Tag: commercial real estate

How Tax Reform Impacts Real Estate

How Tax Reform Impacts Real Estate

The Senate and House have passed similar tax reform plans, but the bill is not yet finalized. Legislators are still working to create a unified bill, and the real estate industry can expect significant changes under the “Tax Cuts and Jobs Act.” Key changes include:

Temporary 100% Bonus Depreciation

House Bill:

Modifies existing bonus depreciation rules under the “PATH Act” by increasing the rate to 100% through the end of 2022. It also makes bonus depreciation applicable to both new and used property, where it currently applies only to new property. The 100% bonus depreciation will not apply to real property trade or business (i.e., commercial and residential real estate).

Senate Bill:

Similar to the House bill, except the 100% bonus depreciation will apply only to new property and to real property trade or business.

Section 179 Expensing

House Bill:

The Section 179 expense limitations for 2018 will increase from $500,000 to $5 million while the phase-out limitations for assets placed in service will be increased from $2 million to $20 million.

Senate Bill:

The Section 179 expense limitations for 2018 will increase from $500,000 to $1 million while the phase-out limitations will increase from $2 million to $2.5 million. Qualified real property eligible for 179 expensing will be expanded to include improvements to certain buildings systems including roofs, HVAC, fire and alarm systems, and security systems.

Real Estate Recovery Periods

House Bill:

No changes to current depreciation recovery periods of 27.5 years for residential and 39 years for non-residential real property.

Senate Bill:

Nonresidential real and residential rental property depreciable lives would be shortened to 25 years.

Like-Kind (1031 Exchanges)

House bill:

1031 exchanges will continue for real property, but not for tangible personal property. CAUTION: The proposed rules will trigger 1245 recapture for tangible personal property.

Senate Bill:

Same as House bill.

An updated version of the Tax Cuts and Jobs Act must be approved by both the Senate and House before going to the president to be signed into law.

We’ve Got Your Back

At KRS, we’ve been tracking tax reform legislation closely and are ready to assist you in your tax planning and preparation when it is finally signed into law. Don’t lose sleep wondering what impact the tax changes will have on your real estate holdings. Contact me at 201.655.7411 or [email protected].

Update: Tax reform has now been passed into law. Stay up-to-date on how it impacts real estate investors by checking out the New Tax Law Explained! For Real Estate Investors.

What Is the New GAAP Lease Accounting Standard?

In February 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standard Update (“ASU”), ASU 2016-02, Leases (Topic 842).

New GAAP Accounting Rules for Leases
For public companies, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018. For all other entities, this update is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for all entities, using a modified retrospective approach.

ASU 2016-02 impacts all entities that lease property, plant, or equipment. ASU 2016-02 defines a lease as a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment for a period of time, in exchange for consideration.

What will change?

Currently, operating lease obligations (for example, a lease of office space for 10 years) are disclosed in a company’s financial statement footnotes, but not recorded on the balance sheet. Under the new guidance, a lessee will be required to report on its balance sheet assets and liabilities related to lease obligations with lease terms of more than 12 months. This differs from current GAAP, which requires only capital leases to be recognized on the balance sheet.

How will the change impact financial reporting?

Companies will have to report their leases (finance leases and operating leases) as both assets and liabilities on their balance sheets. This must be done regardless of the lessee’s (tenant’s) intent to vacate the space at the end of its lease term. Rent obligations that were previously disclosed in the footnotes of financial statements will be reflected on the balance sheet as debt. Debt impacts a company’s credit, compliance with debt covenants and other capital requirements.

What about the lessor (landlord)?

For lessors, the impact of ASU 2016-02 is largely unchanged from current GAAP. For example, the vast majority of operating leases should remain classified as operating leases. In general, lessors should continue to recognize lease income for those leases on a straight-line basis over the lease term.

We’ve got your back

Not sure how the new FASB lease reporting standards impact accounting for your real estate leases? The real estate accounting experts at KRS CPAs are here to help. Reach out to me for a complimentary initial consultation at [email protected] or (201) 655-7411. 

