Money has never been tighter, with the United States in our first recession since the real estate crash of 2008. Fortunately, recent changes in tax law may provide construction and real estate professionals with the ability to manage cash flow on their projects and keep more funds in the business.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law. With it came corrections and new provisions intent on providing relief during these tough economic times. The provisions of most interest to the construction and real estate industry are outlined below.
Fixing the “Qualified Improvement Property (QIP) Glitch” of the 2017 Tax Cuts and Jobs Act (TCJA)
One of the significant TCJA provisions was an increase in the ability to immediately expense the purchase or construction of certain assets, through accelerated (bonus) depreciation. This included property with a depreciation recovery period of 20 years or less, which was intended to include qualified improvement property (QIP).
QIP is defined as any improvement made by the taxpayer to the interior of a nonresidential building placed in service after the building was first placed in service and excluding enlargement of the building, elevators and escalators, and internal structural framework. When IRC Code Section 168 was amended as part of the TCJA, however, QIP was not included in the list of short-lived assets. This meant that it defaulted to a 39-year life, making it ineligible for accelerated depreciation. The CARES Act rectified this mistake. QIP placed in service on January 1, 2018, or later is now given a 15-year life and is eligible for bonus depreciation, which is 100% for qualifying assets placed in service prior to January 1, 2023.
Relaxing the Interest Limitation Rules of IRC Section 163(j)
Another rule that came into play as a part of the TCJA was the limitation on business interest under IRC Section 163(j). This law gave many taxpayers the option of either limiting business interest expense to 30% of adjusted taxable income (taxable income with certain adjustments), plus business interest income and floor financing interest, or making an irrevocable election to become an “electing real property trade or business” and adopting ADS (alternative depreciation system) depreciation for building assets, slightly extending depreciable lives.
This limitation doesn’t apply to everyone, with a notable exception for small business taxpayers as defined under the law. The CARES Act relaxed these rules. For taxpayers except partnerships, for taxable years beginning in 2019 and 2020, taxpayers can elect to use 50% of adjusted taxable income in the interest limitation calculation instead of 30%. For partnerships, there is a different benefit. Partners (not partnerships) that have disallowed interest expense from 2019 can release 50% of the interest expense in 2020. In addition, all affected taxpayers can elect in 2020 to use 2019 income to calculate their interest limitation instead of 2020 income. If an electing trade or business election was made in 2018 or 2019, the new law provided for a limited opportunity to “undo” this.
Changes to Net Operating Losses and Excess Business Losses
The CARES Act temporarily reversed the elimination of the net operating loss (NOL) carryback imposed by the TCJA. For calendar year taxpayers, NOLs that are generated from 2018-2020 can be carried back for five years. For fiscal year taxpayers, NOLs arising in a year starting in 2017 can carry this loss back for two years. Another change is that the rule limiting the use of NOLs to 80% of taxable income has been suspended until 2021. Finally, the so-called “excess business loss limitation,” which limited the business losses that could be used to offset non-business income to $500,000 on a married-filed-jointly return, was suspended for tax years 2018 through 2020.
These changes allowed in the CARES Act can provide construction and real estate professionals with the opportunity to retroactively and proactively strategize ways of reducing tax and putting additional cash into their projects.
Applying the above provisions is complex and can vary depending upon what law you are applying, the year you are applying the law to and the type of entity that is involved (e.g., corporation, partnership, etc.). We highly suggest you consult a tax professional before attempting to make any of the changes outlined in this article. Contact us to learn more.