Armanino Blog

The Impact of the CARES Act on the Real Estate Industry

by Robert E Tuvell
April 02, 2020

On March 27, 2020, the CARES Act was signed into law to provide relief to millions of American taxpayers and businesses impacted by the COVID-19 pandemic. Here are the key provisions of the legislation and its applicability to the real estate industry.

Bonus Depreciation on Qualified Improvement Property (QIP)

Previously, a drafting error in the 2017 Tax Cuts and Jobs Act (TCJA) resulted in QIP being ineligible for 100% bonus depreciation under the modified accelerated depreciation system (MACRS) as Congress had intended. The CARES Act corrects that error, making QIP eligible for 100% bonus depreciation. Taxpayers can choose three options for depreciating QIP:

  1. Claim 100% bonus depreciation
  2. Depreciate using 15-year MACRS depreciation
  3. Depreciate under the alternative depreciation system (ADS) over a 20-year life (Due to the 2017 drafting error, QIP previously had a 40-year ADS class life)

One reason taxpayers may choose not to claim bonus depreciation or MACRS depreciation on QIP is that real estate entities may need to be electing real property trades or businesses (ERPTB) in order to avoid a limitation on deductibility of interest expense under §163(j). In order to make the ERPTB election, taxpayers are required to use ADS depreciation on depreciable real estate (including QIP). Where significant QIP has been placed in service by real estate entities in 2018 or 2019, taxpayers will need to consider the benefits gained and lost as a result of a number of interdependent rules including bonus depreciation, the §163(j) interest expense limitations, the §199A qualified business income deduction, individual or corporate net operating loss provisions, etc. Particularly where a taxpayer is subject to §163(j) limitations, bonus depreciation may not be a good option for taxpayers.

163(j) Business Interest Limitation

As a result of TCJA, many business entities (including passthrough entities) became subject to new limitations on the deductibility of interest expense. The limitation was generally equal to 30% of the taxpayer’s adjusted taxable income for the year, and interest expense in excess of the limitation could not be deducted — and was generally deferred — at the partner level. The CARES Act does not change the partnership limitation for the 2019 year, but instead allows partners to deduct 50% of the excess business interest allocated to them from partnerships in 2019.

Given that many real estate entities avoid the application of §163(j) via an election to be an ERPTB, this modification that the CARES Act provides may not create a significant benefit. However, an analysis should be performed to consider the potential benefits of accelerated depreciation and changes in the qualified business income deduction. It is unclear at this point whether taxpayers who previously made the ERPTB election will have an opportunity to amend prior tax returns versus making prospective changes.

Payroll Tax Credits and Deferrals

While a significant number of real estate entities do not have employees due to the utilization of management companies, those that do may be able to obtain payroll tax-related relief. The CARES Act includes two major provisions:

  • Employee retention credits: Provides for a refundable payroll tax credit for 50% of eligible wages paid by eligible employers
  • Deferral of employer payroll tax payments: Permits the deferral of the employer potion of certain payroll taxes through the end of 2020

Net Operating Losses

Previously, net operating losses (NOL) were limited to 80% of taxable income and did not allow for NOLs to be carried back. Under the CARES Act, the 80% limitation has been suspended for years beginning before January 1, 2021. Additionally, NOLs generated in taxable years beginning after December 31, 2017 and before January 1, 2021 can be carried back to each of the five preceding years. For individuals, it does not appear that the 90% limitation under the alternative minimum tax has been removed, so taxpayers will need to assess whether they stand to benefit more from carrying NOLs back versus forward.

Excess Business Loss Limitations

Business loss limitation rules previously deferred deductibility of an individual’s annual net business losses in excess of $500,000 (excess business losses), with such losses becoming part of a taxpayer’s net operating loss to be carried forward. The CARES Act repeals the excess business loss limitations for the 2018, 2019 and 2020 tax years. Individual taxpayers who were subject to this limitation in 2018 and/or 2019 should consider amending prior tax returns and adjusting relevant tax calculations (carryforward balances, etc.) for 2019 and 2020. This may create an opportunity for individual taxpayers to create (or increase) an NOL for 2018 and 2019 and utilize those NOLs to claim refunds for taxes paid as far back as 2013.

Forbearance From Federally-Backed Mortgages and Moratorium on Evictions

The CARES Act allows borrowers with a federally-backed mortgage who are experiencing financial hardship due to the COVID-19 emergency (directly or indirectly, with no documentation required beyond the attestation of the borrower) to request a forbearance (a temporary reprieve on payments) by submitting a request to the borrower’s servicer, regardless of their current delinquency status. The forbearance may be granted for up to 180 days and may be extended for an additional 180-day period. During the forbearance, a servicer of a federally-backed mortgage may not assess fees, penalties or interest beyond those which are regularly scheduled or calculated as if the borrower made all required payments, nor shall such a servicer execute foreclosures (or foreclosure-related evictions) for at least 60 days beginning March 18, 2020, except with respect to a vacant or abandoned property.

Forbearance From Federally-Backed Multifamily Mortgages and Moratorium on Evictions

Similarly, the CARES Act allows a multifamily borrower with a federally-backed multifamily mortgage who is experiencing financial hardship due to the COVID-19 emergency (directly or indirectly, with no documentation required beyond the attestation of the borrower) to request a forbearance for up to 30 days. Borrowers can additionally request two 30-day extensions. During the forbearance period, a borrower may not evict any tenant for nonpayment of rent or charge late fees or other penalties for late payment of rents.

Temporary Moratorium on Evictions

Beginning on the enactment date of the Cares Act and continuing for a period of 120 days (the moratorium period), a landlord is prohibited from filing for an eviction because a tenant has not paid rent or other fees or charges, or charging the tenant any fees or penalties because the tenant has not paid rent. Additionally, during the moratorium period, the landlord is prohibited from giving a tenant a notice to vacate. Once the moratorium period has ended, the landlord must give the tenant 30 days to vacate the rented premises and cannot require the tenant to vacate at an earlier time. This temporary eviction moratorium applies to residential tenants that live in a residence that participates in a covered housing program, assuming the landlord’s mortgage is insured, supplemented, guaranteed or protected by HUD, Freddie Mac, Fannie Mae, the rural housing voucher program or the Violence Against Women Act of 1994.

Forgivable Loans for Businesses

Qualified businesses can obtain loans to keep personnel employed. The loans also allow for qualifying costs to be paid such as rent, mortgage interest and utilities. These loans not only provide funds to landlords in order to pay their operating costs, they also provide funds to tenants to pay their rents to landlords.

Given the various components of the CARES Act, multiple analyses will need to be performed in order to consider the interrelationships between interest deductions, NOLs, bonus depreciation and qualified business income tax deductions. The ultimate benefits of the CARES Act remain to be seen at this point. However, the legislation provides real estate entities with more flexibility to maximize deductions and provides non-tax economic relief to assist with the impending economic downturn.

For the latest regulatory updates and more information on keeping your business running through disruption, visit our COVID-19 Resource Center.

April 02, 2020

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