debits and credits
Rx for Recovery
by Christopher L. Paris
On February 17, 2009, President Barack Obama signed a significant piece of new legislation: the American Recovery and Reinvestment Act of 2009. Included in the Recovery Act are a number of tax law changes that will positively affect the real-estate industry, although the changes are not as substantial as many had hoped.
Accelerated Depreciation
Fortunately for real-estate owners and investors, depreciation deductions is one area where Congress was generous. Under the new law, property placed in service after December 31, 2008, is eligible for an accelerated depreciation deduction equal to 50% of the cost of “qualified property.” In other words, 50% of the cost of the property can be written off in the first year, with the remaining 50% being depreciated using conventional methods. The property generally must be acquired and placed in service prior to January 1, 2010.
Qualified property is property with a recovery period of 20 years or less, as well as qualified leasehold improvement property. Eligible property includes most types of new property other than buildings, including 15-year property such as landscaping, fences, gates and parking lots. Qualified leaseholds include improvements made under a lease by either the lessor or the lesee, but does not include items such as structural modifications or additions to a building. There are also special provisions for improvements and leases between related parties.
The original use of the property must commence with the taxpayer claiming the depreciation deduction, which means the property must be new property. The taxpayer generally must purchase the property after December 31, 2007, and before January 1, 2010, and there cannot be a written binding contract for the acquisition that was in effect before January 1, 2008.
For a taxpayer manufacturing, constructing or producing property for its own use, the requirements are treated as met if the taxpayer begins manufacturing, constructing or producing the property after December 31, 2007, and before January 1, 2010.
First-Year Write Off
IRC §179 allows a taxpayer, other than an estate, trust and certain noncorporate lessors, to elect to deduct as an expense, rather than to depreciate, up to a specified amount of the cost of new or used tangible personal property placed in service during the tax year in the taxpayer’s trade or business (section 179 property).
The Recovery Act extends the 2008 expensing limit of $250,000 to 2009, with the same dollar-for-dollar phase out for purchases exceeding $800,000 (with a full phase out and no expensing allowed when purchases exceed $1,050,000). Unfortunately for residential property owners, this expense election is not available for personal property used predominantly to furnish lodging (such as apartments, duplexes and single-family homes). However, this increased expensing limit will be a major benefit to commercial property owners, as well as hotel and motel owners. Types of property eligible for a first-year write off for commercial property and hotel owners include, but are not limited to, the following: carpeting, certain types of electrical wiring, decorative lighting fixtures, certain types of flooring and floor coverings, signs, furniture and computer equipment.
Both the accelerated depreciation and section 179 depreciation will require detailed records of assets purchased and, in certain instances, cost segregation studies, to maximize deductions for tax purposes.
Extended Net Operating Loss
The net operating loss (NOL) provision was enacted to allow taxpayers to “smooth out” taxable income in cyclical industries. An NOL is the excess of business deductions over gross income in a particular tax year (a taxable loss for any given year). The loss can be deducted, through a NOL carryback or carryover, in another tax year where there is taxable income. In general, NOLs may be carried back 2 years and forward 20 years.
For NOLs arising in tax years ending after December 31, 2007, the Recovery Act permits small businesses to elect to increase the NOL carryback from two years up to five years. This particular provision has the potential to be a huge benefit to residential homebuilders who had great years and paid substantial tax back in 2003 to 2005, when the housing market was a much different place. However, in order to qualify for this relief, the taxpayer must be a small business. In general, a small business is defined as a business where the average gross receipts for a three-year period are less than or equal to $15 million. Beware of the special aggregation rule that applies to taxpayers with several commonly owned entities. This aggregation rule combines the gross receipts of all related entities for purposes of the $15 million test, and can potentially reduce the number of qualified small businesses.
The benefit of this carryback provision can best be illustrated by an example. Let’s say that during the year ended December 31, 2008, a condo developer forfeited option deposits on a piece of property totaling $5 million due to poor economic conditions, resulting in a tax loss in the same amount. The condo developer was very successful from 2003 to 2005, but subsequent to the market peak in 2005, sales started to slow down and margins became tighter. Let’s assume the condo developer qualifies as a small business with average annual gross receipts for 2006 through 2008 that are less than or equal to $15 million.
Under the old rules, the condo developer could carry back his $5 million tax loss to 2007 and 2006. If the taxable income for those two periods totaled, say, $1,725,000, he could recover $603,750 in taxes previously paid (assuming 35% federal tax bracket).
Under the new rules, the condo developer can carry back his tax loss all the way to 2003 and 2004, and, assuming he made even more money in those years, recover hundreds of thousands more in taxes previously paid. Not only is the immediate refund of taxes previously paid higher, but the condo developer still has 2007 that he can carry back to in the event of a 2009 loss.
Modified First-Time Homebuyer Credit
First-time homebuyers can claim a refundable tax credit equal to the lesser of 10% of the purchase price of a principal residence or $8,000. A person is considered a first-time homebuyer if he didn’t own a residence in the United States during the three years prior to the purchase of the home. Because only ownership in a primary residence is considered, it is possible for a taxpayer who already owns a vacation home to claim the new credit. The credit phases out for individual taxpayers with adjusted gross income between $75,000 and $95,000, and $150,000 to $170,000 for joint filers.
The first-time homebuyer credit was in existence prior to the passing of the Recovery Act. However, the credit was previously recaptured ratably over a 15-year period. What was previously an interest-free 15-year loan from the government is now a credit for 2009 purchases made before December 1, 2009.
Energy Credits
There were a number of favorable changes to various types of energy credits. The renewable electricity production credit was extended for three years (through 2013). A renewable electricity production credit is allowed for electricity produced by taxpayers from wind, geothermal energy and other alternative energy sources.
A 30% business energy credit is also allowed for certain energy property placed in service, including fuel cell property, solar property, small wind energy property and geothermal heat pump property. For facilities placed in service after December 31, 2008, the Recovery Act allows taxpayers to make an election to have qualified property of certain qualified facilities treated as energy property eligible for a 30% investment credit, rather than treating it as a renewable electricity production credit, which requires more extensive calculations. Previously, there was a cap on the 30% business energy credit for qualified small wind energy property. The Recovery Act also removed this cap.
Prior to the Recovery Act, a taxpayer could claim a lifetime nonrefundable credit of up to $500 for making qualifying energy saving improvements to his home, but only $200 of this credit amount could be for qualifying window expenditures. The Recovery Act extends the nonbusiness energy tax credit for one year, through December 31, 2010, in addition to raising the credit rate on the cost of installing energy efficient building components (what was previously 10% is now 30%). The ceiling on credits for residential energy efficient property purchased and placed in service before 2017 has been removed.
Although not as significant as originally expected, there are a number of beneficial tax provisions for the real-estate industry contained in the Recovery Act. The most disappointing change to the Senate version of the bill was the small business requirement of the expanded NOL carryback. The majority of “for sale” residential developers would have benefitted from this provision prior to the small business requirement that will limit its use to a select few. However, Congress was pressured to get this bill to the president as quickly as possible, and hopefully there will be more changes to come in the near future.
The opinions expressed in this article are those of the author, and do not necessarily reflect the viewpoint of the SFAA or the SF Apartment Magazine. Christopher L. Paris is a senior manager at Burr Pilger Mayer and can be reached at 707-544-4078. Copyright © 2009 by Black Point Press. All rights reserved.