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CPA Experts: Tax Changes Posed Challenges for Commercial Real Estate Professionals in 2019

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By Meghan Hall

Tax season has come and gone, but for many within the commercial real estate industry, questions remain. As CRE firms navigated new tax codes and regulations, uncertainty around how to implement and interpret deductions was a challenge for many, according to Michael Hall, a partner and CPA with Moss Adams. The hope is that over time, as changes to the tax code become clearer, that they also become more development-friendly, a positive for regions that are experiencing unprecedented growth like the Puget Sound.

Michael Hall of Moss Adams
Image Credit: Moss Adams

Moss Adams is one of the largest public accounting firms in the United States and offers accounting, tax and consulting services to a variety of enterprises, including those in the commercial real estate industry. In your opinion, was this tax and accounting season what you anticipated it would be from a commercial real estate standpoint? Why or why not?

The most substantive changes to the tax code impacting those in the real estate industry are a) changes to depreciable lives of certain real property assets, b) the Qualified Business Income Deduction c) the Limit on Business Interest Expense and d) the tax benefits available for investments in Qualified Opportunity Zone Funds.

The changes to depreciation were intended to be beneficial, but at least in one material instance were not. Qualified Improvement Property (generally, improvements such as leasehold improvements made to the interior portion of a nonresidential building) was intended to be depreciable over 15-years and eligible for bonus depreciation.  Due to an apparent drafting omission, QIP is depreciable over 39-years and not eligible for bonus depreciation.

The Qualified Business Income Deduction allows those receiving pass-through income from real property trades or business to receive up to a 20 percent reduction in the top marginal tax rate assessed on such income (from 37 percent to 29.6 percent) provided specified thresholds are met with respect to the basis of assets used, and wages paid, in the trades or businesses.

The Limit on Business Interest Expense places a cap on the amount of business interest expense deductible in a given year with respect to trades or businesses.  The cap is 30% of Adjusted Taxable Income, a defined term. Currently, this is generally taxable income of the taxpayer before deduction of interest, net operating losses, the Qualified Business Income deduction, depreciation and amortization.  Beginning in 2022, depreciation and amortization will no longer be added back in determining ATI for purposes of the limit.

Investments in Qualified Opportunity Zone Funds allow investors to achieve a tax deferral on capital gains invested in QO Funds, and, provided certain holding periods are met, a permanent exclusion from tax on up to 15 percent of their original gain deferred, and their appreciation in the investment in the QO fund itself.

What were the biggest challenges that property owners, developers and trusts often face during tax and accounting season? Has Moss Adams seen this change over the course of the market cycle? If so, how?

The biggest challenge faced this tax season has been the uncertainty surrounding interpretation and implementation of the four provisions noted above.  

The industry is hopeful that a technical correction will be made to change the depreciable life of QIP to 15-years, making it eligible for 100 percent bonus deprecation, and that such correction will be made retroactive to January 1st2018.

Final regulations regarding the Qualified Business Income Deduction were just published in January of 2019.  Taxpayers and their advisors continue to wrestle with determining such things as a) whether their real estate holdings rise to the level of a trade or business making them eligible for the deduction; b) whether and to what extent to make aggregation elections that cannot easily be unmade later if interpretations change; and whether certain real estate advisory business will be considered Specified Service Trades or Businesses ineligible for the full benefits of the provisions.

Final regulations are yet to be published with respect to the Limitation on Business Interest Expense.  Certain real property trades or business can make an irrevocable election out of the limitation – the cost of which is to change the depreciation on their real property assets to the Alternative Depreciation System. Given that this election, once made, is irrevocable, taxpayers and their advisors are hesitant to proceed in making such elections without clearer guidance regarding the impact presently and in the future.

As this response was being written, additional guidance has been published with respect to what types of property and businesses will qualify for investment by QO Funds.

While none of the above has anything to do with the market cycle, the changes have been extraordinary, and we’ve been devoting substantial time and resources to providing the best guidance possible to our clients as they navigate the new provisions.

Looking at local policy, what are some of the tax and investment advantages to operating and investing in the Puget Sound region? Are there any disadvantages? What are the biggest risks that real estate professionals currently face?

Several areas within the region have been designated as opportunity zones.  Developers and investors are beginning to see the Opportunity Zone Fund program as a means to attract capital for investment and achieve potentially higher after-tax returns for investors in QO Funds.

Are there any investment opportunities that those in the commercial real estate industry are not capitalizing upon? What conditions are preventing them from investing?

Due to the operation of the rules related to Qualified Opportunity Zone Funds, projects generally have to be “shovel-ready” to attract investment, and those holding property within the zones prior to 2018 are limited in their ability to participate on a tax-deferred basis with developers wishing to partner with them.

As additional guidance is released and developers and investors understand the benefits, we believe these programs will attract significant investment and foster development opportunity.

Looking ahead, does Moss Adams expect tax legislation to continue to change in the next couple of years, either regionally or nationally? If so, what impact could this have on the Puget Sound commercial real estate market?

The one constant both regionally and nationally when it comes to legislation is change.  Regionally, the general hope is that legislation will become more development-friendly. That being said, there are real societal concerns to be addressed for the region to continue to prosper.  Organizations such as the Urban Land Institute and others like it work tirelessly to assist governmental bodies, developers, the businesses they serve and their communities they live and work in address the needs of tomorrow.