Do You Hold Real Estate in a C Corporation?

Here’s why you should think twice about using a C corporation for rental real estate property.

Do you hold real estate in a C corporation?
In practice I have encountered legacy entities that were set up before the rise in popularity of S Corporations or the general acceptance of Limited Liability Companies. Occasionally, there is still the investor who was advised to purchase or is contemplating purchasing, rental real estate in a C Corporation. Utilizing a C Corporation as an entity choice could prove costly.

Real estate and double taxation

A C corporation is not a pass-through entity. Corporate taxable income is initially taxed at the entity level. If the corporation distributes its earnings to shareholders as a dividend, the recipient of the dividend must include it in his or her individual income tax return, where it is again subject to tax.

Individuals invest in real estate for its current income (cash flow) and future value (appreciation). If real estate appreciates in value while owned inside a C corporation and the asset is sold by the corporation, the gain will be taxed at the corporate level at corporate income tax rates. If the C corporation then makes distributions to its shareholders as a dividend, the recipients must include the dividends, where it will be subject to a second level of tax.

Getting real estate out of C corporations

Property owners may hold real estate inside a C corporation because they desire liability projection. It is also possible the entity was inherited from a family member and it already held title to the real estate. The limited liability protection can be offered by the use of S Corporations and Limited Liability Companies (“LLC”), which provide the liability protection of a corporation without the double taxation.

There are options available to address real estate owned by a C Corporation that include:

  1. Distributing the property in kind to the shareholders.
  2. Selling the real estate to the shareholder or an unrelated party
  3. Converting the C Corporation into an S Corporation.

Distributing appreciated real estate to shareholders

A corporation that transfers a real estate deed to one or more shareholders has made a “deemed sale” that is taxable to both the corporation and the shareholders (assuming a non-liquidating transaction). At the corporate level, the distribution is treated as a sale to the shareholders at fair market value. Corporate gain is calculated as the excess of fair market over the corporation’s basis in the real estate. The shareholders that receive the property will be taxed on the full amount of the distribution. If the corporation has current or accumulated earnings and profits, the distribution is treated as a dividend.

Selling appreciated real estate

The sale of the real estate is a taxable event to the corporation. Unlike a “deemed sale” mentioned above, an actual sale generates cash for the corporation to pay the resulting tax. If the proceeds from the sale are not distributed to the shareholders, there will be no tax to the shareholders (along with no cash).

Converting a C corporation into an S corporation

Shareholders can convert a C corporation into a subchapter S Corporation. Unlike the first two options, this can completely avoid double taxation. However, there are potentially costly tax issues that should be addressed including:

  • Built-in gains (“BIG”) tax – if an S Corporation that was formerly a C Corporation sells appreciated real estate, the entity may still pay C Corporation taxes on the appreciation.
  • Excess passive investment income – S Corporations that were formerly C Corporations with passive investment income (which includes rents) in excess of 25% of their gross receipts are assessed a corporate tax at the highest corporate rate.

I will discuss converting from C Corporation to an S Corporation in a later blog post.

If you currently own rental real estate through a C Corporation, you should contact your tax adviser to determine what, if any, action should be taken. More than likely, you will at least need to set up a plan to minimize negative tax implications.

Will President Trump Benefit or Distress Real Estate?

What will Trump's impact be on the real estate industry?The presidential campaigning has finally ceased and the transition to the Trump presidency has begun. Many questions are being asked in real estate circles, but mostly, how will President Trump’s policies impact real estate in this country?

Here are my thoughts.

Immigration

Throughout the presidential campaign, Trump was firm about deporting immigrants. It is quite common that immigrants who come to this country find work in the construction industry.  A large immigrant deportation effort would put pressure on the number of skilled workers available in the real estate industry, especially in residential real estate.

A labor shortage in the construction industry will force builders to compete for skilled workers with higher wages. Those costs would most likely be passed on to buyers in the form of higher new home prices.

