IRA Financial’s Adam Bergman Esq. discusses two key provisions of the CARES Act that could potentially save real estate investors a bundle in taxes this year.
The CARES Act was passed in March of 2020 to help the country deal with the onset of the financial crisis brought on by the COVID-19 pandemic. The Act brought with it much needed stimulus to the economy, including checks sent to every eligible Americans, the PPP loan program and expanded unemployment benefits. Along with several retirement plan-related provisions, there were a couple of provisions that real estate investors need to pay attention to. This podcast details these and Mr. Bergman e explains how they could lower your tax bill for 2020.
What Real Estate Investors Should Know
The two CARES Act provisions real estate investors should be aware of are 100% Bonus Depreciation changes and amendments to Net Operating Losses (NOL).
100% Bonus Depreciation
The CARES Act expands the definition of qualified improvement property to include nonresidential rental property and retroactively allows businesses to use that expanded definition back to tax year 2018. This means that businesses engaged in leasing commercial rental property can deduct 100% of improvement costs versus depreciating over 39 years. Practically speaking, taxpayers who made qualified improvements to nonresidential rental property in tax year 2018 but were unable to fully expense their costs, are entitled to file an amended 2018 return to retroactively obtain this benefit.
Some examples of qualified improvements include replacing drywall, improving fire protection, and repairing electrical and plumbing systems. These all qualify for the 100% bonus depreciation. Essentially, the CARES Act want to reward you for making these improvements, not only on residential rental properties, but commercial as well.
However, it’s important to keep in mind that not every real estate investor can take advantage of this provisional. You must be a designated real estate professional (REP). You qualify if you can demonstrate 750 hours annually on activities such as leasing, marketing, tenant recruitment, or property management that is more than 50% of your work. REP status combined with material participation in real estate activities is a powerful classification which allows real estate losses to offset income – any income.
If you have multiple properties, you may not be able to qualify as a real estate professional unless you elect to treat all your rental real estate interests as a single activity. The provision provides that the cost to improve interiors of non-residential buildings may be immediately written-off, rather than depreciated over 39 years.
Net Operating Losses
A net operating loss occurs when a company’s deductions exceed its taxable income. Under the Tax Cuts & Jobs Act, net operating losses could be carried forward but not back to earlier years. Moreover, the deductible amount was limited to 80% of taxable income. The CARES Act temporarily suspends those limitations for tax years 2018, 2019, and 2020.
The provision allows for NOLs to fully offset prior year income for the preceding five years. This modification provides significant opportunities for businesses to strategize and, potentially, receive refunds.
For example, a restaurant that sustains losses in 2020, but had earlier profitable years may, ultimately, carry-back its 2020 NOL to prior “gain” years and obtain a refund of previously paid income taxes. Similarly, a company that sustained losses in 2018, but had a good year in 2017, should review its tax returns to see if it is currently eligible for a refund.
This is huge for business owners who have been severely impacted by the coronavirus pandemic, like restaurants, hotels and retail stores. If you have losses this year, you can offset income you have generated over the last five years and receive a refund! Business owners are urged to look into their NOLs to see if they can offset income. This is also true for real estate investors. If you are an active investor (not just passive), you can also use an NOL to offset gains made.
If you are a real estate investor or small business owner, you need to look into these CARES Act provisions. They may help offset your taxes, either this year, or from previous years. The financial crisis is far from over and you should take advantage of every bit of relief that you can.