How Does Tax Reform Affect Real Estate Developers & Investors?

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1 How Does Tax Reform Affect Real Estate Developers & Investors? FEBRUARY 20, 2018 TO RECEIVE CPE CREDIT Participate in entire webinar Answer polls when they are provided If you are viewing this webinar in a group Complete group attendance form with Your printed name, signature & address All group attendance sheets must be submitted to training@bkd.com within 24 hours of live webinar Answer polls when they are provided If all eligibility requirements are met, each participant will be ed their CPE certificate within 15 business days of live webinar 1

2 INTRODUCTIONS Please add Picture Scott Humphrey Director Dallas, TX Michael Hill Director Jackson, MS WHAT WE LL COVER TODAY Quick overview & hot takes Closer look at Depreciation changes Net interest rules New 20 percent pass-through deduction Choice of entity considerations after the TCJA 2

3 TAX RATES Corporate Corporate Tax Rate Flat rate of 21 percent effective January 1, 2018 (Previously top rate of 35 percent) Alternative Minimum Tax Repealed (Previously 20 percent) Personal Service Corporations Flat rate of 21 percent effective January 1, 2018 (Previously flat rate of 35 percent) Bracket 2018 Ordinary Rates 2018 Capital Gains Rates Previous New Tax Previous New Tax Tax Law* Law*^ Tax Law* Law*^ TAX RATES Tax brackets: single $0 $9,525 10% 10% 0% 0% 9,526 38,600 15% 12% 0% 0% 38,601 38,700 15% 12% 0% 15% 38,701 82,500 25% 22% 15% 15% 82,501 93,700 25% 24% 15% 15% 93, ,500 28% 24% 15% 15% 157, ,450 28% 32% 15% 15% 195, ,000 33% 32% 15% 15% 200, ,950 33% 35% 15% 15% 424, ,800 35% 35% 15% 15% 425, ,700 35% 35% 15% 20% 426, , % 35% 20% 20% More than 500, % 37% 20% 20% *Plus 3.8 percent net investment income tax on unearned income when modified adjusted gross income exceeds $200,000 ($250,000) ^Expires after December 31,

4 Bracket 2018 Ordinary Rates 2018 Capital Gains Rates Previous New Tax Previous New Tax Tax Law* Law*^ Tax Law* Law*^ TAX RATES Tax brackets: married filing jointly $0 $19,050 10% 10% 0% 0% 19,051 77,200 15% 12% 0% 0% 77,201 77,400 15% 12% 0% 15% 77, ,150 25% 22% 15% 15% 156, ,000 28% 22% 15% 15% 165, ,950 28% 24% 15% 15% 237, ,000 33% 24% 15% 15% 315, ,000 33% 32% 15% 15% 400, ,950 33% 35% 15% 15% 424, ,000 35% 35% 15% 15% 479, ,050 35% 35% 15% 20% 480, , % 35% 20% 20% More than 600, % 37% 20% 20% *Plus 3.8 percent net investment income tax on unearned income when modified adjusted gross income exceeds $200,000 ($250,000) ^Expires after December 31, 2025 LIMITATIONS ON LOSSES Net Operating Loss (NOL) Deduction limited to 80 percent of taxable income (1) No carryback (except property/casualty insurance companies & certain farm losses) (2) Carried forward indefinitely (2) Excess Business Loss Limitation Aggregate deductions attributable to trades or businesses over aggregate gross income & gain limited to $250,000 single/$500,000 married filing jointly (MFJ) Excess loss treated as NOL Sunsets December 31, 2025 (1) Applies to losses arising in tax years beginning after December 31, 2017 (2) Applies to losses arising in tax years ending after December 31,

5 Carried Interest Partnership profits interest in connection with performance of services Long-term capital gain rate after three-year holding period with respect to any applicable partnership interest Does this apply to IRC Sec gains? Like-Kind Exchange Deferral of gain limited to real property not held primarily for sale How does this impact properties that had a cost segregation study? OTHER CONSIDERATIONS State & Local Income/Sales, Real Estate & Personal Property Tax Expense Combined deduction for amounts not paid or accrued in a trade or business capped at $10,000 Amounts paid in 2017 for income taxes imposed for 2018 or later treated as paid in 2018 Consider election to capitalize real estate taxes, interest &/or carrying charges OTHER CONSIDERATIONS 5

6 Other Items No change to Low-Income Housing Tax Credits Rehabilitation credit only eligible for qualified rehabilitation expenditures with respect to historic structures & claimed over five-year period Non-taxable contributions of capital grandfathered Removal of technical terminations OTHER CONSIDERATIONS Qualified Opportunity Zones & Fund QO Zone yet to be named, but will be lowincome census tracts identified by states QO Fund: corporation or partnership that invests in QO Zone property QO property not limited to real estate QO Zone business: substantially all of tangible property owned or leased is QO Zone business property Cannot be golf course, country club, gaming, etc. QUALIFIED OPPORTUNITY ZONES & FUND 6

