Real Estate Companies: Don’t Delay Tax Planning

This blog post was previously published on November 7, 2018. It was updated on November 15, 2019.

Opportunity zones, promote (i.e., carried interest) and reporting changes could impact your 2019 tax bill

The ongoing impact of the Tax Cuts and Jobs Act has made year-end tax planning with your advisors more essential than ever. And new accounting method and reporting requirements may mean more even more preparation and planning will be needed for real estate companies ahead of tax season.

Maximize deduction for qualified business income (QBI)

Owners of some pass-through entities will continue to receive a 20% deduction on qualified business income, which may reduce their maximum effective tax rate for 2019. Pass-through entities, include subchapter S corporations, partnerships and some limited liability companies. There’s another plus for pass-throughs: they keep the deduction on entity-level state and local taxes.

Also, be aware that filers who claim the QBI deduction must now show how they calculated QBI, by using Form 8995. Each qualified trade or business activity must stand separately and as such, will require its own Form 8995.

The QBI deduction limitations and restrictions are set at the owner level. Planning for year-end 2019 should include discussion of salaries, timing and distribution of income in order to maximize the deduction for the tax year.

Opportunity Zone investments require additional reporting

Opportunity Zones can offer tax benefits for real estate developers, investors and investment funds, by offering the opportunity to defer capital gains by investmenting in certain economically distressed communities. The longer you hold the property, the greater the benefit. If you defer your gains on opportunity zone investments for 10 years, you’ll pay no tax on the appreciation of your investment.

For 2019, Qualified Opportunity Funds will need to provide more information to the IRS, through a new Form 8996. Funds must report the value of business properties, the census area tract number for each property, the value of investments allocated to each area, each investments current valuation and other information.

Your tax advisor may need additional information about your Opportunity Zone investments.

Consider impact of selling an asset or partnership interest

Section 1061 of the Tax Cuts and Job Acts says that if you sell a capital asset you’ve held for less than three years, any promote (i.e., carried interest) that you’ve earned on the sale of that asset must be recharacterized from a long-term capital gain to a short-term gain. While long-term capital gains are taxed at 20%, short-term gains are taxed at your ordinary income rate. The IRS has still not issued guidance on which assets are included or excluded in the application of this section.

If you’re selling what may be considered a capital asset that you’ve owned for less than three years, consult with your tax professional.

Increased benefit from bonus depreciation and cost segregation

Bonus depreciation is a method of accelerated depreciation, allowing you to take an additional deduction the first year you own qualified property. Under the new tax law, the rules changed in two ways: the portion that can be depreciated and the types of property that qualify.

Previously, bonus depreciation was calculated at 50% of the basis of qualified property, and only new property qualified. For property acquired after September 27, 2017, and through the end of 2022, 100% of the basis can be depreciated. And the property can be “used,” as long as it’s new to the taxpayer. Both changes provide notable advantages to real estate businesses.

In addition, developers, buyers and owners of commercial real estate often overlook the benefits of a cost segregation study because of the perception that the study will simply result in a timing difference in how a building is depreciated. However, an engineering-based cost segregation analysis can lead to significant tax deferrals, a boost in cash flow, and an increase in capital immediately available for new projects. Cost segregation will look at the costs associated with the construction or purchase of a commercial real estate property or a residential rental property.

Consult with your tax advisor about properties you think may qualify for bonus depreciation or cost segregation.

Limitations on interest expense deduction

The Tax Cuts and Jobs Act expanded limits on interest deductibility to all businesses and controlled groups with gross receipts in excess of $25 million, including real estate partnerships. It capped the deduction of interest to interest income plus 30% of EBITDA, limiting the excess interest that many businesses traditionally deducted.

This might be a non-issue for some real estate businesses that elect to use the alternative depreciation system (ADS). The new tax law retains the existing 40-year alternative depreciation system for non-residential real property. The good news is that there is a new 30-year ADS period for residential property for property acquired subsequent to 2017.

Any time you consider a highly leveraged transaction, discuss the possible tax ramifications with your advisor. Electing ADS may be a strategy to consider to help you deal with the new limitations on excess interest deductibility.

Tax-basis capital reporting is now required for partnerships

Partnerships no longer have a choice of how to report each partner’s capital account for tax purposes. You must now report each partner’s capital account using a tax basis capital method. If you haven’t tracked this in the past, it’s time to start. Speak with your tax advisor about whether the new requirements apply to you and how to comply.

Additional reporting requirements for foreign investors, lenders

If you have foreign investors or any type of foreign business connections (such as lenders), gather up-to-date, signed W-8 forms, and be prepared to provide more information this year to your tax advisor.

Prepare for Schedule K-1 changes

In addition to the tax-basis capital account reporting requirement and the new QBI worksheet, Schedule K-1 (Partner’s Share of Income, Deductions, Credits, etc.) will see other changes for the 2019 tax year. Although the form hasn’t yet been finalized, the IRS said in a news release that the changes “aim to improve the quality of the information reported by partnerships.” In November, it issued a draft of the 2019 form, with several additions, including:

• Disregarded entity names and Tax Identification Numbers must now be included, along with the individual beneficial owner’s information.
• Should a partner be allocated 704(c) gain or loss, the K-1 now requires reporting of the unrecognized portion of this gain or loss.
• Property contributed to a partnership must be valued using tax basis capital account reporting.

Contact your Kaufman Rossin tax advisor to learn more about these and other tax provisions that could affect you or your business as you plan for the coming year.