Federal and State Tax Compliance and Consulting
With the enactment of the Tax Cuts and Job Act (TCJA), tax compliance and strategic planning has never been so complex and overwhelming. Our team of experts can help navigate through some of the most controversial topics related to real estate activities:
Business Interest Deduction
The TCJA limits the interest expense deduction to 30% of business “adjusted taxable income”. This is applicable to all taxpayers regardless of the form in which the business is operated, with the exception of small businesses with average gross receipts of $25 million or less. Any business interest that is not deductible due to this limitation can be carried over to future years indefinitely. Investment interest is excluded from this limitation. However, mortgage interest paid by a business for its real property used in its trade or business is not considered as investment interest and therefore is subject to such limitation. Similarly, real property trades or businesses such as real estate development, rental, management, or leasing are also subject to the same treatment. Luckily, there is an election that can be made to avoid such limitation. There are many issues around this provision which taxpayers should consider such as control group gross receipts, aggregation, and mandatory depreciation method under ADS.
Qualified Business Income Deduction
One of the tax benefits introduced by TCJA is the 20% deduction of “qualified business income” (QBI) for certain taxpayers. There is significant controversy regarding whether rental activities owned by an individual are qualified businesses. In January 2019, the IRS issued guidance clarifying the application of QBI deduction related to real estate activities. In particular, the IRS provided a safe harbor to determine if individuals owning rental properties are qualified to take the QBI deduction. To qualify for safe harbor, a taxpayer will have to spend 250 or more hours performing rental services and adhere to specific record-keeping requirements. This part of the tax code is still lacking clarity and therefore need IRS guidance.
Rental activity is subject to passive activity rule which limits the application of rental loss against non-passive income. However, under certain circumstances rental activity can be grouped with operating business activity thereby allowing the taxpayer to use the rental loss against operating business income. Taxpayers can also use the strategy of grouping to maximize a QBI deduction.
Qualified Improvement Property and Bonus Depreciation
The TCJA eliminates the separate classification of qualified leasehold improvement, qualified restaurant improvement, and qualified retail improvement property and consolidated them into a single category called “qualified improvement property” (QIP). Although Congress intended for QIP to fall under the same 15-year MACRS treatment for depreciation purpose, it never made it into the tax code. Therefore, QIP still has a 39-year recovery period and is not eligible for bonus depreciation. To soften the blow of deduction restrictions, there are other strategies a taxpayer can consider, such as a cost segregation study.
Listed below are other real estate-related topics that are beneficial in maximizing deductions for taxypayers.
- 1031 Exchange
- Cost Segregation Opportunity
- Delaware Statutory Trust
- Green Energy Tax Credit Consulting (45L & 179D)
- Opportunity Zone
At KROST, we understand that Federal and State Tax Compliance is complex and ever situation is unique. Our team of real estate experts can provide much needed guidance and analysis to ensure an optimal outcome.