The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Pub. L. No. 116-136), signed into law on March 27, 2020, provides a variety of avenues to generate cash inflows for taxpayers affected by the COVID-19 pandemic. The CARES Act addresses areas that can create cash inflows for real estate taxpayers, including net operating loss (NOL) carrybacks and the much-anticipated technical correction to qualified improvement property.
Net Operating Losses
The passage of the Tax Cuts and Jobs Act (TCJA) in 2017 eliminated the option to carry back NOLs arising in tax years ending after December 31, 2017, for most taxpayers. In addition, the TCJA created an income limitation on using losses carried forward to future years. This limit allowed for a NOL carryforward to offset only 80 percent of taxable income in the year used.
Section 2303, Modifications for Net Operating Losses, of the CARES Act provides for numerous changes to the previous NOL laws passed in the TCJA. The most notable change to existing NOL regulations was the addition of a special rule for NOLs arising in 2018, 2019, and 2020. NOLs arising in taxable years beginning after December 31, 2017, and before January 1, 2021, may be carried back to each of the five taxable years preceding the taxable year of the loss.1 In addition, the CARES Act temporarily removes the 80 percent income limitation for NOLs used for tax years arising before tax year 20212; therefore, a taxpayer can deduct up to 100 percent of the taxable income in the year used, if available.
The TCJA also created limitations on excess business losses for entities other than corporations for taxable years beginning after December 31, 2017, and before January 1, 2026. These limitations were to disallow losses in excess of $250,000 for single and married filing separate taxpayers and $500,000 for taxpayers married filing jointly.6
Section 2304, Modification of Limitation on Losses for Taxpayers Other Than Corporations, of the CARES Act amended Internal Revenue Code (IRC) §461(l)(1) to allow business losses without limitation for taxable years beginning after December 31, 2017, and before December 31, 2021.7
Qualified Improvement Property
Qualified improvement property (QIP) was created as a result of the TCJA in 2017 and is defined as any improvement made by a taxpayer to an interior portion of a building that’s nonresidential real property if such improvement is placed in service after the date such building was first placed in service.3 QIP doesn’t include the enlargement of a building, any elevator, or escalator or the internal structural framework of a building.4 This term replaced qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property. While Congress’ original intention was to classify QIP as 15-year MACRS assets and, thus, eligible for 100 percent bonus depreciation, there was a drafting error in the final text of the TCJA. This drafting error, which became notoriously known as the “retail glitch,” required QIP to be classified as 39-year straight-line MACRS property, which isn’t eligible for bonus depreciation.
Section 2307, Technical Amendments Regarding Qualified Improvement Property, of the CARES Act addresses the “retail glitch” created by the TCJA. This technical correction provided in the CARES Act now retroactively assigns QIP as 15-year MACRS property eligible for 100 percent bonus depreciation.5
Cash Flow Opportunities & Planning Considerations
The passage of the CARES Act brings several planning options to the table in creating cash inflows for taxpayers to help increase or generate NOLs on 2018, 2019, and 2020 tax returns.
- Consider reviewing prior-year tax returns with NOLs for potential amendment or filing for a tentative refund claim to receive cash.
- NOLs carried back to tax periods beginning before January 1, 2018, prior to the passage of the TCJA, can offset prior-year income taxed at higher rates.
- The potential benefits of NOL carrybacks vary depending on the taxpayer’s circumstance:
- For example, if a carryback year had a capital gain transaction with preferential tax rates, the taxpayer may want to consider carrying forward the NOL if it can offset ordinary income taxed at a higher, marginal tax rate.
- Review 2018 QIP placed in service for amendment of 2018 or 2019 returns or file Form 3115 in tax year 2020 (and 2019 with regard to 2018 QIP if the 2019 return hasn’t been previously submitted) to create a favorable §481(a) change in accounting method adjustment.
- As the change in classification of QIP to a 15-year MACRS asset is retroactive, QIP that was placed in service as a 39-year straight-line asset in 2018 or 2019 is considered being depreciated on an improper accounting method. The return must be amended, or a Form 3115 must be filed to correct the improper tax accounting treatment.
- See Rev. Proc. 2020-25 for more information.
- Consider the following example:
Other Cash Flow Planning Considerations
- Consider accounting method changes to increase or generate a NOL:
- Prepaid expenses (looking for possible prepaid insurance to drive down taxable income)
- Accrual-to-cash accounting method changes for taxpayers under the §448(c) gross receipts test
- If your real estate entity has payroll, refer to BKD’s COVID-19 Tax & Accounting Resource Center for more information on the Paycheck Protection Program and other U.S. Small Business Association lending services.
- Consider advancing depreciation on new construction through a cost segregation study for owner-occupants.
- After the CARES Act, the 163(j) business interest limitation is 50 percent of adjusted taxable income (taxable income before interest expense, depreciation, amortization and depletion) for 2019 and 2020 for corporations and 2020 for partnerships.
- Consider delaying any federal and state tax remittances until July 15, 2020 (or state extended due date), if applicable.
- Due to the uncertainty of future cash flows and COVID-19’s economic effect, consider working with your advisor on projecting 2020 taxable income to calculate quarter-by-quarter estimates instead of paying safe harbor estimates based on potentially higher income in 2019.
See this recent BKD Thoughtware® article for more information. If you have questions, reach out to your BKD Trusted Advisor™ or use the Contact Us form below.
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1 IRC §172(b)(1)(D)(i)(I) ↩
2 IRC §172(a)(1) & §172(a)(2) ↩
3 IRC §168(e )(6)(A) ↩
4 IRC §168(e )(6)(B) ↩
5 Pub. L. No. 116-136 §2307(b) ↩
6 IRC §461(l)(3)(A)(ii)(II) ↩
7 Pub. L. No. 116-136 §2304(a)(1)(B) ↩