The CARES Act includes several tax-related provisions intended to mitigate the adverse economic effects of the health crisis by reducing tax burdens and getting cash into the hands of taxpayers sooner. Most of these tax provisions relax changes made by the 2017 Tax Cuts and Jobs Act (TCJA), often retroactively. Those of particular relevance to the real estate industry are discussed below.
Net Operating Losses (NOLs)
The CARES Act temporarily reinstates and expands the NOL carryback that had been eliminated by the TCJA. It allows a taxpayer that incurs an NOL during a taxable year beginning after December 31, 2017 and before January 1, 2021 to carry its NOL back to each of the five taxable years preceding the year of the loss.
The new law also suspends the TCJA’s 80 percent of taxable income limitation for NOL carryovers arising in taxable years beginning prior to January 1, 2021.
Excess Business Loss
For taxable years beginning after December 31, 2017 and before January 1, 2026, the TCJA limited the ability of individuals to offset their non-business income with active business losses exceeding a threshold amount ($500,000 joint return/$250,000 single). Such “excess business losses” are required to be treated as part of the taxpayer’s NOL carryforward to subsequent taxable years.
The CARES Act retroactively defers the effective date of these “excess business loss” rules. Specifically, the rules will now apply only to taxable years beginning after December 31, 2020 and before January 1, 2026.
163(j) Business Interest Expense Limitation
Starting in 2018, new Section 163(j) limited a taxpayer’s deduction for business interest expense to the sum of the taxpayer’s business interest income for that year plus 30 percent of the taxpayer’s “adjusted taxable income” (ATI) for that year. Any excess business interest expense was carried forward to succeeding taxable years, where it could be utilized if sufficient taxable income was generated in the future by the business.
The CARES Act mitigated the impact of this rule for taxable years beginning in 2019 and 2020, by increasing the ATI limitation to 50 percent from 30 percent. For partnerships, the rules are more complicated for 2019; the limitation remains at 30 percent. However, each partner in the partnership may treat 50 percent of that partner’s share of the disallowed business interest expense as a deductible expense incurred in 2020, without limitation. The remaining 50 percent of disallowed 2019 interest expense remains suspended at the partner level until the partner has enough income from that partnership to free it up in 2020 or in a subsequent year. A partnership’s business interest expense for 2020 is subject to a 50 percent ATI limitation at the partnership level and the special partner-level rules are not applicable. Taxpayers have the option to elect out of these new rules.
Bonus Depreciation on Qualified Improvement Property (QIP)
The CARES Act corrected an error in the TCJA, commonly referred to as the “glitch,” which prevented QIP from being eligible for a 15-year depreciable life and qualifying for bonus depreciation. QIP is generally defined as any improvement to the interior portion of a non-residential building. The CARES Act retroactively corrected the “glitch,” effective for property placed in service after December 31, 2017, to treat such property as 15-year property making it eligible for 100 percent bonus depreciation.
The CARES Act did not address the impact of some of these changes on taxpayers who decided to elect to be treated as real property trades or businesses (RPTBs) under 163(j). Electing taxpayers are not subject to the Section 163(j) limitation on interest expense, but are required to use less favorable depreciation methods. The election is irrevocable. Prior to the CARES Act, QIP was required to be depreciated using a 40-year ADS life when the RPTB election was made and was not eligible for bonus depreciation.
However, the IRS has issued guidance (Rev. Proc. 2020-22) allowing a taxpayer to withdraw the otherwise irrevocable election or to make a late election by amending the return at issue. Additionally, the IRS issued Rev. Proc. 2020-25, which is applicable to the 2018, 2019 and 2020 tax years, with guidance on implementing the retroactive fix to the glitch on depreciation. Taxpayers who are making this fix that in connection with either revoking or making a late RPTB election under Rev. Proc. 2020-22 must follow that Rev Proc. Taxpayers who are subject to Rev. Proc. 2020-25 and who have filed only one return under the pre-fix method may either amend that one return or file for an automatic accounting method change utilizing Form 3115 with the succeeding year’s return. Taxpayers who have filed two returns under the pre-fix method must file a Form 3115.
Rev. Proc. 2020-25 also provides relief for taxpayers seeking to either make a late election or revoke an election with respect to electing ADS or opting out of bonus depreciation.
1031 Exchanges
The TCJA repealed Like-Kind Exchanges (Section 1031) for all other types of property that are not real property. The basic mechanics of a Section 1031 exchange haven’t changed. A taxpayer must still identify their replacement within 45 days and exchange within 180 days.
The IRS issued Notice 2020-23, affording taxpayers an extension to July 15, 2020 to perform certain “Specified Time-Sensitive Acts” that are due to be performed on or after April 1, 2020 and before July 15, 2020, including the 45-day identification period or the 180-day exchange period. The Notice does not provide relief if a deadline arose prior to April 1, 2020.
Qualified Opportunity Funds (QOF)
The 180-day investment period to invest gains into a QOF is also extended by Notice 2020-23. Taxpayers electing to invest gains into a QOF within a 180-day period that would have ended between April 1, 2020 and July 15, 2020 will now have until July 15, 2020 to invest in a QOF and elect to defer the eligible gains.
Steve D. Brodsky, CPA, JD, LL.M., is a director in the real estate group with Marks Paneth LLP. Alan M. Blecher, JD, is a principal with the firm.