 2013 Proposed Regulations Default Treatment General Asset Account Election General rule: Depreciation stops Gain or loss recognized on disposition of entire asset, or Partial disposition from casualty, sale, certain non-recognition transactions Partial disposition - optional annual election* any portion of an asset *Amended return or method change for 2012 or 2013 General rule: Depreciation continues - no immediate recovery of basis Exceptions: Disposition of all or last asset in the account Qualifying dispositions: Casualty Charitable Contribution Termination or sale of business Non-recognition transactions 21

23 Observations Planning considerations: Partial disposition election made on a timely filed return in the year of disposition Limited partial dispositions for assets in GAAs (building structural components) Simplified methods for identifying adjusted basis disposed of Need income? Consider making the GAA election Method change to recover stranded basis (ghost assets) available after 2013? 22

24 Transition Rules

25 Common Transition Rules and Options Item Election made with affirmative statement Election made by reporting on the return Method change with 481(a) adjustment Method change with limited 481(a) Book de minimis policy Book capitalization policy Partial disposition Election to capitalize & depreciate rotable or temporary spares Last asset in GAA or qualifying disposition Dispositions of building structural components under temporary regs Repairs vs. improvements Materials and supplies 24

26 Method changes under final tangible property regulations

27 Rev. Proc Supersedes Rev. Proc Provides accounting method changes to comply with the final regulations (T.D. 9636, issued 9/19/13) for: Amounts paid or incurred for materials and supplies (Treas. Reg. sec ) Amounts paid or incurred for repairs and maintenance (Treas. Reg. sec ) General rules for capital expenditures (Treas. Reg. sec (a)-1) Amounts paid or incurred for the acquisition and production of tangible property (Treas. Reg. sec (a)-2) Amounts paid or incurred for the improvement of tangible property (Treas. Reg. sec (a)-3) Also applies to the temporary regulations issued in 2011 under these sections 26

28 Rev. Proc (continued) Effective Years Applies to taxable years beginning on or after January 1, 2014 Alternatively, taxpayers may Apply final regulations to taxable years beginning on or after January 1, 2012 Apply temporary regulations to taxable years (or where applicable, to amounts paid or incurred) beginning on or after January 1, 2012 and before January 1, 2014 Staggered early implementation permitted Taxpayers may apply some parts and not others to 2012 or

29 Transition Rules for Previously Filed Form 3115 Rev. Proc is effective January 24, 2014 Transition rules for Forms 3115 filed under Rev. Proc prior to January 24, 2014 If Form 3115 filed under the advance consent procedures, and IRS ruling letter not received as of January 24, 2014, may choose to make the change under the new automatic procedure if otherwise eligible. Must notify the National Office of intent to make the change under the automatic procedures prior to receiving a ruling letter from National Office. After notifying the National Office that it will make the change under the automatic procedure, the National Office will return the Form 3115 to the taxpayer and refund the user fee. Taxpayer must modify and resubmit the Form 3115, along with a copy of the National Office letter, to the National Office within 30 calendar days. 28

30 Transition Rules for Previously Filed Form 3115 (continued) Options for Form 3115 filed under Rev. Proc : Make change under Rev. Proc if application was filed and post-marked or received by IRS on or before January 24, 2014 File amended application under Rev. Proc no later than the due date of the federal income tax return for the year of change (excluding extensions) following the procedures outlined in Rev. Proc Example: Calendar year taxpayer with a 2013 year of change must file amended application no later than March 15,

31 Elections available under final regulations May be made for tax yeas beginning (or, in some cases, amounts paid in tax years beginning) on or after January 1, 2014 (or for tax years beginning on or after January 1, 2012 by following the procedures provided in the regulations). Elections include: Election to capitalized and depreciate amounts paid or incurred for certain materials and supplies (rotable spare part, temporary spare part, or standby emergency spare part) (Treas. Reg. sec (d)) Election to expense amounts paid or incurred under the de minimis safe harbor (Treas. Reg. sec (a)-1(f)) Election to capitalize amounts paid or incurred for employee compensation or overhead as amounts that facilitate the acquisition of real or property (Treas. Reg. sec (a)- 2(f)(2)(iv)(B)) Election to expense amounts paid or incurred for repairs, maintenance, improvements performed on eligible building property under the safe harbor for small taxpayers (Treas. Reg. sec (a)-3(h)) Election to capitalize amounts paid or incurred for repair and maintenance costs consistent with the taxpayer s books and records (Treas. Reg. sec (a)-3(n)) 30

