Tax Cuts and Jobs Act Real Estate Industry Impact. April 30, 2018 Mary Beth Saylor, CPA Brent A. Wilkinson, CPA, JD

Transcription

1 Tax Cuts and Jobs Act Real Estate Industry Impact April 30, 2018 Mary Beth Saylor, CPA Brent A. Wilkinson, CPA, JD

2 Topics for Today Rate Changes Business Interest Limitation Net Operating Losses Excess Business Losses Depreciation Section 1031 Exchanges/Like Kind Exchanges Carried Interest 199A Deduction Real Estate Industry Impact of Individual Provisions

3 Individual Tax Rates (MFJ) Married Filing Joint (MFJ) 2018 Taxable Income Prior Law New Law $0-19,050 10% 10% $19,050-77,400 15% 12% $77, ,150 25% $156, ,000 $165, ,950 $237, ,000 28% 22% 24% $315, ,000 33% 32% $400, ,950 $424, ,050 35% 35% $480, , % $600, %

4 Individual Tax Rates - Single Single 2018 Taxable Income Prior Law New Law $0 9,525 10% 10% $9,525 38,700 15% 12% $38,700 82,500 $82,500 93,700 $93, ,500 $157, ,450 $195, ,000 $200, ,950 25% 28% 33% $424, ,700 35% 22% 24% 32% 35% $426, , % $500, %

5 Capital Gain Rates (MFJ) Married Filing Joint (MFJ) 2018 Taxable Income Prior Law New Law $0 $75,900 0% 0% $75,900 $77,200 15% 0% $77,200 $470,700 15% 15% $470,700 - $479,000 20% 15% $479, % 20%

6 Corporate Tax Rate Pre-TCJA - Graduated tax rates of 15%, 25%, 34% and 35% - Personal services corporations taxed at a flat 35% Post-TCJA beginning January 1, 2018 PERMANENT flat tax rate of 21% for all corporations (including PSCs) Fiscal year filers with years beginning before and ending after January 1, 2018 will use a blended rate (Notice ). - Example: March 31, 2018 YE corporation in the 34% bracket will use a blended rate of 30.79% [(34%x275/365)+(21%x90/365)].*

7 Business Interest Expense Limitations - Sec 163(j) The deduction for business interest is limited to the sum of (1) business interest income Plus (2) 30 percent of the adjusted taxable income (ATI) of the taxpayer for the taxable year and (3) floor plan financing. Adjusted Taxable income taxable income without regard to (1) any item of income, gain deduction or loss which is not properly allocable to a trade or business income (2) any business interest or business interest income (3) NOL Deduction (4) deduction for depreciation, amortization before 2022 (5) income from the performance of services as an employee and (6) before the 199A 20% deduction (the pass thru deduction).

8 Business Interest Expense Limitations Cont. Exceptions: 1. Limits do not apply to businesses with gross receipts in the 3 prior years of $25 million or less. 2. Any electing real property trade or business (a real property trade or business as defined in 469(c)(7)(C). Defined as any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operating, management leasing or brokerage trade or business.

9 Business Interest Expense Limitations Cont. If the (irrevocable) election is made, the real property trade or business is required to use the alternative depreciation method for any nonresidential real property, residential rental property and qualified improvement property held. ADS depreciation has longer recovery periods (40 years for nonresidential property, 30 years for residential rental property and 20 years for qualified interior improvements).

10 Business Interest Expense Limitations Cont. Limit is first applied at the entity level for Partnerships and S-Corporations. For Partnerships and S-Corporations, there are special rules and calculations of excess business interest and excess taxable income that is passed through to members.

11 Net Operating Losses For losses arising in taxable years beginning after December 31, NOL deduction limited to 80% of taxable income, NOL carrybacks eliminated, and NOLs may be carried forward indefinitely. No change to pre-2018 NOLs Expire after 20 years, May be carried back 2 years, No AMT limitation. Tracking of Pre- and Post- NOLs will be necessary Fiscal year taxpayers look to when taxable year begins.

