Unraveling the Latest Tax Reform and Its Effects on the Real Estate Industry
Recently, real estate industry leaders gathered in standing room only fashion at the PDX Live Studio to hear how tax reform may impact their business. The discussion was led by a distinguished panel consisting of senior leadership from Perkins & Co and Schwabe, Williamson & Wyatt shareholder, Dan Eller. The panelists joked, “Do they make XXL sized postcards?” Indicating that simplification, generally, was not the theme of the night. Numerous caveats were mentioned with the need of more guidance from the IRS on various provisions presented. And while this post is a highlight of topics discussed, if you’d like more in-depth information, please turn your eyeballs to our “Tax Cuts? What They Mean for the Real Estate Industry” bulletin.
So, let’s dive in. Senate rules require the Tax Cuts & Jobs Act (TCJA) not to add to the federal deficit after ten years. Failing to meet this window would have required 60 votes in the Senate that has only 52 Republicans. Since the bill aimed to cut corporate taxes in perpetuity, they had to find a means to pay for that cut; thus, the various sunset provisions for individuals in seven years. Some people question if the GOP will let the individual tax cuts expire in 2025. Which begs the question, if not, will they raise money to offset the permanent corporate tax reduction?
Partnership Audit Rules
Getting to the first topic of the evening, the panelists covered the new IRS audit rules for partnerships and if one needs to make amendments to their operating or partnership agreements any time soon. Our recommendation is yes, and soon to at least address the new rules. It’s also recommended that you identify a partnership representative—which is not the same as the Tax Matters Partner (TMP)—and consider indemnification agreements for new and/or exiting partners.
Pass-Through Entities Deduction
Now to transition to our hottest topic of the evening: the new 20% deduction for pass-through entities, or, in IRS code speak, Sec. 199A deduction. With the elimination of the Domestic Production Activities Deduction (DPAD) and the new flat 21% tax rate for C Corporations, this was the means to equalize the tax rate reduction for individuals primarily using pass-through entity structures. This deduction focuses on the “trade-or-business” definition; passive or active participation doesn’t come into play. A limited partner in a partnership that has what is called Qualified Business Income (QBI) may receive the deduction. The same goes for ordinary real estate investment trust (REIT) dividends and publicly traded partnership flow through income.
The Sec. 199A deduction was one of the areas where more guidance from IRS is a must, and, like you, we wonder when that will be. Our best guess is sometime later this year, but there’s a lot of pressure on the IRS to provide that guidance soon. Unfortunately, guidance may not be coming as soon as we had hoped. In late February, Dana Trier, the key person who oversaw the Office of the Tax Legislative Counsel, and who was also a key player in implementing the landmark tax bill, suddenly announced his retirement. It’s believed that he may have had troubles implementing the law. However, priority of further guidance is said to be:
- The 20% deduction
- Business interest deduction limitation
- Depreciation on new QIP – qualified improvement property 15 yr. SL depreciation method, which will require a technical correction to the code vs. just guidance
- International rules
- And various other provisions
Depreciation and Carried Interest
Following the hottest topic of the evening, our panelists explored bonus depreciation and carried interest rules, which led to planning opportunities including 1031 exchanges which can only be applied to real property and are no longer available for personal property. But with the new 100% bonus depreciation and increased Section 179 expense election, the question raised is, “Will the 1031 rule change impact your trade-in of equipment or vehicles much?” The answer is no: Any gain recognized on disposition of personal property will likely be offset (or more than offset) if you take 100% bonus depreciation or if allowed take the 179 expense deduction on the new asset acquisition.
Business Interest Deduction Limitation
A close second to the hottest topic of the evening was the business interest deduction limitation, which clearly hit a cord as lively discussion took place surrounding the issue of “tax shelter” rules. But before we proceed further, this limitation doesn’t apply if your gross receipts for the prior three years’ average is less than $25 million. Why does it matter if you are a tax shelter, you ask? Because it comes into play in the $25 million gross receipts exclusion. In general, a partnership or Non-C Corp. entity that has an allocation of 35% or more of losses to limited partners is a “syndicate” which comes under the definition of a tax shelter. Perhaps you should consider the real property trade or business election to avoid limitations, also known as Alternative Depreciation System (ADS) for longer depreciation lives and method; please note that bonus depreciation is not allowed under ADS. However, would someone consider an LLC as falling under this definition as a syndicate? Most say it doesn’t apply, as they generally have active management by members which provide an exemption to the rule.
Excess Business Loss Limitation
Once the lively chatter around business interest deduction limitation faded, our panel moved on to the new excess business loss limitation. Which brings us to the question, have you had a year where your business losses exceeded $500,000? If so, you may want to consider the new excess business loss limitation where you may only claim up to $500,000 in losses on your personal return each year. Any excess is carried forward to future years as part of your net operating loss, but its limitation is 90% of taxable income vs. the 80% limitation discussed below.
Net Operating Losses (NOLs)
A quick overview of the new NOL rules were discussed. Can one carry back losses to a prior year where the marginal rate was higher than the tax rate carrying it forward? The answer is a resounding NO. Now you may only carryforward NOLs, and, further, the usage is only at 80% of taxable income. Please note that if you have excess business losses and an NOL, the excess business loss component retains the 90% usage in future years.
Lifetime Exclusion for Estate and Gift Taxes
Toward the end of program, the panel covered the increased lifetime exclusion for estate and gift taxes, which is at approximately $11.2 million per person, so you may want to consider various estate planning vehicles to minimize estate and gift taxes before this provision sunsets in 2025. Please note that the valuation discounts are still in play and have not changed.
Other Business Deductions
As the evening progressed, the panelists touched upon various other business deductions, including:
- Elimination of entertainment expense
- Limiting all meals to 50% (except for those provided to all employees such as a company holiday party)
- Transportation fringe benefit expenses, which are now non-deductible for employers (no change to employees’ non-taxable fringe limit)
- And many changes to your itemized and standard deductions
Closing the evening, the discussion focused on whether you should consider restructuring your business—deciding on the best entity choice for your activity is very fact specific. There are many considerations to be mindful of, such as the ever present “double taxation” that’s associated with C Corporations in conjunction with exit strategies, and which requires further discussion and analysis with your tax advisor.
We covered some serious tax reform ground and know it’s a lot to take in. Clearly tax law has become more complex with new provisions needing much guidance and clarification by the Treasury. You’re likely to have questions, so we highly recommend you contact your (Perkins) tax advisor to figure out what’s best for your situation. And don’t forget, if you’re craving more in-depth coverage about the various topics addressed above, check out our “Tax Cuts? What They Mean for the Real Estate Industry” bulletin.
Author: Kimberly Woodside, CPA, Shareholder