Seyfarth Synopsis: On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act includes federal tax provisions that should provide relief to real estate businesses, which may be severely impacted by the COVID-19 pandemic. The CARES Act corrects one lingering technical error from 2017 relating to qualified improvement property, relaxes several limitations under current tax law, and provides payroll tax related provisions for 2020 that are intended to lessen the burden to employers of keeping employees on their payroll during this financially difficult period.
1. Qualified Improvement Property Fix
Real estate businesses have been waiting since the enactment of P.L. 115-97 (popularly referred to as the Tax Cuts and Jobs Act of 2017) (the “TCJA”) for a technical correction bill that would resolve an obvious drafting error in the TCJA. Specifically, Congress intended to change the depreciation period for “qualified improvement property” (which, generally, is any improvement, including leasehold improvements, made to the interior portion of a nonresidential building after the building was placed in service) from 39 years to 15 years, but inadvertently neglected to make the required change to the statutory text. The error created two problems: (1) qualified improvement property had a longer-than-intended depreciation period, and (2) qualified improvement property was not eligible for the immediate expensing provided by the TCJA because that benefit was only available for assets with a depreciable life of 20 years or fewer. Fortunately, Congress included the technical correction in the CARES Act and real estate businesses can now depreciate qualified improvement property over a 15-year period or immediately expense its cost if certain other requirements are met. The change is retroactive to January 1, 2018, such that real estate businesses should also consider amending prior tax returns to take advantage of the accelerated depreciation alternatives.
2. Increased Cap on Business Interest Expense Deduction
Businesses, other than certain small businesses, are subject to an annual limitation on the amount of business interest expense that they can deduct. Generally speaking, the limitation denied businesses a current deduction for any business interest expense that exceeded 30% of the taxpayer’s adjusted taxable income (“ATI”). Any excess business interest expense must be carried forward to the next taxable year. ATI is defined in a manner that approximates EBITDA for tax years 2018-2022 and EBIT for tax years beginning after 2022. Congress allowed certain real estate businesses to elect out of this limitation, but the election is not necessarily advantageous because it requires the electing real estate business to use longer depreciation periods for its real estate (especially multifamily property) and improvements and denies it the ability to immediately expense qualifying property.
For those real estate businesses that are subject to the limitation, the CARES Act increases the 30% of ATI cap to 50% of ATI for taxable years beginning in 2019 or 2020. Moreover, Congress expects that businesses will have a lower ATI in 2020 than they did in 2019, so the CARES Act also allows businesses to elect to use their 2019 ATI rather than their 2020 ATI when determining the business interest expense limitation for any taxable year beginning in 2020.
In addition, partnerships are subject to a different rule in the case of business interest expense for any taxable year beginning in 2019 (but not 2020) than the one above. Thus, 50% of a 2019 excess business interest a partnership allocated to a partner and that is carried forward to 2020, is treated as business interest expense paid or accrued by the partner in the partner’s first taxable year beginning in 2020 that is not subject to the business interest expense limitation (the remaining 50% of excess business interest is subject to the regular rules as modified by the CARES Act).
3. Relaxation of the Net Operating Loss Limitation
Under current law, a business can only carry forward excess post-2017 net operating loss (“NOL”) and cannot offset more than 80% of its taxable income using the NOL carryforwards. The CARES Act temporarily relaxes both limitations. Thus, NOLs generated in taxable years beginning in 2018, 2019 or 2020 can be carried back to the preceding 5 years. In addition, businesses can fully offset their taxable income for taxable years beginning before 2021 using NOL carrybacks and carryforwards and can fully offset their taxable income for taxable years beginning after 2020 using pre-2018 NOL carryforwards. Any post-2017 NOL carryforwards can be used to offset up to 80% of taxable income after using pre-2018 NOL carryforwards.
Accordingly, real estate businesses with NOLs should consider amending their tax returns to maximize their NOL utilization. Unfortunately, the CARES Act explicitly excludes real estate investment trusts from making use of the rule that permits NOL carrybacks to the preceding 5 years.
4. Temporary Suspension of Net Business Loss Limitation
Under current law, the amount of “net business loss” that an individual (including an individual who has net business losses through pass-through entities) can use to offset income from other sources is capped at $250,000 (or $500,000 for taxpayers that are married filing jointly). The CARES Act suspends this cap for taxable years beginning in 2018, 2019, or 2020. Accordingly, individual taxpayers that are beneficial owners of real estate businesses operated in pass-through form should consider amending prior tax returns to take advantage of this provision.
5. Employee Retention Credit
The CARES Act creates a new refundable credit for businesses with respect to wages paid from March 13, 2020 to December 31, 2020. The credit is available to businesses of any size that either have to fully or partially suspend operations due to a COVID-19 related governmental authority order or during a “significant decline in gross receipts” period (generally, any calendar quarter during the period starting with the first calendar quarter in which the business’s gross receipts are less than 50% of the gross receipts of the same calendar quarter in the prior year and ending with the calendar quarter after the first calendar quarter after the start of the period in which the business’s gross receipts are greater than 80% of the gross receipts of the same calendar quarter in the prior year).
For each quarter in the applicable period, an eligible business can credit 50% of its employees’ qualifying wages (plus properly allocable health plan expenses) against the business’s share of the Social Security payroll tax (6.2%). Any excess credit is fully refundable. The amount of qualifying wages per employee for the entire period that can be taken into account for these purposes is capped at $10,000.
The qualified wages calculation depends on whether or not the business had more than 100 full-time employees on average during 2019 (meaning that the business cannot change its classification at this point). If a business does not cross this threshold, all wages it pays during the applicable period are taken into account (subject to the above cap). If the business crosses the threshold, then only wages that the business continues to pay to employees who are not providing services to the business during the applicable period are taken into account (subject to the above cap).
This provision is not available to businesses that obtain a loan under the paycheck protection program established by the CARES Act (see below).
6. Deferral of Employer’s Share of Social Security Payroll Tax
The CARES Act includes a provision that allows businesses to defer payment of the their share of the Social Security payroll tax (6.2%) for the period from March 27, 2020 through December 31, 2020 . Businesses must pay 50% of the deferred amount by December 31, 2021 and the remaining 50% of the deferred amount by December 31, 2022. Similar provisions apply to taxpayers subject to self-employment tax.
This provision is not available to businesses that had a loan obtained under the paycheck protection program established by the CARES Act (see below) forgiven.
7. Tax-Free Debt Forgiveness of Paycheck Protection Loans
The CARES Act creates a new “paycheck protection program” under Section 7 of the Small Business Act to help small businesses (generally companies with no more than 500 employees) cover payroll and certain operating costs until June 30, 2020. You can read our coverage of this new program here. The CARES Act also provides that borrowers are eligible to have loan amounts forgiven to the extent that they are used to pay for payroll expenses, interest on covered mortgage obligations, covered rent obligations, and utilities. Importantly, the CARES Act provides that, for federal income tax purposes, any amount that would be included in such borrower’s gross income due to such loan forgiveness is excluded from gross income.