12 Net Operating Losses Cont. Must now track NOLs generated before and after the effective date separately. Income (Loss) NOL Carryover 2017 & Prior $2,000, ($15,000,000) $15,000, Taxable Income $15,000,000 Pre-2018 NOL Utilized ($2,000,000) 2018 NOL Utilized (80%) ($12,000,000) Net Taxable Income after NOL $1,000,000 NOL Carryforward to 2020 $3,000,000

13 Excess Business Loss Limitation for Individuals Sec 461(l) For taxable years beginning after 2017 and before 2026 excess business losses of a taxpayer other than a corporation are not allowed for the taxable year. These losses are carried forward and treated as part of the taxpayer s NOL. Excess business losses for the year is the excess of the taxpayer s aggregate business deductions over the aggregate gross income or gain of the taxpayer which is attributable to such trades or businesses plus $500,000 joint or $250,000 single.

14 Excess Business Loss limitation for Individuals Cont. For partnerships and S-corporations the excess business loss limitation applies at the partner or shareholder level. Limits apply after considering basis, at risk, and passive activity rules.

15 Section 1031 Like-Kind Exchanges Like-kind exchanges are still allowed for real estate used in a trade or business or held for investment. Like kind exchanges are no longer allowed for personal property. Impact on industry cost segregation studies - Beware of elements of personal property on exchanged real estate. The gain on the sold personal property is subject to Sec 1245 ordinary income recapture. Likewise, the elements of personal property acquired in a like-kind exchange are not eligible replacement property (however, they may qualify for beneficial depreciation).

16 Carried Interests Sec 1061 Partnership Interests held in connection with performances of services = Carried interest also known as a profits interest. Primarily intended to apply to hedge fund managers to deny them long term capital gain treatment. Requires a 3 year hold of the partnership interest (if the interest is sold) and the 3 year hold of the underlying assets (if the assets are sold) to obtain long-term capital gain treatment. Otherwise, shortterm capital gain (taxed at same rates as ordinary income). Applies to the holder of an Applicable Partnership Interest (API) Applicable Partnership Interest - An ownership interest for which capital/profits are not commensurate with the amount of capital contributed. This is an interest acquired for services.

17 Carried Interests Cont. Applicable Partnership Interest requires an applicable trade or business conducted on a regular, continuous, and substantial basis through one of more entities that consists of: And 1 - Raising or returning capital 2a Investing in or disposing of specified assets or 2b Developing specified assets Specified assets includes real estate held for rental or investment, in addition to securities and commodities. Applies only if assets held for portfolio investment by third party investors. If all partners are active in the business, it does not apply.

18 Carried Interests Cont. Questions & Issues How is a profit Commensurate with capital invested measured? Examples are preferred capital versus common capital. How encompassing is raising or returning capital? Guidance is needed as to pass through gains where interest has been held for more than 3 years, but asset has not. Can the owner use old shell entities that have a 3 year holding period? How rental real estate assets (which are assets used in a trade or business, not capital assets) fall into this provision, under a technical reading? (compare Sec 1222 versus Sec 1231)

19 Carried Interests Cont. Questions & Issues Does not apply to Corporations - IRS announced it does apply to S Corporations under regulations to be issued see Notice Special rules for transfers to related parties Special exception for Sec 83 related to amounts already included in compensation Consider contributions of intangible assets (contracts) May consider structuring entities with debt versus equity.

20 Depreciation Depreciation - Bonus Extended through December 31, In effect for assets placed in service after September 27, % expensing for certain qualified assets through December 31, 2022.

21 Depreciation - Bonus Depreciation Cont. Now includes used equipment, as long as not previously used by the taxpayer. Bonus phased down by 20% each year from 2023 through May elect 50% bonus in lieu of 100% bonus during the first year ending after September 27, On 5 or 7 year property consider electing out of bonus if concerned about excess business loss limitations

22 Depreciation Cont. Bonus for self-constructed assets & under binding contract Both acquisition dates and placed-in-service dates must be considered. Cutoff date for new law is September 27, 2017 If under binding contract to purchase, look at rules in effect as of date of contract If is self-constructed, acquisition occurs when physical work begins (10% safe harbor) Example Sign a contract on September 1, 2017 to purchase carpeting, then installed and place in service: 12/1/2017 Eligible for 50% bonus (the rate under the old law) 1/31/2018 Eligible for 40% bonus (the rate as scheduled under the old law) If contract was signed on October 1, 2017 and completed December 31, 2017, then eligible for 100% bonus (under new law).

