Real estate professionals listen up. The 2020 CARES Act enables you to generate losses that can result in significant tax savings. You qualify as a Real Estate Professional (REP) if you can demonstrate 750 hours annually on activities such as leasing, marketing, tenant recruitment, or property management that is more than 50% of your work. REP status combined with material participation in real estate activities is a powerful classification which allows real estate losses to offset income – any income.
The first important change made by the CARES Act provides that the cost to improve interiors of non-residential buildings may be immediately written-off, rather than depreciated over 39 years. Second, net operating losses may now be carried back to offset taxable income reported in previous years. Combined, these two legislative changes offer new opportunities to improve properties and obtain tax refunds through the generation of losses resulting from increased deductions.
Qualified Improvements Property (QIP)
Replacing drywall, improving fire protection, repairing electrical and plumbing systems are good examples of interior improvements that qualify for a 100% bonus depreciation in the first year. The CARES Act makes this change retroactive for property placed in service after December 31, 2017.
Net Operating Loss (NOL)
Under the CARES Act, net operating losses generated during 2018, 2019, and 2020 may now be “carried back” five years preceding the loss year (beginning with the earliest year first). Any excess business loss remaining after carryback to the fifth prior year can be applied against the taxable income of the next year, resulting in tax refunds. Any unused net operating loss remaining can be carried forward to future years.
Tax Advantages for Real Estate Professionals
Designated Real Estate Professionals who “materially participate” in real property businesses can deduct unlimited amounts of losses and avoid the net investment income tax. If a taxpayer cannot meet the REP thresholds, the losses are treated as passive and therefore, available only to offset passive income.
Material participation includes substantial activity in businesses including real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage. Financing activities and mortgage brokering do not qualify as a real property trade or business.
To help taxpayers achieve REP status, the materially participating test can be met by grouping separate real estate activities into one activity. Also, the 750 hours requirement is cumulative if you elect to group your properties.
Real Estate Professionals should keep detailed, contemporaneous notes on a calendar of time spent on various properties. Notes such as who you met with, what you discussed, which property was the focus with a date and time stamp can go a long way to proving hours spent. Also, it is important to be consistent in the format of your documentation. If audited, be assured that the IRS will appreciate uniformity but will frown on any attempts to recreate records after the audit has begun. Additionally, since the qualifying requirements must be met annually, Real Estate Professionals should keep their tax advisor updated on their activity levels and changes to their portfolio of properties.
The 2020 CARES Act presented unexpected tax advantages for Real Estate Professionals. Be sure to carefully evaluate your real estate portfolio’s tax strategies with your tax advisor in the context of the new law.
About the Author
Kathleen Braica is a Partner in our Private Client Services group for Daszkal Bolton. She has over 25 years of tax planning and compliance experience, with special expertise in high net worth individuals, trusts, estates, gift planning/compliance, and financial services firms.