Mortgage Interest Deductions

Trump’s tax plan effectively limits the mortgage interest deduction, without eliminating it entirely. This is accomplished by increasing the standard deduction from $6,300 to $15,000.

Under the current system, for example, a homeowner paying mortgage interest of $10,000 would itemize the deduction and receive a greater tax benefit, because their interest deduction would be greater than the standard $6,300 exemption.

Under Trump’s potential changes, however, there would be no need to itemize the $10,000 mortgage interest, as the proposed standard deduction is already greater. Americans therefore may be less incentivized to buy homes as their taxes would not be significantly different than if they had rented.

Real Estate Agents and Brokers

If housing prices soar due to a lack of skilled labor force and the value of a mortgage interest deduction is diminished, residential real estate brokers and agents may find transactions and commissions drying up. A decrease in real estate activity will affect the bottom line for brokers and agents alike.

Commercial Real Estate

I would be doing a disservice to the real estate ‘mogul’ without mentioning the potential impact on commercial real estate.

There is a potential for a pullback on new construction for commercial projects, large residential and mixed-use developments. If the capital markets experience a shock – which could be interest rates, inflation, or regulation – the difficulty of obtaining construction financing coupled with a muddy economic outlook may push some developers to abandon plans for new projects.

What are your thoughts on the Trump presidency and how it will impact the real estate industry?

Trending Now: Real Estate Crowdfunding

Ever hear of real estate crowdfunding? If not, maybe you should take a look.

crowdfunding for real estateIn my practice as an accountant and trusted advisor I often receive inquiries from clients and their advisors because real estate is an important element of a diversified portfolio. Until recently, opportunities to invest in real estate were limited to acquiring a rental property directly, participating in a real estate investment group, flipping properties or a joining a real estate investment trust (REIT).

Investing through a real estate investment group was limited to accredited investors – those who have a net worth of $1 million or earn at least $200,000 a year. The Securities and Exchange Commission’s Title III of the JOBS Act opened the doors to non-accredited investors, who were previously unable to participate in this new asset class.

As a result of the JOBS Act, crowdfunding platforms have become available which offer options for investing in real estate. In these platforms investors can join others to invest in a rental property – either commercial or residential.

An Entry Point to Real Estate

Private real estate deals have historically been the domain of high net-worth investors who possessed the right connections to gain access to a particular property. Real estate crowdfunding provides an entry point into the real estate market, enabling investors of all ages, risk profiles and wealth levels to acquire real estate investment.

Real Estate Crowdfunding Benefits

Larger geographical scope. Investing in real estate in the past relied upon developing networks of personal and industry connections in your local area. The real estate crowdfunding platforms are opening up access to deals outside of personal contacts and local areas. A potential investor can now browse deals from all over the country.

Lower entry point. Historically, investing in real estate required writing a large check to become part of a deal. Typically, a real estate operator would want to syndicate deals with minimum investments of $100,000 or more to keep the process simple. However, through the technology in these crowdfunding platforms and the JOBS Act, investors are able to invest with a minimum of $1,000, depending on the platform. This allows real estate investors to spread their funds over multiple projects at any one time. From a risk perspective, this is less risk than investing larger amounts in fewer projects.

Drawbacks of Crowdfunding

You don’t really own real estate. Investing in crowdfunded real estate does not actually make you an owner of real estate. Rather, you become a member of a Limited Liability Company that holds title to real property. Ownership in the LLC is considered personal property rather than real property and the rights to share in income and distributions are governed by the Operating Agreement.

Less liquidity. Investing in crowdfunded real estate is different that investing in real estate stock. When you invest in a REIT, you invest in a company that owns and operations various real estate investments. REITs offer liquidity, whereas they can be sold on the stock market, while crowdfunded real estate you are locked in until an exit event such as the sale of the property.

If you are considering investing in real estate every investor should consider how to participate. Along with that decision the tax consequences of the different options should be considered in the analysis.

Millennials Are Changing Commercial Office Space

Millennials are changing work place designWave goodbye to corner offices and cubicle farms and welcome to wide open spaces. Millennials are a generation accustomed to collaboration and opportunities for social interaction. As a result, they are changing how companies lease and design office space.