7 Temporary deferral of capital gain (not limited to capital assets) Sale to unrelated party 180-day reinvestment of gain directly in fund Deferral ends on earlier of date of next sale, or 2026 Percentage of deferred gain recognized depends on holding period < 5 years: 100 percent > 5 but < 7 years: 90 percent > 7: 85 percent Permanent exclusion of gain on sale of QO Fund Appreciation in the investment 10-year hold requirement QUALIFIED OPPORTUNITY ZONES & FUND DEPRECIATION PROVISIONS Cost recovery Bonus Depreciation 100 percent through 2022 for qualified property placed in service after September 27, , 60, 40 & 20 percent for property placed in service in , respectively Definition of qualified property expanded by removing requirement that original use begin with taxpayer Specified property included & excluded (Previously 40, 30 & 20 percent bonus depreciation for qualified property in , respectively; property must be new to qualify) 7

8 DEPRECIATION PROVISIONS Cost recovery Qualified Improvement Property Effective January 1, 2018 Removed qualified leasehold, restaurant & retail Any improvement to an interior portion of a building that is nonresidential real property 15-year straight-line depreciation (40 year ADS) Drafting error DEPRECIATION PROVISIONS Cost recovery Section 179 Expensing Up to $1 million Phaseout beginning at $2.5 million of assets placed in service Definition of qualified property expanded to include certain improvements to nonresidential real property, including roofs, HVAC systems, fire protection & alarm systems & security systems (Previously up to $520,000; phaseout beginning at $2,070,000 of assets placed in service) 8

9 Deduction generally limited to sum of Business interest income BUSINESS INTEREST EXPENSE DEDUCTION Floor plan financing interest 30 percent of adjusted taxable income Taxable income +/- Items of income, gain, deduction or loss not properly allocable to trade/business + Business interest expense - Business interest income + Net operating loss + Pass-through business deduction + Depletion, depreciation & amortization (taxable years beginning before January 1, 2022, only) BUSINESS INTEREST EXPENSE DEDUCTION Excess carried forward indefinitely Limit does not apply to Businesses with average annual gross receipts $25 million (affiliated group basis) Regulated public utility business (including electric cooperatives) Following businesses may elect not to be subject to limitation provided they use ADS method for depreciation Real property businesses Farming businesses (including agricultural & horticultural cooperatives) 9

10 NET INTEREST LIMITATION Real Property Business Election Real property trades can elect out of provision Requires depreciation of residential & nonresidential property under ADS lives (30 & 40 years respectively) What trades qualify? Real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage trade or business What about medical facilities or assisted living? NET INTEREST LIMITATION Example 1 Facts Partnership No real estate election made For tax year ending December 31, 2018 Taxable Income of $30,000 (before interest limitation) Depreciation Expense of $100,000 (3,900,000 building) Interest Expense of $70,000 Net Interest Limitation of $60,000 Adjusted Taxable Income 30% of Adjusted Taxable Income Actual Taxable Income Interest Expense Carryover $200,000 ($30, , ,000) $60,000 $40,000 $10,000 10

11 NET INTEREST LIMITATION Example 2 Facts Partnership Real estate election made For tax year ending December 31, 2018 Taxable Income of $32,500 (before interest limitation) Depreciation Expense of $97,500 (3,900,000 building) Interest Expense of $70,000 Net Interest Limitation of $0 Adjusted Taxable Income 30% of Adjusted Taxable Income Actual Taxable Income Interest Expense Carryover $200,000 ($32, , ,000) N/A $32,500 $0 PASS-THROUGH BUSINESS DEDUCTION Noncorporate taxpayer? YES Domestic income? YES Qualified business income (QBI)? YES Taxable income < threshold?(1) NO YES NO NO NO Specified service trade/business? NO Taxable income > full phaseout?(2) DEDUCTION(3) = 20% QBI + 20% QUAL REIT DIVS. 20% QUAL PTP INCOME 20% QUAL CO-OP DIVS (4) YES NO YES Taxable income > full phaseout?(2) 20% QBI OR YES NO DEDUCTION(3) = LESSER OF NO DEDUCTION GREATER OF REDUCED DEDUCTION 50% W-2 WAGES OR 25% W-2 WAGES + 2.5% QUAL PROPERTY + 20% QUAL REIT DIVS. 20% QUAL PTP INCOME 20% QUAL CO-OP DIVS (4) (1) $157,500 (single) $315,000 (married filing jointly (MFJ)), indexed (2) $207,000 (single) $415,000 (MFJ), indexed (3) Limited to 20 percent of excess of taxable income over the sum of any net capital gain (4) Limited to taxable income less net capital gain 11