23 Depreciation Real Property Depreciation Cont. Defined a summarized class of qualified improvement property (QIP)- (formerly qualified leasehold improvements, qualified retail property, and qualified restaurant property), effective 1/1/2018. Any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service. Does not include any improvement for which the expenditure is attributable to: (i) the enlargement of the building, (ii) any elevator or escalator, or (iii) the internal structural framework of the building.

24 Depreciation Cont. Depreciation Real Property Removed the requirement for a non-related qualified lease, and that the improvement be placed into a building greater than 3 years old. Intends to, but due to a drafting omission fails to, provide a 15-year recovery period for all qualified improvement property technical correction expected therefore eligible for Sec 179 and not bonus. Intends to, but due to a drafting omission fails to, provide a 20-year ADS recovery period for all qualified improvement property technical correction expected.

25 Depreciation Cont. Depreciation Real Property Requires a real property trade or business that elects out of the interest expense deduction limitation to use ADS to depreciate its nonresidential real property, residential rental property, and qualified improvement property. Assets required to use ADS are not bonus eligible. ADS life for residential real property reduced from 40 years to 30 years (this is important if elect out of interest limitation and required to use ADS).

26 Section 179 Expensing Depreciation Cont. Effective after December 31, Increases the expense amount under 179 to $1M. Increases the phaseout threshold to $2.5M. Now includes personal property included in rental real estate. State Tax Impact - Sec 179 may be more beneficial than bonus, if state allows Sec 179, but not bonus.

27 Section 179 Expensing Depreciation Cont. Expands the definition of qualified real property to include all qualified improvement property and certain improvements (roofs, heating, ventilation, and airconditioning property, fire protection and alarm systems, and security systems) made to nonresidential real property. Save Sec 179 for assets that are not bonus eligible, i.e. roofs, HVAC. Remember Sec 179 is limited to taxable income, but can elect and carryover excess.

28 Bonus Depreciation Example 1 NOL Example (overly simplified) With bonus total Business income 1,000 1,000 1,000 1,000 1,000 1,000 6,000 bonus depreciation (5,000) (5,000) carryover (used) 4,000 (800) (800) (800) (800) (800) - taxable income ,000 tax Without bonus Business income 1,000 1,000 1,000 1,000 1,000 1,000 6,000 Depreciation (1,000) (1,000) (1,000) (1,000) (1,000) (5,000) carryover (used) - - taxable income ,000 1,000 tax Difference 125

29 Bonus Depreciation Example 2 Capital gain example - (overly simplified) With bonus total Ordinary income 1,000 1,000 1,000 1,000 1,000 1,000 6,000 Business gain (1231) 4,000 4,000 bonus depreciation (5,000) (5,000) carryover (used) taxable income - 1,000 1,000 1,000 1,000 1,000 5,000 tax ,550 Without bonus Ordinary income 1,000 1,000 1,000 1,000 1,000 1,000 6,000 Business gain (1231) 4,000 4,000 Depreciation (1,000) (1,000) (1,000) (1,000) (1,000) (5,000) carryover (used) - taxable income 4, ,000 5,000 tax ,110 Difference (440)

30 Pass-Thru Deduction Sec 199A Beginning in 2018 Taxpayers who have Qualified Business Income (QBI) from a partnership, S corporation or sole proprietorship are entitled to up to a 20% deduction on QBI for each Qualified Trade or Business (QTB). A QTB means any trade or business other than a specified service trade or business (SSTB) or the trade of business of performing services as an employee. A SSTB includes the fields of law, health, consulting, brokerage services, financial services or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners. Engineering and architects are not specified service businesses. QBI also does not include investment type income, guaranteed payments and foreign earned income

