Home Commercial Tax Cuts to Bring New Regulations to Real Estate Businesses

Tax Cuts to Bring New Regulations to Real Estate Businesses

Tax Cuts, S-Corp, HVAC, Section 179, Qualified Leasehold Improvement Property, Qualified Restaurant Property, Qualified Retail Improvement Property, Real Property Trade, Alternative Depreciation System

By Robert Keasal

Rob Keasal
The Tax Cuts and Jobs Act of 2017 will be the most complex re-writing of tax codes for flow-through business income since Congress gave us the passive activity rules in 1986. Every business owner will have to deal with these rules to determine if there is a deduction available or a loss limited. These changes will only apply until the end of 2025, when they expire.

Generally for businesses with employees, the flow-through business owner will get to deduct 20 percent of their business income. However, this might be limited to 50 percent of the wages they pay their employees, or if they don’t pay much in wages, it could be limited based on 25 percent of wages paid plus 2.5 percent of the cost of their depreciable property used in the business. Overall, the deduction may be limited if taxable income is more than $315,000 ($157,500 for singles) for a married couple.

Reasonable wages paid to S-Corp shareholders and guaranteed payments to partners will not qualify for the deduction. Specified service business income and investment management business income will not qualify for the deduction unless the business income is under the threshold amounts described above.

Rental businesses tend to have little in wages. Therefore, the deduction entitled to a landlord will be determined based on 25 percent of the wages they pay in that rental business plus 2.5 percent of the cost of their rental properties. The cost of the assets used in that business will not be used in the calculation if they have been held for the longer of 10 years or the depreciable life of the property. So, 10 years for personal property, 15 years for land improvements, 27.5 years for residential property and 39 years for commercial property.

Another peculiar rule is that if the business produces a loss, the loss is carried to the subsequent year to be combined with that year’s income to determine the deduction in the subsequent year.

Also, trade or business losses will now be limited in general to $500,000 for married couples and $250,000 for singles. The amount of business losses in excess of these amounts will be carried to the following year. This rule is applied after the passive activity rules, therefore it only applies to materially participating businesses or the combined loss of a real estate professional.

Starting in 2018, roofs, HVAC, fire protection systems and alarm systems can be expensed rather than depreciated. They will be included in the taxpayers overall expensing election under Section 179 of $1,000,000. This has been increased from $500,000 and the rules relaxed for commercial structures only.

Qualified Leasehold Improvement Property, Qualified Restaurant Property and Qualified Retail Improvement Property have all been combined into one item called Qualified Improvement Property that can be depreciated over 15 years. This is non-residential property placed in service after the original property is placed in service.

Generally, businesses will only be able to deduct interest expense equal to 30 percent of the adjusted taxable income of the business plus interest income. There is an exception for small businesses, those with less than $25,000,000 in gross receipts, but not for tax shelters. Tax shelters include partnerships that offered their interests for sale in any offering required to be registered with any Federal or State agency having the authority to regulate the offering of securities for sale. Therefore, many real estate funds will have to deal with these rules unless they elect to be treated as an “Electing Real Property Trade or Business” and such election once made is irrevocable. While this election will allow deduction of all interest paid for the property, it will require depreciation under the Alternative Depreciation System, which uses longer lives, such as 20 years for land improvements and Qualified Improvement Property, 30 years for residential properties and 40 years for commercial properties.

Other things to consider:
• Like-Kind exchanges will only be available for real property
• Profits interests will have to be held for more than three years in order for the gain on sale to be treated as long-term capital gain
• Rehabilitation credit will only be allowed for historic structures

The Tax Cuts and Jobs Act has some very complex new concepts in it. These new circumstances have put into motion an alternative set of rules that should be considered with care.

Rob Keasal is the Tax Director for Peterson Sullivan, a leading public accounting and advisory firm based in Seattle. He has more than 33 years of public accounting experience, and specializes in providing tax and business consulting services to a variety of industries including real estate development and operations, law firms, manufacturing, heavy equipment sales, and restaurants. Rob has a broad range of experience in entity selection and formation, including allocations for partnerships; estate planning; estate and trust taxation; and family wealth preservation. For more information, contact him at rkeasal@pscpa.com.

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