12 Domestic: effectively connected with conduct of trade/business within U.S. & Puerto Rico QUALIFIED BUSINESS INCOME DEDUCTION Sunsets 12/31/2025 Qualified business income: net amount of items of income, gain, deduction & loss with respect to any qualified trade or business, except Reasonable compensation Guaranteed payments Investment income Short-term & long-term capital gain/loss Dividend income Interest income (Note overall loss treated as loss for purposes of calculation in subsequent year) Specified service business: Any trade or business involving performance of services in fields of QUALIFIED BUSINESS INCOME DEDUCTION Sunsets 12/31/2025 Health Law Accounting Actuarial science Performance arts Investing & investment management, trading or dealing in securities, partnership interests or commodities Consulting Athletics Financial services Brokerage service Principal asset is reputation or skill of one or more of its employees or owners 12

13 Need further guidance in several areas Definition qualified trade or business QUALIFIED BUSINESS INCOME DEDUCTION Sunsets 12/31/2025 Application of grouping elections Clarification on how definition of specified service trade or business applies Whether wages paid by an affiliated management company count for purposes of wage limitation Possible technical corrections Deduction for sales to farm cooperatives Impact on choice of entity QUALIFIED BUSINESS INCOME DEDUCTION Sunsets 12/31/2025 Limitations: Apply when taxable income exceeds $157,500 single ($315,000 MFJ) & phase out over next $50,000 ($100,000) of taxable income 1) Wage limitation: Greater of 50 percent of W-2 wages paid with respect to business OR 25 percent of W-2 wages paid plus 2.5 percent of unadjusted basis (immediately after acquisition) of all qualified property 2) Not allowed for specified service trade or businesses once income exceeds threshold amounts 13

14 QUALIFIED BUSINESS INCOME DEDUCTION Example 1 Facts Rental Partnership 2 partners 50/50 Real Estate Election No employees No QBI loss carryover For tax year ending December 31, 2018 Taxable income of $200,000 Compensation to owner: $0 Qualified business income of $200,000 Depreciable cost of real estate $10,000,000 Allocable qualified business income deduction = $20, percent of QBI $20, percent of W-2 wages $0 ($0 x.50 = $0) 25 percent of W-2 wages percent of unadjusted basis of qualified property $125,000 ($5,000,000 x.025 = $125,000) QUALIFIED BUSINESS INCOME DEDUCTION Example 2 Facts Rental Partnership 2 partners 50/50 Real Estate Election No employees QBI loss of $50,000 For tax year ending December 31, 2018 Taxable income of $200,000 Compensation to owner: $0 Qualified business income of $200,000 Depreciable cost of real estate $10,000,000 Allocable qualified business income deduction = $10, percent of QBI 50 percent of W-2 wages 25 percent of W-2 wages percent of unadjusted basis of qualified property $10,000 (($100,000 - $50,000) x.20 = $10,000) $0 ($0 x.50 = $0) $125,000 ($5,000,000 x.025 = $125,000) 14

15 APPROACH TO PLANNING AFTER TCJA Step 1 Step 2 Step 3 Review your current income tax situation Understand how tax changes affect you & your business in 2017 & beyond Evaluate accounting methods & possibility of future guidance before filing 2017 tax returns Step 4 Step 5 Step 6 APPROACH TO PLANNING AFTER TCJA Consider how tax law changes affect 2018 estimated tax payments Review choice of entity considerations under new tax law Evaluate other strategies to plan for new tax law 15

16 More Clarity Ahead 1. Resource Center bkd.com/taxreform 2. Simply Tax Podcast bkd.com/simplytax 3. BKD Thoughtware bkd.com Questions? 16

17 CONTINUING PROFESSIONAL EDUCATION (CPE) CREDITS BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: CPE CREDIT CPE credit may be awarded upon verification of participant attendance For questions, concerns or comments regarding CPE credit, please the BKD Learning & Development Department at training@bkd.com 17

18 The information contained in these slides is for your information only, based on data available as of the date of the presentation & is not to be considered as tax or legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. We are under no obligation to update these slides if changes occur. Consult your BKD advisor before acting on any matters covered. Thank You! Scott Humphrey Michael Hill 18

19 ABOUT BKD BKD now has more than 2,600 CPAs, advisors & dedicated staff members working together to serve you. Our expertise goes well beyond the standard accounting services to include risk management, forensic & valuation services, technology & wealth management. Personalized Service with a Global Reach Our trusted advisors offer solutions for clients in all 50 states & internationally. With 36 offices in 16 states, BKD & its subsidiaries combine the insight & ideas of multiple disciplines to provide solutions in a wide range of industries. 19

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