My REIT Partner Wants … to Know How the CARES Act Affects Our Business
4.13.20 | Berdon Industry Insights – REIT Special Edition
Hey all you cool cats and kittens! There are two things I, as the author of a blog-ish about REIT JV issues, know for certain at this moment:
- The best way to reheat pizza is by starting cheese side down in a cast iron skillet on the stove top
- Your REIT partner wants to know, in simple terms, what the CARES Act means for your joint venture (“JV”).
I write this in jest, of course, but a little levity can often be useful. Now, in an exceptionally smooth and certainly on point transition, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) offers relief to businesses affected by COVID-19 through various programs, including forgivable loans, federal income tax credits, and loosening of the reigns on some tax provisions introduced in the Tax Cuts and Jobs Act (the “TCJA”) in late 2017.
The most publicized provision of the CARES Act is the Paycheck Protection Program (“PPP”) which is administered by the Small Business Administration (“SBA”). This program provides relief for small businesses by providing 100% guarantees for up to $349 billion in loan commitments to help small businesses pay costs like payroll, rent, interest, health benefits, and insurance premiums. There are a variety of intricate rules related to both eligibility and specific costs & payments that qualify for loan amount computation and loan forgiveness. Importantly for your JV, or REITs in general, the SBA issued an interim final rule (“IFR”) relating to the PPP loan and loan forgiveness programs which appears to meaningfully limit the field of eligible borrowers, specifically in the real estate arena. The IFR contains exclusions for several types of businesses:
- Passive businesses owned by developers and landlords that do not actively use or occupy the assets acquired or improved with the loan proceeds
- Businesses engaged in subdividing real estate
- Businesses that are engaged in owning or purchasing real estate and leasing it for any purpose are not eligible. However, real estate management and other service companies with payroll should still qualify
- Businesses that lease land for cell phone towers
- Businesses that enter into management agreements with third parties that give the management company sole discretion to manage the operations.
- Apartment buildings
Accordingly, this IFR should temper the expectation of any REIT inclusive joint venture from receiving a PPP loan, as the nature of your business is very likely in one of these categories. This is a developing issue which we believe warrants further guidance before such borrowers decide whether to proceed or not. Further information about the PPP program in general is available here.
If the business does not qualify for a small business loan under the PPP (or does not otherwise obtain such a loan), you may be eligible for an Employee Retention Tax Credit if the business’s (a) operations have been fully or partially suspended due to a COVID-19-related government shut-down order, or (b) gross receipts declined by more than 50% compared to the same quarter in 2019. Additionally, by not participating in the PPP, the employer would be eligible to defer its remittance of payroll taxes. The CARES Act prevents businesses from claiming benefits that are considered duplicative, so the credits and deferral are only available where no PPP loan has been received. For a more detailed description of the Employee Retention Tax Credit and payroll deferral provisions please click here.
Outside of the SBA loan or payroll tax provisions, the CARES Act also rolled back and corrected some tax provisions from the TCJA. One change slightly relaxed the limits on the deductibility of business interest expense for the 2019 and 2020 tax years. Prior to the CARES Act (and post TCJA) the amount of deductible business interest expense was essentially limited to the sum of business interest income and 30% of the taxpayer’s adjusted taxable income (ATI). Real estate businesses are able to elect out of this rule, the consequence of which is to accept longer depreciable lives for its assets. The CARES Act appeared to increase the limitation from 30% to 50%, however, upon further reading of the statute, this increase only really applied to businesses operating in the corporate form. Partnership’s (such as your JV with the REIT) still must apply the 30% limit. You weren’t completely left in the wind though. If a partnership had disallowed, business interest expense in 2019 (i.e., allocated ‘excess business interest expense’ to its partners), 50% of the suspended excess business interest expense from tax year 2019 “frees up” and is fully deductible at the partner level on the partner’s 2020 tax return. Partnerships can use the 50% limitation for 2020 and all taxpayers may use 2019 ATI to calculate the limit for 2019 and 2020.
One of the key tax provisions included in the CARES Act is also the long-awaited correction of the “glitch” contained in the TCJA which failed to designate “qualified improvement property” (“QIP”) as 15-year Modified Accelerated Cost Recovery Systems (MACRS) property, eligible for bonus depreciation. The CARES Act now includes QIP as 15-year MACRS property and assigns a 20-year life if Alternative Depreciation System (ADS) is elected or required (due to the business interest expense real estate opt out). Significantly, this amendment is made retroactive to tax years beginning January 1, 2018, as if originally included in the TCJA. As a reminder, QIP includes any improvement to the interior of a non-residential building which is placed in service after the building has been first placed in service. However, specifically excluded are expenditures attributable to:
- Any enlargement of the building
- Elevators and escalators, and
- The internal structural framework of the building.
The retroactive application can mean a few things for your joint venture if QIP assets were placed into service in 2018 under the correct (but also now wrong) 39-40 year life. First, as discussed in previous iterations of this series, you should check if your REIT partner wants the application of bonus depreciation. After this knowledge is in hand, it is important to check whether (a) the JV made the Real Estate election under 163(j), (b) the JV placed other assets into service and opted out of bonus for all class lives (including the non-existent 15-year life at the time), or (c) the 2018 tax return contained no election or bonus opt outs. Depending on the answers there are a variety of corrective/amending methods available to the joint venture tax return.
In response to the aforementioned changes which the CARES Act brought about regarding Section 163(j) and QIP, the IRS released Revenue Procedure 2020-22, which permits certain taxpayers to make a late election — or to withdraw an election — under Section 163(j)(7)(B) or 163(j)(7)(C) on an amended federal income tax return, an amended Form 1065, or an administrative adjustment request. Furthermore, Rev Proc. 2020-22 describes the time and manner for electing (a) Out of the 50% ATI limitation for tax years beginning in 2019 and 2020 (b) to use the taxpayer’s ATI for the last tax year beginning in 2019 to calculate the taxpayer’s Section 163(j) limitation for tax year 2020 and (c) out of deducting 50% of excess business interest expense for tax years beginning in 2020 without limitation.
Finally, while not directly relevant for the joint venture operations (or tax compliance), under the CARES Act, net operating losses (NOLs) arising in tax years beginning after December 31, 2017, and before January 1, 2020 generally may be carried back to each of the five tax years preceding the tax year of such loss (can you sense the foreshadowing in that italicized “generally”?). Since the enactment of the TCJA, NOLs generally could not be carried back but could be carried forward indefinitely. Further, the TCJA limited NOL utilization to 80% of taxable income. The CARES Act temporarily removes this 80% limitation, reinstating it for tax years beginning after 2020. Special carryback rules, however, are provided for REITs, which ultimately negate the availability of carrybacks generated in any year the entity was operating as a REIT (or utilization in a REIT year if subsequent conversion to C-Corp form occurred).
Ultimately the CARES Act contains a lot of provisions to digest for real estate businesses. Hopefully the results to your joint venture are as scrumptious as my reheated pizza slices. If you have questions on this matter, contact Thea Kruger (firstname.lastname@example.org) or your Berdon Advisor.