In the midst of economic fallout tied to the COVID-19 crisis, the U.S. Congress passed the Coronavirus Aid, Relief and Economic Security Act (CARES Act) to offer financial assistance to both American individuals and businesses. While most of this $2 trillion stimulus bill focuses directly on emergency Coronavirus-related relief, there is an amendment within the CARES Act that corrects a mistake from the 2017 tax law. This correction will benefit commercial property owners and some tenants, not only today but well into the future.
The correction specifically expands the tax deduction for a variety of property improvements at 100% of the cost. Fixing an error that has been designated as a ‘typo’ in the 2017 tax act, the deduction is available immediately instead of over many years. Before the CARES Act update, most interior property improvements, including qualified improvement property (QIP), could be written off only over a period of 39 years. QIP includes any improvement to an interior portion of a building that is a nonresidential real property.
The intention of the 2017 Tax Cut and Jobs Act was to increase the QIP tax deduction from 50% of the cost of improvements to 100%. It also sought to expand on the types of improvements covered. However, the Act ended up leaving out building improvements all together. This meant that there was no 50% or 100% deduction, but instead, the law reverted to previous guidelines where depreciation would occur over a 39-year period. This discrepancy resulted in a decreased incentive for real estate owners to invest in interior upgrades on their properties.
The error has been a hot topic since passing in 2017 with real estate trade organizations calling for changes to fix the language in the Act. Even with organizations campaigning to fix the law, Congress was unable to make the update until the Coronavirus pandemic created a need for economic relief. The update is found in Section 2307 of the CARES Act titled Technical Amendments Regarding Qualified Improvement Property and is retroactive, helping businesses who invested in the interior of their properties over the past few years.
Many of our clients and other eligible businesses are left wondering if and how they can take advantage of this tax law amendment. On its face, the correction affords opportunities to accelerate depreciation, but companies are urged to perform extensive analysis and modeling to ensure that they will maximize benefits. Once an organization determines that the technical correction will be beneficial, there are several options available to take corrective action. The following information outlines these options.
This change is retroactive to the passage of the Tax Cuts and Jobs Act (TCJA) and therefore applies to QIP placed in service in 2018. Eligible businesses that would have derived a 2018 benefit from the technical correction should consider the following options:
- Amend your 2018 tax returns now to claim
benefits afforded by the technical correction.
- See comments below regarding Revenue Procedure 2020-23. Bipartisan Budget Act of 2015 (BBA) partnerships are now able to amend 2018 and 2019 returns, rather than request Administrative Adjustment Requests (AARs).
- File for an automatic accounting method change in 2019. In many cases, amended partnership returns are impractical or impermissible. In those situations, an eligible business may choose to apply for an automatic accounting method change using Form 3115. This change is filed with your 2019 return, affording the opportunity to “catch up” on any missed 2018 deductions with the 2019 filing.
If your company has already filed a 2019 return, you should look into:
- Filing a superseded return to take advantage of the benefits afforded by the technical correction, as long as it is filed by the extended due date.
- Choosing to either amend your returns.
- See comments below regarding Revenue Procedure 2020-23. BBA partnerships are now able to amend 2018 and 2019 returns, rather than request AARs.
- Waiting until 2020 and filing for an automatic accounting method change to “catch up” on any missed deduction with your 2020 returns.
A Note on Amended Returns
Many real estate businesses are structured as partnerships. It’s worth noting that not all partnerships are eligible to amend a prior year return. For smaller partnerships not subject to the Centralized Partnership Audit Regime, amended returns can be filed to claim the benefits of the correction. Subsequently, each of the partners would also file an amended return to claim their share of the benefit at the partner level.
For partnerships subject to the Centralized Partnership Audit Regime, which are generally large or multi-tiered partnerships, amended returns are not permitted. Instead, the partnership may file an AAR, which will require that the partners reflect the change in the year the request is filed, rather than the year that the deduction would have been taken.