32 Camp Proposal

33 Camp Proposal Camp Proposal Impact on the real estate industry Clarification of UBIT treatment The unrelated business income tax (UBIT) would apply to all organizations exempt under IRC section 501(a) - even if an organization is also exempt or excludes amounts from gross income by reason of another provision For example, a state pension may have a ruling that is exempt under section 501(a) and may also exclude its income from tax by reason of section 115(1) under the proposal, state pension funds will be subject to the unrelated business tax. Repeal of exclusion of gain or loss from disposition of distressed property The provision concerning an exclusion to UBTI for gains and losses from the sale of distressed property (i.e., certain real property acquired by the tax-exempt organization from a bank or savings and loan association that held the property in receivership or conservatorship or as a result of foreclosure) will be repealed. 32

34 Camp Proposal REIT spin-off transactions Would prevent a spin-off transaction from qualifying for tax-free treatment, if either the distributing corporations or the controlled corporation is a real estate investment trust (REIT). The proposal also prevents any corporation (or successor corporation) that was a party to a tax-free spin (either as the distributing or the controlled corporation) from electing qualified REIT status for any tax year prior to the tenth tax year beginning after the year of the spin transaction. Effective for distributions made on or after February 26, 2014, but would not apply to any distribution made pursuant to an agreement that was binding on such debt and at all times thereafter. 33

35 Camp Proposal Short-lived properties not qualify as real estate assets The term real property would not include any tangible assets that have a class life that is less than 27.5 years. This provision would apply to tax years beginning after December 31, Repeal of preferential dividend rules for public REITs The preferential dividend rules would not apply to distributions by a publicly offered REIT in tax years beginning after December 31, E&P purges must use cash In numerous recent transactions in which new REITs had significant carryover E&P from a taxable C corporation the REITs used taxable stock dividends to satisfy the E&P purging requirement. The proposed changes will require that the purges would have to be done in cash, which could be a significant impediment to completing a conversion transaction. 34

36 Camp Proposal C corporation conversion or asset transfer to a RIC or a REIT Require that any C corporation (other than a RIC or a REIT) that coverts to a regulated investment company (RIC) or real estate investment trust (REIT) would be required to recognize gain or loss as if all its assets were sold immediately before the close of the last tax year before the RIC or REIT election was effective. A similar rule would apply to any transfer assets from a C corporation to a RIC or a REIT in a carryover basis transaction. Effective for elections and transfers on or after February 26, Repeal of IRS section 1031 Like-kind exchanges 35

37 Camp Proposal Taxation of Carried Interest Recharacterize a portion (and, in some situation, all) of a service partner s share of partnership income as ordinary base on a formula designed to approximate the compensation earned by the service partner for managing the partnership s capital. The service partner s defined share of partnership capital would be multiplied by a specific rate of return (the Federal long-term rate plus 10 percentage points). This calculation would produce a number (the recharacterization account balance ) that would establish the amount of partnership income that could be allocated to the service partner as ordinary income under the provision. The carried interest provision would apply to a partnership engaged in a trade or business conducted on a regular, continuous, and substantial basis consisting of: Raising or returning capital Identifying, investing in, or disposing of other trades or business; and Developing such trade or business 36

38 Camp Proposal Although not stated in the proposed statutory language of the discussion draft or the Joint Committee on Taxation s technical explanation of the discussion draft, the Ways and Means staff explanation indicates that the provision would not apply to a partnership engaged in a real property trade or business. 37

39 NCREIF Presentation State & Local Tax Updates 2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International Cooperative (KPMG International).

40 Agenda State Nexus Issues Nonresident partners nexus Management Companies Economic Nexus Funds Activities State withholdings on Nonresident Partners Real Estate Transfer Taxes Controlling Interests Transfers Current Updates 39

41 State Nexus Issues State Nexus for nonresident partners In Alabama, an Administrative Law Judge ruled that the state could not assess income tax against a nonresident individual who received income from an Alabamabased LLC but had no other contacts with the state. In another Alabama case, an Administrative Law Judge upheld Alabama s mandatory composite income tax on an Alabama LLC owned in part by a nonresident who lived abroad. The state was not imposing the tax on the nonresident but on the LLC which had nexus in Alabama. The California State Board of Equalization (SBE) held that a Nevada corporation was liable for California s minimum tax. The corporation was a general partner of a Nevada limited partnership. One of the limited partnership s other general partners was a corporation located in California. The SBE held that the limited partnership was doing business in California through the activities of the general partner in California, and then attributed the California nexus of the limited partnership to the other general partner. In essence, the in-state activities of one general partner were attributed to another. 40

42 State Nexus Issues State Nexus for nonresident partners CA An LLC is required to file and pay the $800 annual tax if it is either organized or registered to do business in California, or is doing business in the state. A taxpayer is doing business in the state if it actively engages in any transaction for gain or profit in California, or meets any of the factor presence tests based on property, payroll, or sales in the state. Additionally, a non-california LLC that is a member of an LLC or a general partner in a limited partnership doing business in California is considered to be doing business in the state. California has reported that approximately 59,000 additional taxpayers will be contacted through its Delinquency Control Program which has been expanded to include LLCs. 41

43 State Nexus Issues State Nexus for Management Companies Management company activities can create nexus and potential tax liabilities (or withholding and filing obligations if in partnership form) in various ways. Physical presence of property and/or employees traditionally creates nexus. Entities generally file in jurisdictions where they have offices and employees. Employees that travel into other states to perform services can also create nexus and filing obligations as well as payroll tax obligations. More recently, states have adopted economic and/or bright-line factor presence nexus standards and customer-based sourcing rules that need to be considered. 42

44 State Nexus Issues What is economic nexus Economic nexus asserts that physical presence is not necessary for a state to assert taxing jurisdiction over a taxpayer for income, franchise, gross receipts, and other types of taxes. Under this theory, a taxpayer s economic connections alone are sufficient to satisfy substantial nexus. Some states impose economic nexus on the basis of very broad doing business statutes: Examples Minnesota: Tax is imposed on every trade or business that obtains or regularly solicits business from within the state, without regard to physical presence. New Hampshire: Business activity means a substantial economic presence evidenced by a purposeful direction of business toward the state examined in light of the frequency, quantity, and systematic nature of a business organization s economic contacts with the state. Connecticut: Bright-line test to determine whether a business has purposefully directed business activities towards the state. A company is deemed to have nexus if it has receipts from business activities attributable to CT sources that are more than $500,000 during the taxable year. Income from passive investment activity will not create economic nexus. 43

45 State Nexus Issues 44

46 State Nexus Issues Fund activities Certain fund activities can potentially create nexus and potential tax liabilities (or withholding and filing obligations if in partnership form) in various ways. Some real estate funds have begun exploring alternative ways to invest in real estate including direct investment in certain loan portfolios as well as entering into direct or indirect lending activities. Funds must consider the impact of economic and/or bright-line factor presence nexus standards as well as customer-based sourcing rules on these types of activities. Lending activities are generally considered to create nexus under most economic nexus rules as a lender would be considered to be conducting business within a state. Investing in a portfolio of loans originated by a third party may not in and of itself create economic nexus; however, certain activities incurred in procuring the portfolio or conducted AFTER the portfolio is acquired may cause nexus under traditional or economic nexus standards. 45

47 Pass-Through Entity State Tax Withholding Update States continue to focus on and aggressively enforce pass-through entity withholding requirements. Most states require PTEs to withhold tax on certain nonresident investors state-sourced income. Many states consider withholding to be an obligation of the PTE and to be reported on the partnership return. Withholding rules vary among states and continue to change as to imposition, rates, frequency, and exemptions. 46

48 Recent Withholding Developments California expects withholding related receipts to increase from $8 million in FY 2010/11 to $18.2 million beginning in FY 2013/14, and is requesting additional funding to increase compliance by pursuing new discovery activities. Automated Withholding Information Notices (WINS) generated beginning in 2013 are identify discrepancies resulting in tax due notices. The California SBE refused to abate penalties for failing to timely file and pay withholding taxes. The LLC filed Form 592 eleven days after the due date, and failed to establish reasonable cause in spite of receiving late K-1 information from underlying investments. The Utah State Tax Commission upheld the imposition of interest against a pass-through entity that failed to withhold income tax on behalf of a nonresident partner in spite of the fact that the partner had prepaid the tax due that would have otherwise been withheld. 47

