This is the second of our two-part summary of the most relevant provisions of the CARES Act pertaining to the commercial real estate industry (first-part summary can be found here). This summary is intended as an overview to assist real estate professionals in navigating the implications of the CARES Act.
1. Modifications of Rules Regarding Net Operating Losses
Section 2303 of the CARES Act allows businesses to use net operating losses (NOLs) to offset taxable income in certain situations. The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the ability of companies to carry excess NOLs back to prior tax years in order to offset income (and reduce taxes) in earlier tax years. The CARES Act allows excess NOLs arising in a tax year beginning after December 31, 2017 and before January 1, 2021 to be carried back five years to offset taxable income. As a result of the extended carryback provision, some real estate businesses may be able to carry back NOLs arising in years beginning in 2018, 2019, and 2020 to offset earlier ordinary income or capital gains, thereby generating a current refund. Furthermore, in some cases, businesses may be able to take advantage of favorable tax rate differentials between the various tax years involved. Consequently, some real estate companies with losses may be entitled to cash infusions in the form of refunds. The IRS recently published rules regarding the timing of these filings. See IR 2020-67, 4/10/2020; Rev. Proc. 2020-24, 2020-17 IRB. The CARES Act also includes special NOL carryback rules for real estate investment trusts (REITs) and life insurance companies. As with any tax matter, taxpayers are urged to review these new rules carefully with their tax advisors.
2. Temporary Suspension of Excess Business Loss Limitation
TJCA generally disallows excess business losses for noncorporate taxpayers (which include individuals, estates and trusts) for tax years 2018 through 2026. Generally, an excess business loss is the excess of (i) the taxpayer's aggregate trade or business deductions for the tax year over (ii) the sum of the taxpayer's aggregate trade or business gross income or gain plus $250,000 ($500,000 in the case of married filing joint taxpayers). The CARES Act temporarily removes this limitation for business losses in 2018, 2019 and 2020. Therefore, affected taxpayers, including partners of partnerships and members of limited liability companies, may benefit from amending their 2018 returns (and 2019 returns if such returns have already been filed) to claim excess business losses that they were unable to claim on originally filed returns.
3. Limitation of Business Interest
Section 2306 of the CARES Act retroactively increases the amount of business interest expense that may be deducted by some real estate businesses. This retroactive tax relief will affect real estate businesses organized as corporations by allowing an increase in the business interest deduction limitation from 30% to 50% of adjusted taxable income. In addition, for the calculation of the interest limitation for the tax year beginning in 2020, a taxpayer can elect to use its adjusted taxable income from 2019 to calculate the limit. Since many companies can expect higher taxable incomes in 2019 than in 2020, this will increase the amount of deductible interest allowed in 2020.
The CARES Act provides special rules for partnerships with regard to limitations on business interest. The TCJA generally “silos” partnerships, treating business interest expense as deductible to the extent the partnership has sufficient business interest income and adjusted taxable income. The CARES Act allows a partnership to elect to partially suspend this treatment for 2019. The 50% limit does not apply to partnerships for the taxable year beginning in 2019. Instead, 50% of the amount of excess business interest allocated to a partner for the taxable year beginning in 2019 is treated as paid or accrued by the partner in the taxable year beginning in 2020 and is not subject to the interest deduction limitation. The remaining 50% remains subject to the “silo” rules for partnerships.
These provisions will provide cash infusions for some real estate businesses through tax refunds directly to the entity, or in the case of a partnership, by entitling their owners to tax refunds which can be contributed to or loaned to the partnerships. As with any tax matter, taxpayers are urged to review these new rules carefully with their tax advisors.
4. Depreciation of Qualified Improvement Property
The CARES Act includes a significant revision to the depreciation rules enacted under TCJA in 2017 which inadvertently omitted “qualified improvement property” (QIP) from the list of 15-year property items that are eligible for 100% bonus depreciation in the year they are placed in service or acquired. Section 2307 of the CARES Act modifies the depreciable life of QIP from 39 years to 15 years (under modified accelerated cost recovery system, known as “MACRS”), effectively making certain QIP eligible for bonus depreciation. Notably, the change to the TCJA is effective as if originally included in the 2017 law. Taxpayers are encouraged to consult their tax advisors for a more comprehensive analysis regarding the impact of Section 2307.
5. Loan Modifications without Restructurings Classification
Section 4013 of the CARES Act allows banks the option to suspend some of the accounting requirements under U.S. GAAP rules related to troubled debt restructurings (TDR). The intent is to encourage banks to work prudently with borrowers in the wake of the COVID-19 pandemic to make loan modifications. Such modifications could include things such as forbearance arrangements, interest rate modifications and modified payment schedules. Section 4013 frees banks from some of the regulatory burdens associated with TDRs (such as accounting and reporting requirements relating to credit losses) for eligible loan modifications. These changes are intended to diminish the impact on banks’ financial statements when the banks make loan modifications to accommodate their troubled customers. To be eligible, the modification must occur between March 1, 2020 and 60 days after the COVID-19 national emergency is terminated (or December 31, 2020 if earlier). Further, this option is only available if the loan was not more than 30 days past due as of December 31, 2019.
6. Tenants Granted Credit Protection
Section 4021 of the CARES Act amends the Fair Credit Reporting Act to protect borrowers from negative credit reporting arising out of the COVID-19 pandemic in connection with an obligation or account. If a furnisher (meaning a creditor or a third party that provides information about a consumer to a consumer reporting agency) makes an "accommodation" with respect to one or more payments on a credit obligation or consumer account, the furnisher must continue to report the account as current if the consumer fulfills the terms of the accommodation. An "accommodation" under Section 4021 includes relief granted to impacted consumers such as an agreement to defer a payment, make a partial payment, grant forbearance, or modify a loan or contract. This applies only to accounts for which the debtor has fulfilled the requirements of the accommodation. However, the furnisher is permitted to continue reporting accounts that were already delinquent before the accommodation was made unless the consumer brings the account current. This new reporting requirement does not apply to consumer accounts that have been charged off. For tenants, this means that when and if their account had been "charged off" matters. The landlord has the right and ability to report delinquent accounts if no accommodations were made or kept. These furnisher responsibilities will apply to reporting on accommodations made to consumer accounts between January 31, 2020 through the later of 120 days after: (1) enactment of the CARES Act, or (2) termination of the COVID-19 national emergency.
7. Real Estate Related Appropriations
The CARES Act provides for a $12.4 billion increase in funding for several U.S. Department of Housing and Urban Development (HUD) programs. For some HUD landlords, the Act increases funding for the maintenance of properties that fall under some HUD programs. Additionally, congress allocated funding to address tenant rental assistance programs, including vouchers. Other programs receiving funding include: (1) the Community Development Block Grant program, (2) the Emergency Solutions Grant program to house individuals and families, (3) the Housing Opportunity for Persons with AIDS program and (4) the Native American and Indian Community Housing Block Grant programs.
8. Relief for Section 1031 Exchanges
Finally, although not part of the CARES Act, it is worth mentioning that just recently the IRS issued guidance extending the time within which taxpayers may effectuate certain aspects of Section 1031 exchanges (a popular tax deferral method frequently used by real estate investors). Taxpayers now have until July 15, 2020 to identify and/or purchase a replacement property for 1031 exchanges with deadlines due on or after April 1, 2020. See IRS Notice 2020-23.
This is a fluid and rapidly changing situation and these resources are current only as of the date of publication. We recommend that you contact your local Quarles & Brady attorney regarding the most up-to-date information or with any other questions regarding this subject matter, or contact