Industry Outlook: Tax Reform s Impact on the Real Estate Industry

Transcription

1 Industry Outlook: Tax Reform s Impact on the Real Estate Industry Please disable pop-up blocking software before viewing this webcast Original Publication Date: April 25, 2018 CPE Credit is not available for viewing archived programs

2 The future of tax Significant provisions that impact real estate

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5 Speakers Joseph Hagedorn, Tax Law Editor, Business Entities and Tax Accounting, Bloomberg Tax Lisa Pfenninger, Federal Tax Law Editor, Bloomberg Tax Lorraine White, Partner, Tax Services, Grant Thornton Karl Seemer, Managing Director, Tax Services, Grant Thornton Chris Young, Tax Senior Manager, Grant Thornton

6 Learning objectives Analyze the key provisions of the Tax Cuts and Jobs Act that impact the real estate industry Identify strategies and solutions in key areas of tax reform including tax rate changes and deduction of qualified business income of pass-through entities Explain the impact of revisions in other areas like mortgage interest deduction, business interest expense deduction, rehabilitation credit, net operating losses, REITs and like-kind exchanges of real property

7 Tax reform overview Rate Changes/199A deduction Recovery periods for depreciation purposes Section 179 expensing Bonus depreciation Business interest expense limitation REIT NOL deductions Like-kind exchanges limited to real property Carried interest Additional considerations

8 Rate changes/199a deduction Corporate tax rate Lowered to a flat 21% on all income, including capital gains As a result, U.S. federal withholding tax rate on distributions to non-u.s. shareholders by REITs that are attributable to gains from sale/exchange of USRPIs (i.e., FIRPTA gains) was lowered Alternative minimum tax rate Repealed alternative minimum tax for corporations Retained the alternative minimum tax for individuals Existing corporate AMT credits can be monetized over the next 4 years

9 Rate changes/199a deduction Corporate rate change Does it make sense to convert to a C Corporation? Corporate rate change REITs REIT can retain their capital gain income and pay the new 21% This could be a way to retain cash at the REIT level

10 Rate changes/199a deduction Deduction for sole proprietors and pass-through entity owners Deduction for combined qualified business income amount (subject to taxable income limitation): 20% of the taxpayer's QBI with respect to the trade or business, (subject to the W-2 wage limitation), plus 20% of the aggregate amount of the taxpayer's qualified REIT dividends and qualified publicly traded partnership income Deduction is limited by wage and investment tests and disallowed for specified services unless income is below threshold amount

11 Rate changes/199a deduction Qualified business income Income, gain, deduction and losses effectively connected with each qualified business within the United States or Puerto Rico, BUT Does not include income or loss from investment items Long-term capital gains and losses Dividends and dividend equivalents Other investment vehicles Interest UNLESS properly allocable to the qualified business Qualified business income does not include: Payments of reasonable compensation by an S corporation Guaranteed payments for services rendered with respect to the business To the extent provided in regulations (not yet issued) any amount paid or incurred by a partnership to a partner for services if the partner is acting other than in his capacity as a partner

12 Rate changes/199a deduction Specified service business not included: Health, law, accounting, actuaries, performing arts, athletics, financial services, brokerage services, investing, investment management, trading or dealing in financial instruments, or any business where the principal asset is the reputation or skill of one or more employees; except to the extent the owner satisfies an income threshold test Engineering and architecture are NOT specified service businesses INCOME THRESHOLD TEST Specified service businesses NOT excluded from section 199A deduction W-2 wage and wage plus asset tests do NOT apply Threshold: $315,000 of taxable income if married filing jointly $157,000 of taxable income if filing single Phase out over next $100,000 (mfj) or $50,000 (single) of taxable income

13 Rate changes/199a deduction Special considerations Section 199A reduces taxable income, but not gross income or AGI Will not affect AGI based phase-ins and phase-outs Not expected to be deductible for state tax in states basing their income tax on Federal measures of AGI Section 199A does not itself modify any employment tax rules There is no distinction between passive and active owners Reporting requirements to investors

14 Recovery periods for depreciation purposes Previously three types of building improvements Qualified Leasehold Improvement Property, Qualified Restaurant Property and Qualified Retail Improvement Property Fifteen-year recovery period Depreciated using the straight-line method The act replaced these categories with a single class of property Qualified Improvement Property (QIP) No Recovery Period assigned to QIP due to unintentional legislative drafting omission Shorter ADS Recovery Period for residential rental property (30 years, down from 40 years)

15 Bonus depreciation Amendments are effective for property acquired and placed in service after September 27, % bonus depreciation for property acquired and placed in service after September 27, 2017, but before January 1, 2023 Subject to exceptions for long production period property Phase-down after December 31, 2022 Used property may be eligible Taxpayers may elect to apply 50% (instead of 100%) expensing for the first tax year ending after September 27, 2017

16 Bonus depreciation Qualified property now excludes property used by certain regulated public utilities and trades/businesses that deducted interest on floor plan financing indebtedness Qualified film, television, and live theatrical productions can be qualified property if certain requirements are met Unclear whether QIP can qualify for bonus depreciation and may depend on guidance or technical correction Real estate business that elect to be exempt from interest limit cannot take bonus depreciation

17 Bonus depreciation State tax considerations Decoupling from federal Impact on an ultimate sale of underlying property Coordination with interest expense limitations Irrevocable after year of election