31 Pass-thru deduction Cont. Determined separately for each separate business you own Determine each business separately and then net them together (net income and losses together) Trusts and estates can take the deduction Limited to your Net Taxable Income before the QBI Deduction

32 Pass-thru Deduction Thresholds Taxable Income Thresholds < $157,500 (Single/MFS) < $315,000 (MFJ) $ $207,500 (Single/MFS) $315,000 - $415,000 (MFJ) > $207,500 (Single/MFS) > $415,000 (MFJ) Deduction Full Deduction Phased out to the extent 20% QBI deduction exceeds the Wage (or Wage/Property) Limitation Fully limited to the lesser of 20% QBI Deduction or Wage (or Wage/Property) Limitation

33 Qualified Business Income Phase-Outs QBI deduction is phased out based upon the lesser of 20% of QBI or Greater of 50% Allocable W-2 wages of the business (wage limitation) or 25% Allocable W-2 wages of the business plus 2.5% unadjusted basis of qualified property (wage/property limitation)

34 Unadjusted Basis of Qualified Property Acquired basis of depreciable property, not reduced by Section 179, bonus depreciation, or regular depreciation The depreciable period is the later of the MACRS recovery period or 10 years The basis is eliminated if the asset is no longer used in qualifying business (abandoned/idle assets)

35 Pass-thru Deduction Flowchart 20% deduction on QBI phased out

36 Simplified Example Sec 199A A real estate business purchases an apartment building for $6 million. Of the $6 million, $2 million is for land and $4 million is for the building. The building has $400,000 of net income per year. The business pays no wages. Maximum deduction before limitation 20% x $400,000 = $80,000 Calculation of limitation - lesser of the maximum deduction of $80,000 or the Wage/Property limitation 2.5% x $6 million ($150,000). Limitation is $80,000 Taxpayer s Deduction - $80,000. Taxpayer not affected by calculation of limitation

37 Other Provisions - Standard Deduction & Personal Exemptions Standard Deduction Married Filing Joint - $24,000 from $12,700 Single - $12,000 from $6,350 Head of Household - $18,000 from $9,350 Expected impact is that 16 million filers will itemize in 2018, down from estimated 36 million itemizers in 2017 Personal Exemptions In 2017, $4,050 per exemption Phased out once AGI exceeds $261,500 single or $313,800 MFJ Effective eliminated

38 Itemized Deductions Taxes State and Local Taxes In 2017 deduction for all state and local income (or sales) and property taxes. In 2018 limited to $10,000 total May deduct state taxes when paid or accrued to carry on a trade or business; i.e. rental property taxes on Schedule E. Limitation does not reduce deduction for Real Estate taxes on investment property.

39 Itemized Deductions Mortgage Interest Mortgage Interest Deduction Old law deduct qualified mortgage interest on a principal residence and one other residence. Phased out once mortgage principal balance exceeds $1M and up to $100,000 home equity indebtedness. New law limitation reduced to acquisition indebtedness of $750,000 for debt incurred after December 15, Limitation of $1M remains for older debt. No deduction for interest on home equity loan, unless used to acquire, build, or substantially improve the residence. If refinance for cash out not all interest deductible. No change to gain exclusion on primary residence.

40 Opportunity Zones Program that offers taxpayers the opportunity for three tax incentives, by investing in low-income communities through Opportunity Zone Funds: 1) Temporary Deferral of Gains (up to 8 years) 2) Reduction of Deferred gain (up to 15% reduction) 3) Permanent Exclusion on Opportunity Zone Gains Provides deferral of gains from capital investments, including real estate. No dollar limit to amount that can be deferred/invested in program, other than that it cannot exceed the amount of gain being deferred.

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42 Contact Information Mary Beth Saylor, CPA Principal Windham Brannon 3630 Peachtree Road Suite 600 Atlanta, Georgia Main: Direct: Fax: Brent Wilkinson, CPA, JD Principal Windham Brannon 3630 Peachtree Road Suite 600 Atlanta, Georgia Main: Direct: Fax: