Commercial real estate: Federal tax updates
July 20, 2020
By Miranda L. Aavatsmark, CPA
When I scroll through articles on social media I often read the comments first before falling victim to the clickbait. The comments help me decide if it’s a worthwhile read and are usually entertaining in and of themselves. Recently an article about the “new normal” of working from home caught my eye. The headline was along the lines of workers not being able to “go home” from work and may struggle with escaping from the home office. One person commented, “normal working conditions for accountants anyway.” Personally, I can relate to that statement and I suspect many of my fellow colleagues could as well. After two years of digesting The Tax Cuts and Jobs Act of 2017 (TCJA), tax professionals settled into 2020 with more confidence. But as soon as March Madness was replaced with more tax law changes, deadline extensions and the Paycheck Protection Program, accounting professionals may have certainly felt tethered to their office chairs, wherever they may be.
The idea of working from home becoming the new normal begs the question of whether the future of commercial real estate is at stake. Companies have been forced to allow employees to work from home and are realizing the work can still be done efficiently. Will employers begin to downsize their office spaces and conduct business in a more virtual environment? Or rather, will companies have office reconfiguration in mind as their new normal? Cubicles and open floorplans may be less desirable as social distancing fears linger in the minds of workers. Although the future is unclear, there are some favorable tax updates that offer a taste of certainty to owners of real estate right now. The most notable tax update for us to delve into is that of Qualified Improvement Property (QIP).
Qualified Improvement Property
The Internal Revenue Code § 168(e)(6) defines the term “qualified improvement property” as any improvement made by the taxpayer to an interior portion of a building which is a nonresidential real property if such improvement is placed in service after the date such building was placed in service. Certain improvements, such as the enlargement of the building, an elevator or escalator, or the internal structural framework of the building are excluded from this definition.
A mistake in the hastily passed TCJA resulted in QIP not being assigned a 15-year life. As a result, QIP had to be depreciated over 39 years and was therefore not eligible for bonus depreciation. At the time this came as an unpleasant surprise to many business owners who were counting on the immediate deductions for improvements they placed in service. A technical correction would be required to correct this drafting error and hope was fading that it would happen anytime soon. However, the long-awaited fix for QIP was retroactively provided for in The Coronavirus Aid, Relief and Economic Securities (CARES) Act that was passed on March 27, 2020. For all intents and purposes, the CARES Act goes back in time to amend TCJA and assign a 15-year life to QIP. Effectively, this change is put in place at the time that the TCJA bill was passed and applies to QIP placed in service after December 31, 2017.
To account for this retroactive change, the Treasury Department released additional guidance through Revenue Procedure 2020-25. Contained within are instructions for taxpayers who would like to change to the shorter life for QIP and/or elect 100 percent bonus depreciation on these assets. Taxpayers will have to file an amended return, an administrative adjustment under Section 6227 (AAR) and/or Form 3115 (Change in Accounting Method) as provided by the revenue procedure. In addition, the Department of Treasury and Internal Revenue Service had the foresight to predict that the flood of incoming returns would create an administrative nightmare and therefore decided to limit the time period in which this could be done. Therefore, returns filed before April 17, 2020 for the 2018, 2019 or 2020 tax years can be amended or adjusted by October 15, 2021 to make QIP depreciation changes.
Treasury Department issued separate guidance for partnerships in Revenue Procedure (2020-23) which lessens restrictions on amended returns. Certain partnerships that were previously limited in their ability to amend returns (by having to file Forms 8986 and 8985 with an Administrative Adjustment Request) can now file under this Rev. Proc. for 2018 and 2019 and furnish K-1s to respective partners before September 30, 2020.
Other tax provisions
Many business owners were fortunate to be able to keep their business afloat for several months with forgivable PPP loans. However, since the loan amount is based on payroll expenses, owners of commercial rental real estate may not have been eligible for much or any of these funds. All the more reason for these taxpayers to contemplate amending returns to elect bonus deprecation on QIP assets. Additionally, other attractive tax law changes were brought back to life and enhanced in the CARES Act.
Net operating losses
TCJA dramatically changed the net operating loss rules by eliminating the ability to carryback and limiting the carryforward to offset only 80 percent of taxable income. The CARES Act largely reversed this by temporarily allowing individuals and corporations to carryback net operating losses arising after December 31, 2017 and before January 1, 2021. The losses can be carried back five years to claim much-needed refunds. Additionally, losses that are carried forward to the 2019 and 2020 tax years can be used to offset 100 percent of taxable income.
Revenue Procedure (2020-24) provides guidance for taxpayers on how to carryback net operating losses as part of the CARES Act. Specifically, taxpayers must carry the losses to the earliest tax year in the carryback period first and then carry forward any unused amounts to each succeeding tax year. Rev. Proc. 2020-24 also explains that taxpayers must make an election under § 172(b)(3) to waive the carryback period for the 2018 and 2019 tax years filed after March 27, 2020.
Tentative carryback adjustment applications are filed on Form 1139 for Corporations and Form 1045 for individuals. Generally, filing either of these forms is advantageous because the IRS is required to process these forms within 90 days of receipt. The kicker is that these forms must be filed within 12 months of the loss year. Since this filing requirement may have expired by the time the CARES Act was passed, Revenue Procedures 2020-24 and 2020-26 explain in detail extension of time in most cases. Below is a summary of certain tax years that are provided additional time beyond the standard 12 months (and some that are not):
Tax years beginning before January 1, 2018 and ending after December 31, 2017 are given an additional three months from the enactment of the CARES Act to file a claim of refund by July 27, 2020.
Tax years beginning in 2018 and ending June 30, 2019 are provided an additional six-month extension to file a claim for refund. For example, a tax year ended December 31, 2018 would be due June 30, 2020 instead of December 31, 2019.
Tax years beginning on or after January 1, 2018 and ending before March 27, 2019 were not provided additional time to file the expedited method through the CARES Act. As such, the normal due date has expired and taxpayers must file amended returns instead.
Excess business losses
Individual taxpayers with losses may be pleased to know that the Internal Revenue Code (IRC) §461 is temporarily erased from the tax law for 2018, 2019 and 2020. IRC §461 was added through TCJA and limited business losses in excess of $250,000 for single taxpayers and $500,000 for married taxpayers. Through the CARES Act, taxpayers may also amend their 2018 and 2019 returns if losses were disallowed by this TCJA limitation. However, starting with the 2021 tax year, wages will no longer be considered business income, which may limit more losses than would have previously been under the original TCJA rules. Keep in mind, the excess business loss limitation is a temporary TCJA change that is scheduled to sunset after December 31, 2025.
Note that passive activity loss and at-risk rules for individual taxpayers should still be considered in determining the cost-benefit of additional filings.
Even though the future is unknown at this time, tax professionals and real estate owners should take advantage of the tax laws in place at this moment. The federal government is essentially putting extra cash in taxpayers’ pockets during a time when it is needed most. For some of these provisions in the CARES Act, time is of the essence and quick action is needed.
Only time will tell whether working from home is here to stay or cubicles will be replaced with private offices. Until then, accounting professionals will undoubtedly strap in and make the best of their new normal.
About the author: Miranda L. Aavatsmark, CPA, is a tax manager of Blue & Co., LLC in Lexington. She can be reached at firstname.lastname@example.org.