CARES Act Tax Changes for Real Estate

Alongside numerous provisions for corporations and small businesses, the Coronavirus Aid, Relief, and Economic Security (CARES) Act brings about several key changes for taxpayers operating in the real estate sector. We’ve outlined three major provisions set forth in the bill.

Changes to Business Interest Expense Rules

Section 2306 of the CARES Act has temporarily modified tax code section 163(j) pertaining to the limitation on the deduction for business interest expense. Under normal circumstances, taxpayers could deduct business interest up to the sum of the following:

• The taxpayer’s business interest income for the tax year;
• 30% of adjusted taxable income (ATI) for the tax year; and,
• The taxpayer’s floor plan financing interest for the tax year.

Under the CARES Act, the 30% limit on ATI is increased to 50% for tax years beginning in 2019 and 2020. Taxpayers may opt out of this adjustment, or they can choose to use their 2019 ATI (rather than 2020 figures) when determining maximum business interest deduction for 2020.

Special provisions apply for partnerships. The 30%-to-50% increase does not apply to these entities beginning in 2019. However, there are new provisions for excess business interest expense allocated to a partner:

• 50% of excess business interest expense will be treated as business interest that is paid or accrued by the partner in its first tax year beginning in 2020.
• The other 50% will be subject to the limitations of section 163(j)(4)(B)(ii) in the same manner as any other excess business interest so allocated.

This change paves the way for taxpayers to deduct more of their business interest expense, thus reducing their overall tax liability in 2019 and 2020. This effectively helps to combat the tax burden that may be incurred as the result of reduced earnings due to business lost during the COVID-19 pandemic.

Changes to Net Operating Loss (NOL) Rules

Prior to the CARES Act, tax deductions for NOLs could not be carried back and were capped at 80% of a business’s taxable income. Now, under Section 2303 of the CARES Act, all taxpayers (other than real estate investment trusts) can carry back NOLs created in 2018, 2019 or 2020, up to five years.

Furthermore, the NOL deduction limit of 80% has been suspended, allowing taxpayers to offset 100% of their income accruing in 2020. The 80% limit will be reinstated in tax year 2021 moving forward. There is no change to rules pertaining to capital losses.

Both of these changes effectively improve cash flow for real estate entities by allowing them to realize current losses and amend prior years’ returns to apply for tax refunds.

The CARES Act also offers a technical correction for fiscal year filers with an NOL in the 2017-2018 straddle year. Due to a drafting error, the existing Tax Cuts and Jobs Act (TCJA) provision disallows NOL carrybacks made applicable in tax years ending after December 31, 2017. The CARES Act fixes this error. NOLs from a tax year that straddled December 31, 2017 are now eligible for the two-year carryback period and 20-year carry forward period (pre-TCJA).

Technical Correction Regarding Qualified Improvement Property (QIP)

The provision outlined in Section 2307 of the CARES Act brings a much-needed amendment to reporting of qualified improvement property (QIP). Under the CARES Act, QIP is defined as any improvement made by the taxpayer to an interior portion of a nonresidential property if the improvement is placed in service after the date such building is placed in service. However, QIP was inadvertently not included in the TCJA’s list of 15-year property—even though Congress intended for such property to have a 15-year depreciation period.

The CARES Act corrected the error that had resulted in a 39-year depreciation period for costs associated with QIPs.  Not only is this a significantly shorter recovery period, but QIP is also now eligible for 100% bonus depreciation.

This change is retroactive to tax years 2018 and 2019. Taxpayers will need to file either an amended return or a change in method of accounting with Form 3115 to benefit from the correction for property included on tax returns already filed.

Real estate entities should plan accordingly.

The CARES Act provisions outlined above have significant ramifications for the real estate sector—particularly businesses adversely affected by COVID-19 and subsequent state shutdowns and shelter-in-place orders. It’s important to begin immediately planning for these changes, as well as revisiting prior-year tax filings.

For more information about the CARES Act’s impact on the real estate segment, continue following James Moore for guidance and insights. Contact a James Moore accountant today to discuss your situation.

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