2018 Income Tax Update - Commercial Real Estate - Stephen M. Lukinovich, CPA, PFS, CVA Andrew J. Ackermann, CPA, CVA
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2018 Income Tax Update -
Commercial Real Estate
Stephen M. Lukinovich, CPA, PFS, CVA
Andrew J. Ackermann, CPA, CVA
Kentucky Commercial Real Estate Conference
Louisville, KY
October 30, 2018
“Tax Cuts and Jobs Act” A Member of PrimeGlobal – An Association of Independent Accounting Firms 2
Commercial Real Estate Taxation
2018 Agenda
1. Expired income tax provisions
2. New tax reform
3. Depreciation updates
4. Updates on tax incentives
5. Opportunity zones
3
4
Energy Efficient Incentives Expired
Effective 1/1/2018:
• Section 179D Deduction
o Up to $1.80/square foot deduction
• Section 45L - Energy Efficient Home Tax Credit -
$2,000
5
§179D Lookback Rules
• Announced by IRS in December 2010
• Applies for prior year missed §179D
– Now available for more than 3 previous tax years
• Do not amend prior-year tax returns
• Reflect prior year § 179D deductions missed on current
year tax return - Form 3115, § 481(a) full year
deduction - Federal, AMT and State
6
7
Federal Income Tax Reform Legislation
Commercial Real Estate
Substantially unchanged are:
• The rules regarding depreciation tax lives of
commercial real property (39 years)
• Residential real property (27 1/2 years)
• Long-term capital gain tax rates, generally 20%
• The application of the 3.8% Medicare Surtax
• Section 1250 unrecapture rules/tax rate of 25%
• The tax rules regarding Low Income Housing Tax
Credits
8Qualified Business Income Deduction
• Effective for tax years beginning after Dec. 31,
2017, and before Jan. 1, 2026, an individual
taxpayer generally may deduct 20% of domestic
“qualified business income” from a partnership,
LLC, S corporation or sole proprietorship
• Deduction amount for a tax year is the sum of:
1) the lesser of:
a) the “combined qualified business income amount”; or
b) 20% of the excess of taxable income over the sum of i) net capital
gain and ii) qualified cooperative dividends; plus
2) the lesser of:
20% of qualified cooperative dividends; or
taxable income minus the taxpayer’s net capital gain
9QBI Deduction - continued
In the case of a partnership or S corporation, the provision applies at the
partner/shareholder level
• Partnership.
• Each partner takes into account the partner’s allocable share of each
qualified item of income, gain, deduction, and loss, and is credited with W-
2 wages for the tax year equal to the partner’s allocable share of W-2
wages of the partnership
• Partner’s allocable share of W-2 wages is required to be determined in the
same manner as the partner’s share of wage expenses
• S corporation
• Each shareholder of an S corporation takes into account the shareholder’s
pro rata share of each qualified item of income, gain, deduction, and loss,
and is credited with W-2 wages for the year equal to the shareholder’s pro
rata share of W-2 wages of the corporation.
10QBI Deduction - continued
• The deduction is generally limited based on greater of a) 50% of W-2 wages
paid, or b) the sum of 25% of W-2 wages plus 2.5% of the unadjusted basis of
qualified property held by the business (Note: this limitation is phased in
above a threshold amount of taxable income)
• Qualified property must 1) be depreciable tangible property, 2) held at the
close of the tax year, 3) used to produce qualified business income, and 4) the
property’s depreciation period cannot end before the close of the tax year
(later of 10 years or last day of MACRS recovery period).
• The deduction is generally not allowed for certain specified service trades or
businesses (Note: this disallowance is also phased in above the threshold
amount of taxable income)
• Threshold amount is $315k MFJ ($157,500 for other taxpayers)
• Phase-in range is $100k MFJ ($50k for other taxpayers)
• Fully phased in at $415k MFJ ($207,500 for other taxpayers)
11QBI Deduction - continued
• Qualified trade or business – any trade or business other than a specified
service trade or business (phase-in threshold) and other than the trade or
business of being an employee
• Specified service business is any trade or business:
– involving the performance of services in the fields of accounting,
actuarial science, athletics, brokerage services, consulting, financial
services, health, law, or the performing arts; or
– involves the performance of services that consist of investing and
investment management, trading or dealing in securities,
partnership interests or commodities; or
– where the principal asset of such trade or business is the reputation
or skill of one or more employees or owners.
