There are a few items in the Coronavirus Aid, Relief, and Economic Security (CARES) Act and other recent legislation that have a direct effect on many of our real estate clients. These include:
- The correction to the 2017 Tax Cuts and Jobs Act (TCJA) regarding Qualified Improvement Property (QIP);
- An extension of certain timelines for like-kind exchanges for real property; and
- The opportunity — for only a short time — to revoke the previously irrevocable election out of the business interest deduction limitations.
Like-Kind Exchange Provisions
The like-kind exchange provisions are easier, and just factual, so we will tackle those first. One of the relief provisions in IRS Notice 2020-23 (an update to Notice 2020-18) states that for those engaged in a 1031 exchange, if the taxpayer’s 45-day identification period or 180-day exchange period deadline falls between April 1, 2020 and July 14, 2020, the deadline is automatically extended to July 15, 2020. Likewise, for taxpayers engaged in reverse exchanges, if the 45-day period to identify relinquished property or 180-day period to un-park replacement property falls between April 1, 2020 and July 14, 2020, the deadline is automatically extended to July 15, 2020. To illustrate, below are two examples of the current extension:
- Example 1
Exchange began April 1, 2020. The 45-day identification period ends May 16, 2020, but is now extended to July 15, 2020. The 180-day exchange period ends September 28, 2020, and is NOT extended because it falls after the last day of the disaster period (July 15).
- Example 2
Exchange began December 31, 2019. The 45-day identification period ends February 14, 2020 and is NOT extended because it falls before the first day of the disaster period (April 1). The 180-day exchange period ends June 28, 2020, but is now extended to July 15, 2020.
Easy, right? Now on to the more difficult topic.
Qualified Improvement Property
Prior to 2018, we had a concept of qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property. All three of these property types qualified as a 15-year property. These property types were consolidated into Qualified Improvement Property (QIP) in the TCJA. “Qualified Improvement Property” is defined as any improvement made by the taxpayer to an interior portion of a building which is nonresidential real property, if such improvement is placed in service after the date such building was first placed in service. QIP does not include expenditures attributable to (i) enlargement of the building, (ii) any elevator or escalator, or (iii) the internal structural framework of the building.
Because of an error in drafting, QIP inadvertently became a 39-year property instead of a 15-year property. As such, a 39-year property does not qualify for bonus depreciation; however, a 15-year property does qualify. Therefore, for 2018 and for those 2019 returns already filed, many landlords in restaurant and retail industries, which have been hit particularly hard by COVID-19, did not get to take bonus depreciation on these assets.
After much lobbying and false hopes, the CARES Act has finally corrected this drafting error. QIP now qualifies as a 15-year property eligible for bonus depreciation. The new law makes this correction retroactive to 2018. That is a good thing, right? Perhaps, but amending 2018 and 2019 returns opens up a lot of new challenges.
Amending returns always opens up new issues, but particular to this change is the fact that many of our landlord clients made an irrevocable election out of the business interest deduction limitations by agreeing to use the alternative depreciation system (ADS). The ADS does not allow for bonus depreciation and the irrevocable election could not be changed without further action by Congress. However, for certain clients, there may be relief. Revenue Procedure 2020-22 allows businesses that elected out of Section 163(j) as a real property trade or business in 2018 or 2019 a “do over” for the ADS election if they file an amended return before October 15, 2021. In some cases, it may make more sense to lose a part of the interest expense deduction in order to take advantage of bonus depreciation.
As has become the new saying lately, “this is a very fluid situation.” Next week, we will be issuing further guidance and a detailed example of the amendment process to take advantage of these new provisions. Stay tuned.
For more information about real estate issues in regard to the CARES Act, contact Michael Kovacs at [email protected] or call him at 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group. If you’d like to receive Client Alerts on timely topics that may affect your business, update your blog preferences.