Millennials are typically considered individuals born between 1980 and 1995, making most of this generation under 35 years of age. According to a report published by the White House, 15 Economic Facts about Millennials (October 2014), this demographic makes up approximately one-third of the U.S. population.

This generation has many unique characteristics that shape how they work and what they want out of life. They are the first cohort who can’t remember life before the Internet, and this is reflected in their attachment to technology. However, they value connection in the real world as well.

A Shift in Workplace Design

Millennials favor open floor plans and collaborative work spaces. They value flexibility and common areas that are set up for specific tasks rather than specific people. This changes the amount and type of space required by the companies for whom they work. In many cases, the ideal Millennial workplace includes fewer square feet per employee, as more shared spaces are adopted.

According to Randy Horning, senior broker associate with James E. Hanson Inc., average square footage required for commercial office space is on the decline to approximately 100 to 150 square feet per person.  This continues a downward trend from 200 to 250 square feet, which was already down from the 400 sq. ft. per person in prior years.

Enjoying the time spent at work is more important to Millennials, and they look for amenities in the workplace. This has led to the popularity of office perks such as coffee bars, outdoor spaces, game rooms and onsite daycare. Horning explains that because owners want people to spend time in the office, the space is becoming more amenity driven. Says Horning, “When amenities such as a large kitchen space are inside the building, it keeps employees at-hand and productive.”

Sustainability Increases in Importance

Green design is another Millennial priority that is influencing commercial spaces. Natural light, sustainable materials and energy efficiency have grown in popularity, which is reflected by the push towards LEED Certification for new and existing work spaces.

According to a report published by the U.S. Green Building Council, over 675 million sq. ft. of U.S. real estate space became LEED certified in 2014, the largest area to be certified in a calendar year In 2015 an estimated 2,870 projects were certified, representing an additional 464 million sq. ft. of real estate.

Real estate features that include recycling collection, bike storage and even rainwater catchers will score points with Millennials, and can even translate into better health and productivity.

Shift to City Centers

Where companies choose to locate has also been heavily influenced by this generation. They prefer working near city centers – where commutes are short or non-existent – as well as convenient transit options. Millennials also favor easily accessible attractions, such as museums and dining.

The Takeaway

The future of office space may appear to be the end of cubicle farms, however there will be more work space flexibility and opportunities for Millennials and other groups to interact in the workplace than before. Companies will continue to adapt office environments as they seek to accommodate this generation.

Real Estate Trends – Foreign Sellers

Foreign Capital and U.S. Real Estate

Understand FIRPTA withholding rules There have been continued international capital inflows into U.S. real estate assets and the trend is expected to grow. Political uncertainty and global economic factors continue to drive foreign money into the United States, long considered a safe haven.

The U.S. property market is the most stable, transparent in the world, making it an easy investment choice. According to research firm Real Capital Analytics, foreign purchases of U.S. real estate assets rose to $62 billion over the 12-month period ending in October 2015.

It should be expected that these foreign investors will eventually reposition their assets and liquidate certain holdings based upon expected returns and market changes.

Understand the Foreign Withholding Rules

Buyers of real estate from foreign sellers, escrow agents and closing agents who close on such transactions need to be aware of the federal withholding requirements set in the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA).

Under FIRPTA, the buyer of U.S. real estate from a foreign person or entity must withhold tax equal to 10% of the “amount realized” from the sale. The amount realized includes the total amount received for the property including cash, the existing balance of mortgages encumbering the property, and any non-cash personal property.

Withholding under FIRPTA

Withholding is required when the seller is a foreign person (including non-resident alien individuals, partnerships, trusts and estates, and certain corporations domiciled outside of the United States). At or before the closing, if the seller signs a certification of non-foreign status stating under penalty of perjury that he is not a foreign person, the buyer can rely on that unless he has actual knowledge that it is not accurate. If the seller is able to sign the certification, no withholding is required, but the buyer must retain the certification for five years after the transfer.