– Note: engineering and architecture are not specified service
businesses
12QBI Deduction - continued
• Commercial and residential rental real estate
activities (for this purpose only) will generally be
considered a trade or business unless in the form of
a triple net lease arrangement
• Self-rental arrangements will need to be carefully
reviewed for eligibility of the 20%/2.5% deduction
• Economic unit self-rental arrangements will require
further guidance
• Owners who are passive, with passive income, will
be entitled to this new 20%/2.5% deduction
1314
Beginning 1/1/2018 – New
EBIDTA Interest Expense Limitations
• 30% EBIDTA Interest Expense limitation applies
• The 30% of EBITDA interest expense limitation applies to
commercial rental real estate activities
• The 30% interest expense limit is determined at the entity
level
• Entities with less than $25 million in annual sales are exempt
• Real estate development activities with sales in excess of $25
million can elect ADS depreciation deductions instead
o 40-year tax life for commercial rental real estate
o 30-year tax life for apartments/single rental residences
o 20-year tax life for QIP
o Real estate developers that elect ADS depreciation will not be
able to take bonus depreciation
15Beginning 1/1/2018 – New Like-Kind
Exchange Rules
• Only commercial/investment real estate activities are
eligible for tax-free exchange treatment
• Personal property is no longer eligible
• If real property (building) has Section 1245 property
(personal property) embedded, especially pursuant to a
cost segregation study, that portion of the property is
ineligible for Section 1031 tax-fee treatment
• Important to determine the value of Section 1245 property
embedded in real property upon pursuing a Section 1031
exchange
• Cost segregation studies on the replacement property,
identifying Section 1245 personal property, with 100%
bonus depreciation expense (especially on used property)
should assist in minimizing the impact to this tax-free
treatment limitation 16Effective 1/1/2018 through
12/31/2025 – New Loss Limitation
• $500,000 Trade or business loss – new annual
loss limitation
• Losses incurred by trade or business activities
will continue to have basis limitations and the
historical passive loss limitations apply
• $500,000 (MFJ)/$250,000 (MFS/Single) loss
limitation
• Excess loss amounts will be carried forward
• Watch Cost Segregation Studies
17Cash Basis Method of Accounting –
Reminder for Commercial Real Estate
Activities
• The new 1/1/2018 $25 million revenue threshold does
not apply to commercial rental real estate ventures
• Since rental real estate ventures do not have inventory,
the cash basis method of accounting is generally available
to pass-through commercial rental real estate ventures
regardless of the level of sales revenue
• Syndicates are generally required to use the accrual basis
method of accounting
If 35% or more of the commercial rental real estate
venture is owned by passive investors, and losses
exist, generally, the activity must be accrual basis
method of accounting
181/1/2018 - Reduced C-Corporate Tax
Rate
• Reduced Tax Rate:
– Tax years beginning after December 31, 2017, all C-
Corporations, including personal service corporations,
will be taxed at a 21% flat corporate tax
– Graduated rate structure is eliminated
– Corporate AMT repealed
– Any unused AMT credit carryforward is refundable
beginning in 2018 – refundable credit is equal to 50% of
excess of the credit over amount allowable against the
regular tax liability (100% beginning in 2021)
191/1/2018 Other New Tax Reform Rules
• Watch for new built in loss rule - applies if
$250,000 loss is allocated to an incoming
member
• Most individual income tax rates are lowered,
and the top marginal rate is reduced from 39.6%
to 37%
– Expires 12/31/2025
• The Tax Reform Bill still permits individuals to
itemize and deduct state and local taxes
(including property taxes), but only up to $10k
20Kentucky State Tax Update
• House Bills 366 & 487 – broaden tax base
• Effective 1/1/18 – Flat 5 % on business &
individuals
• Effective 7/1/18 – Sales tax on services
– Landscaping & lawn services
– Janitorial services
– Labor charges on installation of tangible personal
property
– Others
2122
Rental Real Estate Depreciation
Effective 1/1/2018:
• 39 year and 27 ½ year tax lives maintained
• Special real property depreciation categories
eliminated, except for Qualified Improvement Property
(QIP)
• Section 179:
– $1 Million per year, beginning 1/1/2018
– $500k per year through 12/31/2017
23New Bonus Depreciation %’s -
