On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (CARES Act) was signed into law in response to the unprecedented economic disruption caused by the COVID-19 pandemic. The $2.2 trillion stimulus package was intended to provide relief and assistance for families and small businesses and broad support to all sectors of the economy during the nationwide shutdown of the economy.
Buried in the 300+ pages of enhanced unemployment benefits, eviction moratoriums, and paycheck protection provisions, the CARES Act contains important tax relief measures specifically designed to help commercial real estate operators, investors and businesses maintain liquidity by recouping already-paid taxes and deferring new taxes. If successfully deployed, these measures provide significant benefits to the real estate industry.
Net Operating Loss Changes: Before passage of the Tax Cuts and Jobs Act (TCJA) in 2017, net operating losses (NOL) incurred by real estate businesses could be carried back for two years and forward for twenty years. TCJA changed how losses could be claimed, eliminating the ability to carry losses back, limiting claimed losses to 80% of taxable income, and allowing losses to be carried forward indefinitely. The CARES Act will temporarily suspend those TCJA provisions for tax years 2018, 2019, and 2020. Now 100% of NOL in those years can be carried back for five years, thus allowing taxpayers to recoup taxes already paid in those three years. For example, a real estate business that suffers net operating losses in 2020 can carryback those losses to prior profitable years and receive a refund of previously paid income taxes. This provision applies to NOLs suffered in 2018, 2019, and 2020. However, this measure does not allow REITs to carry back losses.
Elimination of Excess Business Loss Limitations: The TCJA limited the ability of non-corporate taxpayers to deduct “excess business losses.” The Code defines an “excess business loss” as the excess of an investor’s deductions from all trades or businesses over aggregate gross income from the taxpayer’s trades or businesses plus $250,000 (or $500,000 if a joint return is filed). This limitation went into effect in 2018 and adversely affected many real estate owners. The CARES Act delays the effective date of this provision to tax year 2021, thus allowing the deduction of excess business losses for tax years 2018, 2019 and 2020. Filing amended returns for those tax years could create or increase net operating losses which could then be carried back as described above.
Increase of Business Interest Expense Deduction: Under the TCJA, the deductibility of business interest is limited to no more than 30% of the real estate business’s adjusted taxable income. For a highly leveraged industry like real estate, this limitation constricts the industry liquidity. The CARES Act increases the allowed amount of deductible interest from 30% of the business’s adjusted taxable income to 50% of that income for tax years 2019 and 2020. This increase will provide incentives for businesses to take on additional debt during the pandemic. Additional net operating losses may also be created by this increase, which can then be carried back to prior tax years. Partnerships and individual partners are subject to variations of this new rule.
Correction of Qualified Improvement Property Deduction: A drafting error in the TCJA regarding the deduction of the costs of interior capital improvements to commercial property (called “Qualified Improvement Property” or QIP) was corrected in the CARES Act. The original intent of Congress in drafting this provision was to allow nonresidential commercial property owners to deduct 100% of the cost of interior capital improvements in the year the improvements were placed in service. But as drafted in the TCJA, property owners would have to depreciate QIP expenditures over 39 years. The CARES Act not only corrected this drafting error but also expanded the definition of QIP to include nonresidential rental property and made these changes retroactive to 2018. This expanded QIP definition applies to all commercial rental property types, including office, retail, hotel, and industrial. The CARES Act provisions now allow a commercial property owner to deduct 100% of interior improvement costs in the tax year the improvements are made, instead of depreciating those expenses over 39 years. The retroactivity provision allows taxpayers who made QIP improvements in the years 2018 or 2019 to file amended returns to claim tax refunds.
The CARES Act tax provisions described above offer significant relief to commercial real estate stakeholders dealing with the effects of the pandemic. CRE owners, operators, and investors should watch for Treasury and IRS guidance and consult with their tax attorneys and accountants to structure the most effective path forward to maximize liquidity and minimize risk going forward.
Director of Research