The CARES Act- impact on the commercial real estate investors

The CARES Act

The CARES Act is a $2.2 trillion economic stimulus package. The United States Federal Government passed this act in March 2020 and it helps accredited investors in the real estate industry greatly. 

From tax reliefs to grants, loans, and direct cash payments, this legislation provides an advantage to real estate investors. Let’s dive into how the CARES Act will benefit accredited real estate investors.

What is the CARES Act?

The CARES Act is an acronym for Coronavirus Aid, Relief, and Economic Security Act. It is a $2.2 trillion economic stimulus bill. 

It was passed by the 116th U.S. Congress and signed into law by President Donald Trump on March 27, 2020. 

As the name suggests, this Act aimed to contain the rapid decline in the US economy due to the COVID-19 pandemic. So, it is the largest rescue package in U.S history.

Thus, the CARES Act helps real estate investors to increase cash flow, finance development projects, make timely acquisitions, etc.

How does the CARES ACT benefit real estate-accredited investors?

1. QIP Depreciation

The tax reform reconciliation act of the Tax Cuts and Jobs Act (TCJA) of 2017, grouped all interior and structural improvements of a property into the single category of Qualified Improvement Property (QIP). 

Qualified improvement property is any improvement to an inside portion of a non-residential property that is made after the date the building first came into being. 

But, these improvements exclude expenditures related to the expansion of the building. For instance, the installation of an elevator or escalators that changes the internal structure of the building.

Congress aimed to set a 15-year time period as the depreciable life for QIP improvements. 

However, the tax writers made a mistake while drafting the TCJA. Hence, an asset had to be depreciated over 39 years to qualify for QIP for general depreciation system (GDS) treatment.

How does the CARES Act correct this error?

However, The CARES Act makes technical corrections in the TCJA, passed on December 22, 2017. And, the Act reduced the QIP depreciation time period from 39 years to 15 years.

Hence, the correction of the depreciation of QIP ( also known as leasehold improvements) helps hotels, restaurants, and retail properties. 

The change applies to the current 2020 tax year and is retroactive to 2018 and 2019. 

And, taxpayers must file amended 2018 and 2019 tax returns in the prior years to recover any overpaid taxes. 

Moreover, The CARES Act correction helps any QIP placed in service on or after January 1, 2018, to be eligible for bonus depreciation. 

For taxpayers following the ADS treatment, QIP assets have a 20-year life. But they are ineligible for bonus depreciation. 

And, the taxpayers who provide tenant allowances or otherwise refurbish existing commercial properties enjoy higher deductions in depreciation.

But, taxpayers who made a Section 163(j)(7) real property trade or business elections in 2018 or 2019 under Internal Revenue Code (IRC) Section 163 (j) did not qualify for bonus depreciation. 

Nevertheless, the recently issued Revenue Procedure 2020-22 enables taxpayers to withdraw the Sec. 163(j)(7) election. 

So, taxpayers must file amended returns for the previous tax years within a limited time. Besides, they must recover any taxes that they paid extra. 

Furthermore, this allows them to pursue bonus depreciation deductions.

2. Restoration of NOL Carrybacks

Under the Act, a net operating loss (“NOL”) accrued in a tax year beginning in 2018, 2019, or 2020 can be carried back for five prior tax years. 

Also, it permits for NOLs arising before January 1, 2021, to fully offset income. 

Therefore, the Act briefly removes the loss limitations placed by the 2017 TCJA.

Furthermore, the TCJA stated that NOLs for tax years beginning after Dec 31, 2017, were limited to 80% of taxable income. 

Also, this could not be carried back in a prior tax year. 

Under TCJA, losses must be carried back to the tax years before 2018. And corporate taxpayers may profit from a tax refund at rates up to 35%.

However, the CARES Act discontinued the 80% deduction limit from taxable income in 2020.  

As a result, real estate businesses could offset 100% of their taxable income in 2020. 

However, for the taxable years beginning after January 1, 2021, the 80% limit was brought back. 

Moreover, NOLs of a REIT are not allowed to be carried back to any taxpayer. It does not consider whether or not the taxpayer was a REIT in that tax year.

3. Business Interest Expense Limitation

The maximum amount of tax-deductible business interest expenses is increased from 30% to 50% of adjustable taxable income (ATI) for 2019 and 2020. 

Taxpayers are not required to use this change.

Instead, they may elect to use their 2019 ATI to determine their maximum business interest deduction for 2020, rather than their ATI in 2020.

Under TCJA, the deduction for business interest for tax years beginning after December 31, 2017, was limited (under IRC Sec.163(j)) to 30% of the “adjusted taxable income”(ATI) of the taxpayer for that particular tax year. 