If the seller is a foreign entity or person, the buyer must withhold the 10% and remit the tax to the IRS within 20 days of the date of closing. If the buyer fails to do so, the buyer is liable to the IRS for the tax that should have been withheld, plus penalties and interest.

Reduced Withholding

If the ultimate tax liability is expected to be zero or less than the required 10% withholding amount, the foreign seller can apply for a withholding certificate to request a reduction in the withholding amount. This is done by filing IRS Form 8288-B.

There are exceptions to the withholding requirements, including property used as a home and 1031 exchanges, but both are not without specific qualifications.

When purchasing real estate from a foreign seller, it is important for buyers to consult with their advisors to ensure compliance under FIRPTA.

At KRS CPAs, our team supporting commercial real estate is knowledgeable about FIRPTA rules and can assist you. Contact me at [email protected] or 201.655.7411.

Can Real Estate Professionals Pay No Income Taxes (a la Donald Trump)?

real estate professionals can deduct tax losses resulting from their real estate activities

As a CPA with a substantial real estate practice, I found the recent controversy regarding Donald Trump’s tax losses and the possibility that he paid no federal income tax to be quite interesting.  Although we do not know what part, if any, of the losses arose from Mr. Trump’s real estate activities, it is not unusual or illegal for real estate professionals to deduct tax losses resulting from their real estate activities.

News reports indicate that Donald Trump’s 1995 federal income tax return reflected a tax loss of approximately $916 million dollars, which may have been carried forward to offset income and reduce Trump’s taxes in succeeding years. As this revelation appears to be the source of public outrage, I wanted to explain taxation of rental real estate and how owners and investors may legally benefit from losses.

Trump most likely operates many of his business ventures as “pass-through” entities, such as partnerships and limited liability companies. Pass-through entities pass through all of their earnings, losses and deductions to their owner, for inclusion on their personal income tax returns. In the case of losses, the owner or member can use these losses to offset other income and carry forward any excess to future years. As with all things taxes, there are requirements that must be met (see Passive Loss Limitations in Rental Real Estate).

Owners of rental real estate are not only allowed to deduct for mortgage interest, real estate taxes and other items, but also depreciation. The Internal Revenue Code allows for depreciation of assets used in a trade or business, which include rental real estate. This is an allowance for the wear and tear of the building and astute taxpayers can further benefit from depreciation by accelerating their depreciation deductions (see my blog, The Tax Benefits of Cost Segregation in Real Estate). While many properties are increasing in value, the owners are receiving an income tax benefit in the form of an annual tax deduction for the wear and tear of the building.

If certain requirements are met, a real estate professional, as defined by the Internal Revenue Code (there is no reference to “Mogul” in the Code) can offset other items of income with losses generated by their real estate activities. I have more details on the income tax advantages of being a real estate professional in a previous blog posting, Passive Activity Loss and the Income Tax Puzzle for Real Estate Professionals.

Donald Trump invested in many business ventures during the 1980s and 1990s and real estate may have only been a small part of the substantial loss reflected on his 1995 tax return. Without Mr. Trump’s tax returns, we will never know. As an accountant, I’m more curious about the transactions that gave rise to the loss and the application of the specific tax law provisions permitting deduction of these losses.

What are your thoughts regarding the ability of real estate professionals to offset other items of income with their losses from real estate activities?

Why do investors want to participate in Zero Cash Flow deals?

Zero cash flow deals offer tax savingsHint: it’s about deferring taxes

Most zero cash flow Triple Net Lease (“NNN”) investments have two components. First, you purchase a high quality NNN investment with a long-term lease and a tenant with a high credit rating. Next, you obtain zero cash flow financing, where the rents from the tenant equals the debt service. This financing has an amortization period that is typically fixed to the term of the lease and a flat interest rate. Commonly, an investor will put between 10 and 20 percent down, and when the lease’s initial term ends, he or she will have a debt-free building.