through 12/31/2027
Bonus Depreciation Rates
09/11/01 – 05/05/03 30%
05/06/03 – 12/31/04 50%
01/01/05 – 12/31/07 0%
01/01/08 – 09/08/10 50%
09/09/10 – 12/31/11 100%
01/01/12 – 9/27/17 50%
9/28/17 – 12/31/22 100%
01/01/23 – 12/31/27 80% - 20%
• Watch property with construction contract prior to 9/28/2017
• Property no longer needs to be “new,” beginning 9/28/2017
24100% Bonus Depreciation
9/28/2017 through 12/31/2017:
• Normal qualified real estate categories remain through
12/31/2017, along with their historical tax lives –
– Qualified Leasehold Improvement Property (“QLHI”)
– Qualified Improvement Property (“QIP”)
– Qualified Restaurant Property and Qualified Retail
Property
• Used commercial property is now eligible for bonus
depreciation, beginning 9/28/2017
• QLHI and QIP property that is acquired during the above-
referenced period of time is now eligible for 100% bonus
depreciation 25100% Bonus Depreciation
9/28/2017 – 12/31/2027:
• Embedded personal property/section 1245 property
acquired during this period of time, pursuant to a cost
segregation study, qualifies for 100% bonus
depreciation, new and used
• You can elect a lower 50% or 0% bonus depreciation
rate, per class – effective 9/28/2017
26Bonus Depreciation Phase Out
• 100% Bonus depreciation 1/1/2018 -12/31/2022
• Bonus depreciation is scheduled to phase-out
beginning 1/1/2023
• The only qualified real estate property provision that
survived, beginning 1/1/2018, is QIP
• QIP’s tax life is now understood to be 15 years
Note: There is an anticipated Technical Correction to be
issued to permit the tax life of QIP at 15 years and make it
eligible for bonus depreciation
27Section 179
• Beginning 1/1/2018 is $1 million/year
• Certain non-residential real property items qualify (QIP,
HVAC, roof, security systems, and fire protection
systems)
NOTE: Normal Section 179 limitations apply. You need
formal trade or business income; commercial rental real
estate income typically does not qualify for Section 179
unless rising to the level of a formal trade or business
activity
28Rev. Proc. 2015-56 – New Retail &
Restaurant Remodel – Refresh Safe Harbor
• Taxpayers engaged in the trade or business of operating a
retail establishment or restaurant with safe harbor
method of accounting - audited financial statements
• Includes owners of shopping centers or corporate office
with retail shopping
• Not included: 1245 property, automotive dealers, other
motor vehicle dealers, gas stations, manufactured home
dealers, nonstore retailers, hotel and motel business
operators, civic or social organizations, amusement parks,
theaters, casinos, country clubs, caterers
29Rev. Proc. 2015-56 – New Retail &
Restaurant Remodel – Refresh Safe Harbor
• 75% deduction of “qualified costs,” remaining 25%
capitalized and depreciated
• No disposition of prior costs capitalized
30Qualified Leasehold Improvement
Property
• Any improvement to an interior portion of a
building that is nonresidential real property;
excludes enlargements, elevators/escalators,
common area work and internal structural
framework
• Recovery period: 15 years
• Straight line method; half-year convention
• Can be included in Section 179 deduction – if
trade or business
31Qualified Leasehold Improvement
Property
• Eligible for 50% bonus depreciation
• 3 year rule applies - placed in service more than three
years after the date the building was first placed in
service
• Landlord or lessee can make interior improvement but
must be made pursuant to a lease
• Landlord and tenant cannot be related parties
• Expires 12/31/2017
32Qualified Restaurant Property
• Any section 1250 property that is a building - new
building or existing structure - or an improvement to a
building,
• If more than 50% of the building’s square footage is
devoted to the preparation of, and seating for on-
premises consumption of, prepared meals
• Recovery period: 15 years
• Straight line method; half-year convention
33Qualified Restaurant Property
• Can be included in Section 179 deduction – trade or
business – normally tenant
• Not eligible for bonus depreciation unless qualified
leasehold improvement property 2015 or Q.I.P. in 2016
• 3 year rule does not apply - placed in service more
than three years after the date the building was first
placed in service
• Encompasses the entire building structure as well as
interior costs. Can be an acquired building
• Landlord and tenant can be related parties
• Expires 12/31/2017
34Qualified Retail Improvement Property
– Effective 1/1/2016
• Any improvement to an interior portion of a
building which is nonresidential real property.