The amount of forbidden interest carried forward.  

However, taxpayers who qualify to make a “real property trade or business” election (IRC Sec. 163 (j) (7)(B)). 

Therefore the CARES Act commercial real estate makes hotels eligible for the election, occupancy is their real estate product.

However, The CARES Act increased the minimum limit of tax-deductible business interest expense to  50% of ATI for the tax years beginning in 2019 and 2020. 

Hence, taxpayers could deduct more of their business interest.  

Moreover, a business can elect to use its 2019 ATI to calculate its 2020 limitation for the business interest deduction. 

Once made, only the IRS can cancel the election. In the case of a joint venture, the election is made by the partnership.

The CARES ACT real estate excludes the investors who qualify for a real property trade or business election from the business interest limitation.

In addition, for those who did not make the election, the increase from 30% to 50% provided extra deductions and generated better cash flow.

4. Minimum Tax Credits

Under the TCJA, there was a limitation on the number of tax deductions for a business from losses that non-corporate taxpayers could make. 

Taxpayers that had the corporate alternative minimum tax (AMT) credit carryforwards could use them against their regular tax requirement. 

Further, they could also claim a refundable credit of up to 50% of the remaining AMT carryforward from 2018 through 2020, and 100% from 2021 to several coming years.

However, The CARES Act removed these limitations for the taxable years 2018 through 2020. 

Therefore, the taxpayers who were already subject to these limitations may claim a fully refundable credit in 2019. 

Moreover, it allows corporations to claim their previously unclaimed AMT credits immediately. Corporations can elect to claim amendable returns of the credit amount in 2018.

5. Limitation on Losses for Taxpayers Other than Corporations

TCJA contained a provision (IRC Sec. 461(l)) for tax years beginning after December 31, 2017. This limited the deductibility of current-year business losses for flow-through entities and sole proprietorships. 

Further, it also allowed investors to use depreciation to protect $500,000 on a joint tax return of a married couple and $250,000 for all other filers made during that current year. 

A business that faced losses exceeding these amounts was not allowed in that particular year.

Further, it was converted into an NOL that could be carried forward in a future tax year. As a result, real estate professionals were able to use their business losses to outweigh their other incomes. This includes income from portfolio diversification and investments. 

The CARES Act rules out these limits. Hence, real estate investors can write down a depreciation on non-business profits. 

As a result, married couples with more than $500,000 in income or profits from non-business sources possibly faced no tax liability for 2020 and the previous two years. 

However, it depends on whether depreciation and non-business losses equal or exceed those capital gains.

6. Expansion of Small Business

Section 1113 of the CARES Act expands the Small Business Reorganization Act of 2019 (SBRA) to benefit more small businesses. 

It provides small businesses like small real estate developers, owners, and independent contractors. 

Also, it includes self-employed individuals or others with a more forgivable loan program of about $356 billion. 

As a result, the CARES Act helped small businesses to operate within the challenging circumstances created by the pandemic.

7. Mortgage Forbearances 

Under Section 4023 of the CARES Act, borrowers under certain home mortgages and multifamily loans for federally-backed programs are eligible for the temporary forbearance of payments for up to 90 days. 

However, it is only applicable if they are current on payments as of Feb.2020. 

If such borrowers opted for these forbearance provisions, they will face additional restrictions on tenant evictions on the grounds of late fees and penalties.

8. National Moratorium on Residential Evictions for Properties with Federal Loans

For 120 days, succeeding The CARES Act Section 4024(a)(5) states that, an owner cannot evict tenants occupying properties financed by federally-backed multifamily loans. 

Further, they cannot take any action against tenants or penalize them for delays in rent or fees. 

The rule applies to mortgages insured, guaranteed, or assisted by the Federal Government. 

Also, It applies to federal loan programs assisted by Freddie Mac or Fannie Mae, or the HUD program.

Besides, the rule also follows suit by placing a 120-day moratorium on residential evictions for tenants occupying properties financed by federally-backed multifamily loans. 

These loans are made or insured, guaranteed, or assisted by the Federal Government or by a HUD program or purchased or securitized by Freddie Mac or Fannie Mae.

The Lilypads Bottomline

Although The Coronavirus Aid, Relief, and Economic Security (CARES) Act is hailed as the largest economic relief act in the history of the US, some experts believe that it may not be enough to avert the economic crisis caused by COVID-19.

It is unclear the aid the Act aims to provide to several small businesses or landlords who do not have federally-backed mortgages or subsidized renters. However, The CARES Act is a potential life-saver for real estate accredited investors with its provisions for tax reduction obligations, tax refunds, and more.