18 Bonus depreciation Real Estate Impact Planning / Modeling to determine the impact of electing out of interest expense limitations vs. immediate expensing of fixed asset additions Managing partnership tax distributions Managing REIT required distributions How does this impact negotiations of future acquisitions or dispositions? Impact to lease terms (i.e. tenant allowances) Overlap with tangible property regulations best of both worlds? Investor limitations Impact of cost segregation studies (2017 and going forward)

19 Business interest expense limitation Net business interest expense deductions of all taxpayers are generally limited to 30% of a taxpayer s adjusted taxable income (ATI) in 2018 onward, with the definition of ATI changing in 2022 Mortgage REITs generally would not be subject to the 163(j) net business interest expense limitation because they do not have net interest expense A real property trade or business may elect out of the 30% limit but will have to depreciate commercial real property, residential rental property, and QIP over the longer ADS recovery periods Equity REITs generally would be entitled to elect out of the net business interest expense limitation

20 Business interest expense limitation Small business taxpayers are not subject to this limitation Defined as gross receipts in the prior 3 taxable years of $25 million or less Real property companies who can elect out had the administrative burden of updating their tax depreciation for the new ADS lives From a planning perspective companies need to first understand if they are subject to the limitation and plan accordingly Note that the calculation of the limitation changes after the 2021 EBIDTA vs EBIT

21 Business interest expense limitation Residential real property life ADS life was reduced to 30 years from the 40 year life Some companies such as REITs may already be on ADS depreciation for E&P purposes. If not could result in a smaller E&P adjustment going forward Opportunity for planning for those companies are the real estate intensive but would not qualify as a real property trade or business

22 REIT NOL deductions Repealed special rule for REITS under 172 Limits amount of deduction for REIT net operating losses to 80% of REIT taxable income (REITTI) Taxable income = REIT taxable income before application of the dividends paid deduction (DPD) Without this, the limit would have been 80% of REITTI after the application of the DPD REIT NOLs may be carried forward indefinitely to future tax years REIT NOLs may not be carried back

23 REIT NOL deductions Application of REIT NOL From a practical perspective REITs rely on their Dividends Paid Deduction and pay 100% of their taxable income REITs now have similar rules to corporations for their NOLs Application of REIT NOLs with the Dividends Paid Deduction

24 Like-kind exchanges Now limited to real property Previously personal property could qualify Gain recognition will be required in exchanges of property such as hotels and restaurants that also include a significant amount of ancillary personal property Under a transition rule, the prior-law like-kind exchange rules may apply

25 Carried interest Section 1061 newly re-designated by the Tax Cuts & Jobs Act Modifies capital gain treatment for gains arising from non-capital partnership interests, or profits interest (real estate promote), received in connection with the performance of substantial services Applicability became more limited as the Jobs Act continued to evolve into its current form

26 Carried interest Profits interest background Referred to as "future profits interests", "carried interests", or "back-ins" Traditionally used as incentive compensation issued to the management of partnerships Became preferred method for compensating private equity and hedge fund managers at long term capital gains ("LTCG") rates

27 Carried Interest Section 1061 (a) If an applicable partnership interest or interests held by the taxpayer generates LTCG, the excess of such gain over the hypothetical LTCG calculated by substituting a 3 year holding period for the 1 year holding period under Section 1222(3) & (4) is to be treated as short-term capital gain This treatment includes not only LTCG from sale of the partnership interest, but and LTCG associated with the sale of underlying assets in the partnership Example: 1. Partner is allocated LTCG associated with two capital asset held via an applicable partnership interest he held for 4 years 2. Partner's share of LTCG from sale of Asset 1 was $40,000 and Asset 2 was $60,000. The assets were held by the partnership for 2 and 4 years respectively 3. Partner will recognize LTCG of $60,000 and STCG of $40,000, as $40,000 is the excess LTCG over the recalculated LTCG based on a three year holding period

28 Carried interest Specified Asset Section 1061(c)(3) Specified Assets are defined as follows: 1. Securities (per section 475(c)(2) without regard to the last sentence thereof) 2. Commodities (per section 475(e)(2)) 3. Real Estate held for rental or investment 4. Cash or Cash Equivalents 5. Option or Derivative with respect to any of the above, and 6. Interest in a Partnership to the extent of the partnership's proportional interest in any of the foregoing Exceptions Section 1061(c)(4) The following should not be considered applicable partnership interests: 1. Interests directly or indirectly held by a corporation Notice IRS intends to write regulations to exclude S corporations from this definition 2. Capital interests arising from Capital contributions or income recognition under section 83

29 Additional considerations Rehabilitation credit Low income housing credit Changes in timing of income recognition FIRPTA withholding tax rate Mortgage interest limitation Real property tax limitation at the individual level

30 Questions?

31 Speakers Joseph Hagedorn, Tax Law Editor, Business Entities and Tax Accounting, Bloomberg Tax Lisa Pfenninger, Federal Tax Law Editor, Bloomberg Tax Lorraine White, Partner, Tax Services, Grant Thornton Karl Seemer, Managing Director, Tax Services, Grant Thornton Chris Young, Tax Senior Manager, Grant Thornton

32 Disclaimer This Grant Thornton LLP presentation is not a comprehensive analysis of the subject matters covered and may include proposed guidance that is subject to change before it is issued in final form. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this presentation. The views and interpretations expressed in the presentation are those of the presenters and the presentation is not intended to provide accounting or other advice or guidance with respect to the matters covered For additional information on matters covered in this presentation, contact your Grant Thornton LLP adviser

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