Zero cash flow loans are highly leveraged and lenders require a strong credit tenant, which is why drug stores such as Walgreens and CVS are highly sought-after investments for these arrangements.

During the Lease Term

While the real estate investment is not providing current cash flow, the depreciation generated from these investments is structured to more than cover principal payments, leaving a net loss that can be used to offset other taxable income. Refer to my blogs on real estate professionals and passive loss limitations to determine if those losses can be used.

During the term of the NNN investment, principal payments will gradually grow. Once they exceed depreciation, you may be subject to phantom income, which is taxable. (See my previous blog on phantom income.) Prior to reaching this point, an investor should consider disposing of the asset (possibly through a like-kind exchange) or refinancing the property. If you have already reached the point in a zero cash flow deal where principal payments exceed depreciation, tax planning should be undertaken to minimize income taxes.

End of Lease Term

If an investor retains ownership until the end of the lease, the loan will be satisfied and the building will be owned without any debts. If there are options in the lease, it’s possible that the tenant exercises the option and the property will generate cash flow with no debt service. On the other hand, if the tenant decides to move out, it’s reasonable to assume the building will still have value.

While many investors acquire NNN properties for steady cash flow, that is not the only reason investors should consider a NNN deal. Astute investors use NNN investments as a way to minimize their tax exposure. Zero cash flow deals do not provide current cash flow, but can offer tax savings through depreciation deductions and appreciation of the real estate in the long-term.

KRS CPAs can help you establish tax savings with NNN investments. Give us a call at 201-655-7411 or email [email protected].

Will Your Taxable Gain Be Calculated Properly? Make Sure You Are Using The Correct Basis

The rules for basis, or the value of an asset used for computing tax gain or loss when an asset is sold or transferred, can be complicated. Here’s what you need to know.

Background on Basis

When a taxpayer sells an asset, such as shares of stock, capital gains tax may be owed on the difference between the purchase price (basis) and the sales price. For inherited assets, taxpayers receive “step up” tax basis to the value at the time of the benefactor’s death. The Internal Revenue Code allows certain inherited property to receive a new tax basis equal to the fair market value of the property as of the date of death. This means if appreciated inherited property is sold immediately, there will be no capital gain, or later, all pre-inheritance appreciation is excluded from taxation.

taxable gains differ for inherited versus gifted assetsProperty gifted during a taxpayer’s lifetime receives a carryover basis, that is, the gift recipient takes the same basis as that of the donor. This means the recipient of the gift takes the same tax basis in the property as it had when owned by the decedent. Consequently, the increase in value of the property that occurred during the decedent’s lifetime is subject to federal and state taxes when the property is sold.

Basis for Real Estate

Current law provides that the income tax basis of real estate owned by a decedent at death is adjusted (“stepped up” or “stepped down”) to its fair market value at the date of the decedent’s death. Real estate which is gifted causes the donees to have the same tax basis in the gifted real estate as that real estate’s basis would have been in the hands of the donor. There is an exception if the tax basis is greater than the fair market value at the time of the gift.

Partnership Interests

Adjustments to basis do not only occur as a result of death. When a taxpayer purchases an existing partner’s partnership interest, the amount paid becomes the basis for the purchaser’s partnership interest (“outside” basis). The new partner assumes the seller’s share of the partnership’s adjusted basis in its property (“inside” basis), commonly referred to as stepping in the shoes of the partner or capital account. If the partnership’s assets have appreciated substantially, the difference between the new partner’s inside and outside basis can be substantial.

The disparity between the inside basis and outside basis can deprive the incoming partner from depreciation deductions. To remedy this situation, the partnership may make a 754 election, which allocates the purchase price or fair market value of the partnership interest to the new partner’s share of partnership assets. If this election is made, additional depreciation and amortization resulting from the basis adjustment is specially allocated to the new partner, giving him or her additional tax deductions.  A 754 election must be made by the partnership.  Once made, it is binding on all future transfers of partnership interests.

The rules related to tax basis in assets upon death and purchase are complex and should be reviewed with a tax adviser. Contact me at [email protected] if I can assist you.