Presented By: SIOR
What CRE Pros Need to Know About the New Tax Law and Tax Deferral Strategies
In today’s strong real estate market, there is a great deal of activity and discussion—and some confusion—surrounding commercial real estate tax deferral strategies. The Tax Cuts and Jobs Act (TCJA) is the new tax law that’s revitalized interest in tax deferral strategies both old and new. SIORs and all CRE professionals must arm themselves with information so as to best advise their clients on these strategies going forward.
TCJA and Bonus Depreciation
The “new” TCJA was signed into law in 2017. The first comprehensive tax reform since 1986, the TCJA is already having a tremendous impact on all industries.
Since 2001, Congress has introduced incentive packages on almost an annual basis. Often, these packages include a “bonus depreciation” provision, initially introduced as a post-9/11 economic stimulus. Bonus depreciation is a tax incentive that permits an immediate first-year deduction of a percentage of the purchase price of eligible assets. Taking advantage of bonus depreciation will increase your deductions, offset your income and reduce your taxes.
The TCJA has taken this to a whole new level, boosting bonus to a whopping 100 percent for properties placed-in-service between September 28, 2017, and December 31, 2022. What’s more, under the TCJA, acquired properties are also eligible for bonus depreciation. So, whether you’re newly constructing or acquiring commercial, residential or multifamily property, you can use the same strategy and capture that 100 percent bonus depreciation. This is a huge incentive that CRE owners and developers must not overlook.
Which assets qualify for this tremendous incentive? The best way to answer that question is through a cost segregation study. Specialty engineers will assess and categorize your assets into different class lives based on IRS designations. Property with a class life of 20 years or lower is eligible for bonus. Study results will determine which property qualifies for bonus and will support accelerated depreciation and other tax strategies. Quality cost segregation studies are also highly defensible in the rare case of an audit.
An unresolved error
Congress created further incentives by identifying different types of “improvement property.”
In the past, there were qualified leasehold, restaurant and retail improvements, and each was eligible for various types of special treatment.
Today, only one designation remains—Qualified Improvement Property (QIP). QIP placed in service after December 31, 2017, was intended to have a 15-year recovery period and therefore be eligible for bonus depreciation. (Remember, property with a class life of 20 years or below is bonus-eligible.)
However, because of a drafting error, the new QIP designation was never actually included in TCJA. This oversight means that QIP currently has a 39-year recovery period and, as it stands, is not eligible for bonus depreciation.
A technical correction has been expected for some time and bipartisan legislation was introduced in March, but it has not yet been passed. Overall, CRE pros are optimistic that this will ultimately be resolved.
1031 exchanges allow investors to defer paying capital gains taxes on investment properties when they’re sold, as long as another “like-kind property” is purchased. These exchanges have been around for a while, but there seems to be a good deal of renewed interest in them.
Why now? Put simply, because property owners are looking for proven ways to save on their taxes while QIP is still in flux. The changes in bonus depreciation have also increased the appeal of 1031s. The TCJA eliminated 1031 exchanges for personal property but left exchanges on commercial real estate intact, expanding the deductions allowable on commercial property.
A newer tax savings option is the opportunity zone (OZ). These zones were created to encourage investment in low-income areas through tax incentives.
There are 8,700 certified OZs nationwide. Incentives for investment include: a temporary tax deferral until the end of 2026, a step-up in the basis of the original investment from 10-15 percent over time, and permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in a qualified fund, if the investment is held for at least 10 years.
Opportunity zones are all about economic growth and helping underserved communities grow and become more prosperous. OZs differ from 1031 exchanges in that OZs permit investment anywhere and into any type of property. OZs are also a permanent tax deferral.
The challenge with OZs is the timeline: You must make your investment within 180 days and substantially improve the property within 30 months. You have to be certain that you can get that project permitted and completed. If you buy an existing building, you have to make substantial improvements within the aforementioned 30 months. Investment in a zone that straddles a more economically diverse area might minimize risk, particularly if you can start building from the perimeter in or build out around it.
Collaboration is key
Commercial real estate professionals can provide the best counsel to their clients by building a network of trusted referral partners. You have to carefully build relationships with colleagues you can trust to care for your clients the same way you do. The market is so complex that collaboration has become increasingly critical. One of the benefits of SIOR membership is the access to a network of qualified professionals across the country.
The best way for clients to feel confident that they are fully leveraging all appropriate tax strategies starts with having a good CPA—someone who understands all the ins and outs of this market and can bring on qualified referral partners.
On the horizon
Looking ahead, this complex but opportunity-rich environment is expected to continue for some time. Real estate is driving much of the economy and the market will stay strong for a while, especially with these new tax changes. We anticipate more developments as the new law continues to roll out and we encourage CRE professionals to keep abreast of changes in legislation.
Terri S. Johnson, CRE
Co-founder and Managing Partner, Capstan Tax Strategies
Capstan Tax Strategies delivers engineering-driven specialty tax solutions that maximize the valuable tax benefits of real estate holdings. By complementing and collaborating with accounting firms, we arm commercial real estate owners, executives and tenants with the data and analysis required to accelerate depreciation, maximize deductions and capture tax credits.
Robert Dikman, SIOR
Chairman and CEO, The Dikman Company
The Dikman Company, Tampa Bay’s premier commercial real estate brokerage, has been providing clients throughout Florida with a full range of professional commercial real estate services since 1983. Chairman and CEO Robert “Bob” Dikman is a fourth-generation real estate legacy.