Additional Considerations: Real Property Trade or Business Election and Administrative Adjustment Requests
Real estate industry groups have successfully lobbied for IRS guidance on implementing the technical correction. Under the circumstances in which the correction was issued, Congress was unable to fully consider how the technical correction would interact with existing law. Two areas of concern were:
- The real property trade or business election
- The process for amending partnership tax returns under the Centralized Partnership Audit Regime
In both cases, when the CARES Act was issued, the laws at that time undermined Congressional intent for prior tax deductions to be immediately monetized. Below, we discuss each in detail:
Real estate businesses often feature highly leveraged properties producing significant interest deductions. In an effort to circumvent interest expense limitations under Section 163(j), many of our real estate clients have already made the real property trade or business election. The non-revocable election afforded the opportunity to maximize interest deductions. The trade-off was the required use of the Alternative Depreciation System (ADS) on real property, under which bonus depreciation is not permitted. The CARES Act not only made the QIP technical correction retroactive but also increased the 163(j) limitation from 30% to 50% of adjusted taxable income in 2019 and 2020.
Those who made the real property trade or business election did so after carefully weighing the benefits of bonus depreciation against interest expense deductions. Both of these items have retroactively changed as a result of the provisions in the CARES Act. In many cases, if the original QIP provisions were drafted as intended, our clients might have decided against making the real property trade or business election. Unfortunately, that election was irrevocable under the tax law, in spite of the fact that the law used to make that decision has been altered retroactively. Additionally, the increased availability of interest expenses in 2019 and 2020 would factor into the equation when considering the real property trade or business election.
In light of these retroactive changes, real estate industry groups lobbied the Department of the Treasury and the IRS to allow for flexibility with respect to past real property trade or business elections made. The IRS recently issued Revenue Procedure 2020-22, which allows certain taxpayers to make a late election or to withdraw an election to be treated as an RPTB on an amended partnership return. Depending on the circumstances of your business, it may be worth reconsidering whether the Real Property Trade or Business Election is right for you.
Administrative Adjustment Request (AAR)
As indicated above, not all partnerships are eligible to amend tax returns. Large and multi-tiered partnerships must instead file AARs. It is worth noting that to the extent a partnership AAR adjustment reduces income in a given year, the partners are effectively allowed a non-refundable credit against taxes owed in the year that the AAR is filed.
As an example, when an AAR is filed in 2020 to reflect the technical correction to a 2018 return, each partner’s 2018 income tax is recalculated, taking into account the AAR adjustment. The reduction in tax does not produce a refund of the partner’s taxes paid in 2018 but instead is considered a non-refundable credit in 2020, the year the AAR is filed. This is problematic in that (1) the adjustment will not be realized by the partner until the Spring of 2021 (when the 2020 income tax returns are filed), and (2) the credit is not refundable. If the 2018 “credit” generated is more than the 2020 tax burden, the excess is not refunded with the 2020 return.
The IRS recently issued Revenue Procedure 2020-23 to address the issue. This guidance allows BBA partnerships to amend 2018 and 2019 returns, instead of filing an AAR.
Moore Colson understands there is a lot of new information emerging from the CARES Act, and we are here to make the process easier for you and your business during this difficult time. If you would like more information on this topic, please contact us or call 770-989-0028. You can also subscribe here to get our news and alerts as they are released.
Mike Pompilio, CPA, is a Partner in Moore Colson’s Tax Services Practice. Mike leads tax services for our Real Estate Practice. He brings over 20 years of technical expertise to the firm in the complex federal taxation areas of real estate, partnerships and corporation.
Marcia Nally, CPA, is a Director in Moore Colson’s Tax Services Practice. In this role, Marcia’s primary focus is on tax compliance and planning services for closely-held businesses and their owners in the real estate industry.
Steve LaMontagne, CPA, is a Partner at Moore Colson and leads the firm’s Real Estate Practice. Steve has extensive experience in all sectors of the real estate, construction and hospitality industries and specializes in real estate investing, accounting, financial reporting and auditing matters.
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