Retail establishments that qualify include those
open to the public and primarily in the business of
the sale of goods (tangible personal property) to
the general public and not services (grocery stores,
clothing stores, hardware stores, and convenience
stores)
• Recovery period: 15 years
• Straight line method; half-year convention
• Can be included in Section 179 deduction – trade or
business
35Qualified Retail Improvement Property
– Effective 1/1/2016
• Now eligible for 50% bonus depreciation
• 3 year rule applies - placed in service more than
three years after the date the building was first
placed in service
• Excludes enlargements, elevators/escalators,
common area work, and internal structural
framework
• Landlord and tenant can be related parties
• Building can be owner occupied
• Expires 12/31/2017
36Qualified Improvement Property –
Effective 1/1/2016
• New category – 1/1/2016
• Qualified improvement property is any improvement to an
interior portion of a building that is nonresidential real
property if the improvement is placed in service after the
date the building was first placed in service, excluding:
enlargements, elevators/escalators, and internal structural
framework
• The improvements do not need to be made pursuant to a
lease, and the building can be owner occupied
• 39 year tax life, through 12/31/2017
• 15 year tax life, beginning 1/1/2018 – Technical Corrections
37Qualified Improvement Property
• Straight line method; mid-month convention
• Can be included in Section 179 deduction – trade or
business
• Eligible for 50% bonus depreciation
• 3 year rule does not apply - placed in service more
than three years after the date the building was first
placed in service
• Excludes enlargements, elevators/escalators, common
area work, and internal structural framework
• Landlord and tenant can be related parties
• Building can be owner occupied
38Section 179 – Commercial Rental
Real Estate
Through 12/31/2017:
• Section 179 deductions of $510,000 with a phase out
starting at $2,030,000
• Trade or Business only
• A deduction of $510,000 of Qualified Real Property
(Qualified Leasehold Improvement Property, Qualified
Restaurant Property, and Qualified Retail Improvement
Property) is retroactive for 2017 – Max $510,000
3940
Historic Tax Credit
• Historic Tax Credit (HTC):
– The 10% credit was repealed for pre-1936 buildings
– The 20% credit for Qualified Rehabilitation Expenses
(QRE) was retained with a modification.
– The credit allowable over a 5-year period
– Making the credit 4% per year of the QREs
411/1/2018 New HTC Rules, continued
Transition rule to determine if the HTC is claimed
under the old law:
– Was the full 20% in the year placed in service or
under the new law, 4% per year over 5 years
– The taxpayer has a 24- or 60-month window to
claim expenditures during rehabilitation
– If the taxpayer selects to start the window outside of
180 days after December 22, 2017, then the new
law applies, otherwise the old law is still in effect
4243
Qualified Opportunity Zones
• Enacted as part of sweeping federal tax legislation commonly referred to as
the Tax Cuts and Jobs Act of 2017.
• Significant tax incentives for taxpayers to reinvest capital gains in certain
property and businesses located or operating in specially designated tracts.
(“QO Zone”).
• Encourage economic development in “low income areas” by providing various
tax incentives for private investments in qualifying areas
• Estimated $6.1 trillion in unrealized capital gain at the end of 2017.
• This significant amount of capital available for reinvestment makes the QO
Zones program potentially the largest economic development initiative in the
country.
• Designed to channel more equity capital into distressed markets
44Opportunity Zone Designation
• Treasury has designated QO Zones in all 50 states, the
District of Columbia, and five U.S. possessions.
– In Kentucky, Treasury designated 144 low-income census tracts in 84
counties across the state as QO Zones.
• 19 designated QO Zones in Jefferson County.
• 2 designated QO Zones in Bullitt County.
– In Indiana, Treasury designated 156 tracts in 58 counties covering all or
portions of 83 cities and towns throughout the state as QO Zones.
• 5 designated QO Zones in Clark and Floyd counties.
• The zones will effectively not change
• IRS has a listing by state
• States have websites for confirming QOZ locations
45Designated O Zones in Kentucky Source: http://www.thinkkentucky.com/OZ/ 46
Designated O Zones in Louisville Source: https://louisvilleky.gov/government/louisville-forward/opportunity-zones-louisville47
Designated O Zones in Southern IN Source: https://www.cims.cdfifund.gov/preparation/?config=config_nmtc.xml 48
Designated O Zones in Southern IN Source: https://www.cims.cdfifund.gov/preparation/?config=config_nmtc.xml 49
QO Zone Benefits
Qualified Opportunity
Zone Funds (QOFs)
Defer taxes by making when invested in
timely investments
Taxpayers Qualified Opportunity
Zone Property
50QO Zone Benefits
There are three separate investment incentives that a taxpayer can elect to
take advantage of with respect to their investment.
1. Initial gain deferral
2. Partial forgiveness
3. Permanent exclusion of gain
on appreciation
51Gain Recognition
• Gain deferral is temporary because the taxpayer
must recognize the income in the tax year the
investment is sold or the tax year that includes
December 31, 2026, whichever is earlier.
