There are a number of provisions in the new Coronavirus Stimulus package that affect the methods for depreciation of real estate assets for tax purposes — and these changes are likely to be significant for our industry.
At Cherrytree Group, we have studied the legislation, and while not all of the details are publicly available we can make some initial determinations of what it means for our clients.
Tax credits which are generated by real estate development — such as low income housing or historic rehabilitation, and even those generated by creating renewable energy— often generate substantial depreciation benefits. These benefits create “losses” for taxpayers that can be used to offset income generated from other sources — creating a powerful tax planning tool.
The use of those losses had been limited by the Tax Cuts and Jobs Act of 2017 (2017 Tax Reform) in I.R.C. Section 461(l): which provided that losses could only be used to shelter the first $500,000 of a taxpayer's non-business income, such as capital gains from investments. Any remaining losses were required to be rolled over to future years.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act that was recently passed by Congress put a moratorium on Section 461(i) and made the change retroactive to January 1, 2018. This removes that loss restriction for three years — for this year, and for two retroactive years. What it means: taxpayers filing a joint return as a married couple who have in excess of $500,000 in annual capital gains or income from sources other than their business will be able to utilize these losses generated by depreciation (from sources other than their regular business income) to offset their regular business income for 2020 — and to file an amendment to claim the offset for tax years 2019, and 2018.
There is an additional benefit: as part of the 2017 tax reform package, Congress intended to accelerate depreciation on qualified improvement property (QIP); generally defined as any improvement made to the interior portion of a non-residential building any time after the building was placed in service. The depreciable life of QIP was to be reduced from 39 to 15 years; and as property with a useful life of less than 20 years can use accelerated depreciation it would then have been possible to use the accelerated depreciation rules for QIP. However, in enacting the 2017 tax reform Congress omitted the 15-year life for QIP, so the CARES Act provides a much-needed technical correction to the QIP problem by giving it its intended 15-year life — while also making the change retroactive to January 1, 2018.
Taxpayers should be able to file amended returns to reap the benefits of these accelerated depreciation in 2018 and 2019. This would be a welcome respite for investors in historic rehabilitation projects, for whom the 2017 tax reform diminished the value of the historic tax credit by making it a 5-year tax credit rather than a 1-year tax credit.
These provisions, together with the Opportunity Zone Rules that originated in the 2017 tax reform, offer significant opportunities to benefit the historic tax credit and renewable energy investments, which generate significant depreciation benefits. The Opportunity Zone Rules allow depreciation recapture to be muted as part of the structuring of an Opportunity Zone investment, and the CARES Act's changes to the Section 461 limitations make depreciation a far more valuable incentive than it has currently been.
The renewable energy industry has been supported by the Investment Tax Credit (ITC) at the Federal level and various state subsidies at the state level in order to allow the industry to develop and grow so that it continues to be a viable alternative to fossil fuels and assists the goal of decreasing our carbon footprint and becoming a more environmentally conscious economy. However, investors historically have viewed depreciation as an erodable benefit, and have assigned a diminished value to depreciation benefits. This has negatively affected the capital market for equity that renewable energy developers depend on.
It is my opinion that these new provisions in the CARES Act — together with the Opportunity Zone Rules — have given investors a substantial set of tax advantages that will help to provide and generate a market in investments that will have a socially beneficial impact to our world: such as solar energy, rehabilitation of historic buildings and provision of affordable housing.
At Cherrytree Group, we work with developers and investors to determine the path that may best for them. We invite anyone who is wondering about the ramifications of these recent developments to contact us for a consultation.