In December, one of the most significant tax overhauls in 30 years was signed into law. The Tax Cuts and Jobs Act, which promises nearly $1.5 trillion in overall tax cuts, features several tax code changes that could impact the commercial real estate industry.
Think you know the ins and outs of the Act's impact on commercial real estate? Take this quiz, drafted with insight from Baker Tilly's tax specialists, to find out.
1
What percentage deduction does the Act allow taxpayers to take on income from pass-through entities?
YOU'RE CORRECT!
“Pass-through” income refers to the income of an entity that is treated as the income of the investors or owner. The increased deductions under the Act may be beneficial to the owners of rental, development and construction businesses, allowing them to claim a deduction of up to 20% of their shared net income. The deduction is subject to certain limitations based on the W-2 wages paid or the cost basis of assets used by the business.
Taxpayers subject to the highest rate of 37% under the Act could see their effective rate on pass-through income drop to 29.6%.
YOU'RE WRONG!
“Pass-through” income refers to the income of an entity that is treated as the income of the investors or owner. The increased deductions under the Act may be beneficial to the owners of rental, development and construction businesses, allowing them to claim a deduction of up to 20% of their shared net income. The deduction is subject to certain limitations based on the W-2 wages paid or the cost basis of assets used by the business.
Taxpayers subject to the highest rate of 37% under the Act could see their effective rate on pass-through income drop to 29.6%.
2
Which businesses can elect out of the Act's deduction limitation on interest expense in excess of 30% of “adjusted taxable income”?
Real property trades or businesses
Individual businesses with more than $25M in gross receipts
Related companies whose aggregate gross receipts exceed $25M
Entities that allocate more than a certain percentage of their losses to limited investors
YOU'RE CORRECT!
The Act imposes a limitation on the ability of businesses to deduct interest expense in excess of 30% of “adjusted taxable income” — taxable income before deductions for interest, depreciation and amortization. Real property trades or businesses can elect out of the limitation if activities fall under any of the following categories: real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.
The trade-off for not having the interest expense limited is the loss of the ability to claim bonus depreciation. Entities are also required to use a longer depreciation schedule on certain assets. There is another exception from the limitation for small businesses, defined as those with less than $25M in gross receipts. Entities that are part of a larger group of related companies whose aggregate gross receipts exceed $25M, as well as entities that allocate more than a certain percentage of their losses to limited investors, will not be able to take advantage of the small business exception.
YOU'RE WRONG!
The Act imposes a limitation on the ability of businesses to deduct interest expense in excess of 30% of “adjusted taxable income” — taxable income before deductions for interest, depreciation and amortization. Real property trades or businesses can elect out of the limitation if activities fall under any of the following categories: real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.
The trade-off for not having the interest expense limited is the loss of the ability to claim bonus depreciation. Entities are also required to use a longer depreciation schedule on certain assets. There is another exception from the limitation for small businesses, defined as those with less than $25M in gross receipts. Entities that are part of a larger group of related companies whose aggregate gross receipts exceed $25M, as well as entities that allocate more than a certain percentage of their losses to limited investors, will not be able to take advantage of the small business exception.
3
Which of the following actions benefits from 100% bonus depreciation under the Act?
Improvements made to the interior of a nonresidential building
Residential home renovations
YOU'RE CORRECT!
Under the Act, leasehold improvements are eligible for 100% bonus depreciation. To qualify, improvements must be made to the interior portion of a nonresidential building more than three years after the building was first placed in service.
In a retroactive provision of the Act, qualifying assets acquired and placed into service after Sept. 27, 2017, and prior to Jan. 1, 2018, qualify for 100% depreciation, instead of 50%, bonus depreciation for improvements. The Act also eliminated the separate definitions of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property, classifying them instead under one category.
Congress intended to provide a 15-year recovery period for qualified improvement properties placed in service after Dec. 31, 2017. Due to drafting errors in the Act, the provision generally describing properties with a 15-year recovery period, was not amended to include QIPs. As a result, leasehold and certain building improvements are not eligible for bonus depreciation in 2018 and subsequent years.
YOU'RE WRONG!
Under the Act, leasehold improvements are eligible for 100% bonus depreciation. To qualify, improvements must be made to the interior portion of a nonresidential building more than three years after the building was first placed in service.
In a retroactive provision of the Act, qualifying assets acquired and placed into service after Sept. 27, 2017, and prior to Jan. 1, 2018, qualify for 100% depreciation, instead of 50%, bonus depreciation for improvements. The Act also eliminated the separate definitions of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property, classifying them instead under one category.
Congress intended to provide a 15-year recovery period for qualified improvement properties placed in service after Dec. 31, 2017. Due to drafting errors in the Act, the provision generally describing properties with a 15-year recovery period, was not amended to include QIPs. As a result, leasehold and certain building improvements are not eligible for bonus depreciation in 2018 and subsequent years.
4
What is the maximum amount of taxable income a single, noncorporate taxpayer can offset with business losses?
YOU'RE CORRECT!
Noncorporate taxpayers like individuals and trusts may have limited ability to use business losses to offset other types of income, like wages, interest and capital gains. Under the Act, business losses of married, noncorporate taxpayers, who file a joint return, can only be used to offset up to $500K of nonbusiness income. Single taxpayers can offset up to $250K.
Business losses in excess of those amounts become part of a net operating loss carry-forward, and its usage is limited to 80% of the following year’s taxable income. Net operating losses can no longer carry back to previous tax years to claim refunds. The Act contains similar restrictions regarding net operating losses for corporate taxpayers.
YOU'RE WRONG!
Noncorporate taxpayers like individuals and trusts may have limited ability to use business losses to offset other types of income, like wages, interest and capital gains. Under the Act, business losses of married, noncorporate taxpayers, who file a joint return, can only be used to offset up to $500K of nonbusiness income. Single taxpayers can offset up to $250K.
Business losses in excess of those amounts become part of a net operating loss carry-forward, and its usage is limited to 80% of the following year’s taxable income. Net operating losses can no longer carry back to previous tax years to claim refunds. The Act contains similar restrictions regarding net operating losses for corporate taxpayers.
5
The Act lowered the federal tax rate on corporations to which of the following percentages?
YOU'RE CORRECT!
The Act lowered the federal tax rate on C corporations, any corporation that is taxed separately from its owners, to 21%. This has tempted some taxpayers currently using pass-through entities to consider converting to a C corporation due to the lower rate. The choice of entity structure depends on the individual facts and circumstances of each taxpayer, and modeling will be required to assess the impact of any changes.
A taxpayer might need to account for regular distributions from the business or the length of time they wish to maintain ownership. They might also consider the potential for the 3.8% net investment income tax to apply to dividends from the C corporation, and whether they benefit more from the 20% pass-through deduction.
Specific to real estate, a C corporation will pay more in capital gains when trying to sell a property than a flow-through entity, such as an LLC.
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YOU'RE WRONG!
The Act lowered the federal tax rate on C corporations, any corporation that is taxed separately from its owners, to 21%. This has tempted some taxpayers currently using pass-through entities to consider converting to a C corporation due to the lower rate. The choice of entity structure depends on the individual facts and circumstances of each taxpayer, and modeling will be required to assess the impact of any changes.
A taxpayer might need to account for regular distributions from the business or the length of time they wish to maintain ownership. They might also consider the potential for the 3.8% net investment income tax to apply to dividends from the C corporation, and whether they benefit more from the 20% pass-through deduction.
Specific to real estate, a C corporation will pay more in capital gains when trying to sell a property than a flow-through entity, such as an LLC.
To learn more about this Bisnow content partner, click here.