49 Sample of Other Recent Withholding Developments Legislation in Georgia changes the frequency of withholding from monthly for actual distributions and annually for distributive share income to requiring withholding annually only on the nonresident member s share of taxable income sourced to Georgia, whether or not distributed. Legislation in Illinois expands nonresident withholding to include Illinois sourced nonbusiness income in addition to business income for tax years after 12/31/14. Maryland withholding rate on nonresident individual members increased to 7%. Michigan legislation expands flow-through entity withholding exemptions. Previously, the exemption was only available to nonresident individuals Montana issues changes to withholding reporting requirements and forms. New Mexico changes withholding frequency to annually from quarterly. Oregon regulations amend frequency of required withholding on nonresident members to quarterly. Wisconsin requires LLCs to make quarterly payments of estimated withholding tax on nonresident owners share of Wisconsin income. 48

50 Overview of Real Estate Transfer Taxes Real estate transfer taxes ( RETT and sometimes referred to as deed recordation taxes) are generally imposed on the sale or transfer of real property located in a state. The tax is usually based on or measured by the consideration paid for or the fair market value of real estate. The tax is commonly collected by the local official/agency responsible for recording deeds to real estate (e.g., county recorder, court, etc.) and generally must be paid prior to recordation of the deed or other taxable instrument. Currently, some form of RETT is imposed by 37 states plus DC. Frequently, a RETT is also imposed at the county and/or local level. State rates vary from 0.01% to 3%. Additional local rates can cause combined rates to reach close to 5%. Numerous exemptions from RETT exist. 49

51 Controlling-Interest Transfer Taxes Historically, RETT was imposed on the actual sale or transfer of real property or the recording of a deed. Over the past several years, a number of states have begun to impose RETT on controlling interest transfers of entities holding the real estate. Controlling-interest transfer taxes ( CITT ) are imposed under existing RETT statutes or separate CITT statutes. Currently, some type of CITT is imposed by the following 16 states: CA, CT, DC, DE, IL, MD, ME, MI, NH, NJ, NY, PA, and WA FL, MN, and VA (imposed in very limited circumstances) The administration of CITT may be similar or the same as RETT, but filing and reporting differences may exist as a new deed may not be recorded in a CITT transaction 50

52 Unique issues of a controlling-interest transfer tax Transfer of Control What constitutes a transfer of a controlling interest can vary from state to state. Percentages can range from 50% (NY) to 90% (PA) Scope of Tax Indirect versus direct transfers Transfers in a real estate entity Publically traded companies Tax Base Consideration paid versus property value Value may be hard to determine in controlling interest situations Some states require use of assessed value for property tax purposes 51

53 Current Developments San Francisco phase out of payroll tax and phase in of gross receipts tax beginning January 1, 2014 California like-kind exchange reporting starts January 1, 2014 Nevada Margins Tax Initiative will be on the 2014 ballot Pennsylvania extends phase out of franchise tax now expires after December 31, 2015 Texas Court of Appeals holds that items placed in hotel rooms for use by guests may be purchased exempt from sales tax under the resale exemption New York and its municipalities impose various taxes on the recording of a mortgage. The state imposes a special additional mortgage recording tax on mortgages secured by certain types of real estate at the rate of $0.25 per $1,000 of the principal amount of the mortgage. It is creditable against various income taxes in New York and is claimed on the tax return in the year the tax was paid. 52

54 Current Developments Highlights of New York Tax Reform Property Tax Relief Freeze property tax rates in certain localities for two years Create circuit breaker for lower income residents Refundable renter s tax credit Corporate Tax Reform Lower rate from 7.1.% to 6.5% and merge Article 32 and Article 9-A taxes Changes to combined reporting rules and what entities are includable. Notably, all captive REITs and RICs (unless included in a combined Article 33 report) are includable. REITs or RICs that are not a captive REIT or captive RIC are not included. 53

55 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. NDPPS The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.