• Gain is calculated as the lessor of:
1. Amount of gain deferred
OR
2. The fair market value of investment in QOF interest less
the basis in the QOF interest *
* Basis is QOF is initially deemed to be zero
52Deferral Period
The period of capital gain tax deferral ends upon the
earlier of:
53Partial Forgiveness and Permanent
Exclusion of Additional Gains
Basis increased by Basis increased by Basis is equal to
10% of the deferred Additional 5% of the Fair Market Value
Within
180 Days gain deferred gain
Exclusion of
Up to 90% taxed Up to 85% taxed gains on appreciation
of investment
54Example
April 28, 2029
April 28, 2026 (10 years) Taxpayer
(7 years) Taxpayer’s sells its investment for
Before April 28, 2019 basis in investment in $3M. The basis is equal
Taxpayer contributes QOF makes a timely investment of QOF increases another to the FMV. No
the $1M of capital gain the $1M in Qualified Opportunity 5% from $100k to additional tax is owed
to a QOF Zone Property $150k on the appreciation.
Oct. 30, 2018
April 28, 2024
Taxpayer enters into a December 31, 2026
(5 years) Taxpayer’s basis
sale that generate $1M $850k of the $1M of
in investment in QOF
of capital gain initial capital gains are
increases 10% from $0 to
$100k taxed and the basis in
QOF investment
increases to $1M
Notes:
• The Taxpayer’s initial basis is deemed to be $0 in the QOF investment
55Investment Types in Opportunity Zones
Real Estate New Businesses created in
Development and Rehab Project Opportunity Zones
in Opportunity Zones
Expansion of
Businesses already Businesses expanding into
in Opportunity Zones Opportunity Zones
56Qualified Opportunity Fund - Purpose
• A QO Fund is any investment vehicle organized as either a
partnership (including an LLC treated as a partnership for
tax purposes) or corporation that was formed for the
purpose of investing in qualified opportunity zone
property (“QOZ Property”).
• At least 90 percent of the QO Fund’s assets must consist
of QOZ Property.
• Fund can self certify
57Qualified O Zone Property
There are three categories of QOZ Property permitted:
1. Qualified Opportunity Zone Stock
(Qualified Opportunity Zone Business)
2. Qualified Opportunity Zone Partnership Interest
(Qualified Opportunity Zone Business)
3. Qualified Opportunity Zone Business Property
58Qualified O Zone Stock and
Partnership Interests
• The investment must be acquired after December 31, 2017
solely in exchange for cash;
• Must be a qualified opportunity zone business, or is being
organized for the purpose of being a qualified opportunity zone
business;
• Must remain a qualified opportunity zone business for
substantially all of the qualified opportunity fund’s holding
period
59Qualified O Zone Businesses
• A trade or business in which substantially all of the tangible
property owned or leased by the taxpayer is qualified o zone
business property
• At least 50% of income derived from active conduct
• Less than 5% of unadjusted basis of property is nonqualified
financial property
60Ineligible Businesses
“Sin Business”
Golf courses Country clubs
Race tracks Massage parlors
Gambling facilities Hot tub facilities
Liquor stores Tanning facilities
61Qualified O Zone Business Property
• Tangible property used in a trade or business
• Acquired by purchase from an unrelated party (20% threshold) after
December 31, 2017
• During substantially all of holding period, substantially all the use is in a QOZ
• Substantially all is defined as 70%
• Original use in the QOZ commences with the taxpayer
• OR
• Taxpayer substantially improves the property
• during any 30-month period after acquisition, additions to basis exceed an amount equal to the
adjusted basis of such property at the beginning of such period
• Guidance allows for reasonable working capital
62Basic Model for Rental Real Estate
or direct ownership of
QOZ Business Property
within
180 days
Investors QOF QOZ QOZ
Partnership Business Property
Rental Real Estate
• New construction
• Substantial improvement of adjusted basis excluding land
63Civil Penalties for Noncompliance
• Failure to meet investment standard results in
per month penalty
• % of shortfall multiplied by underpayment rate
• No penalty if failure is due to reasonable cause
64Questions?
65IRS Circular 230 Disclosure
As a result of perceived abuses, the Treasury has
recently promulgated Regulations for practice before
the IRS. These Circular 230 regulations require all
accountants to provide extensive disclosure when
providing certain written tax communications to
clients. In order to comply with our obligations under
these Regulations, we would like to inform you that any
advice given in this presentation, including any
attachments, cannot be used to avoid penalties which
the IRS might impose, because we have not included all
of the information required by Circular 230, nor have we
performed services that rise to this level of assurance.
66Thank You!
Stephen M. Lukinovich, CPA, PFS, CVA
Stephen.Lukinovich@mcmcpa.com
Andrew J. Ackermann, CPA, CVA
Andy.Ackermann@mcmcpa.com
502.749.1900
www.mcmcpa.com
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