Real Estate Group Newsletter – Fall 2022
Tamara Partridge, Thomas Kosinski
Why Is ESG Important to Real Estate Developers?
Tamara Partridge, CPA, MST
You may have heard the term ESG, but what does it mean? ESG stands for environmental, social and governance. ESG is a set of non-financial factors that investors use as part of their analysis to screen potential investments. Socially conscious investors want to make sure that companies are minimizing their negative environmental impact, considerate of people and relationships, and are transparent and accountable to investors.
ESG and Real Estate
The application of ESG factors has become increasingly relevant in the real estate landscape. Investors are becoming more aware of these principles and placing a higher value on them. Both investors and tenants want real estate that is sustainable and has a positive impact on the community. This newsletter will provide examples of what investors are looking for in the current real estate market as it relates to ESG.
In general, the real estate sector is a large consumer of energy. Choosing green alternatives will not only make the construction process more environmentally friendly, but also reduce energy usage during the life of the building. Developers should consider using recycled and reusable materials, an effective water management system and the use of solar panels, when possible.
For the past few decades, many buildings aimed to be LEED (Leadership in Energy and Environment Designed) certified, which is a green building certification program. Although LEED will remain an important way to measure a building’s potential energy usage, carbon emissions are becoming a new focus. A more recent initiative is the World Green Building Council’s Net Zero Carbon Buildings Commitment, which calls for all buildings to have net-zero carbon emissions by 2050. Building and construction accounts for a large percentage of global carbon emissions. Developers should consider green construction materials that will reduce carbon emissions during construction.
Implementing ESG standards into your buildings can result in benefits. According to a U.S. Green Building Council study, the initial cost of a green building is only 2-3% higher than a non-green building, but consumes 25-35% less energy. Additionally, operation and maintenance costs are 14% lower than conventional buildings. There have also been analyses done which indicate that the average rent in a green building is almost one-third higher than rent in a non-green building.
Social initiatives can help build trust amongst employees and tenants. People want to feel that their health, well-being and safety is a priority when they are inside of a building. Many landlords have implemented the WELL Building Standard which measures, certifies and monitors the features that impact occupant health. These features include air, water, nourishment, light, fitness, comfort and mind. By making sure that a building is providing high air quality, clean water, natural light and taking COVID-19 precautions, tenants will feel more comfortable and have peace of mind. The WELL v2™ Building Standard, which is currently in a pilot stage, also considers other factors such as sound, materials and community.
The new community factor places value on diversity, equity and inclusion. Designing spaces in a way that enables all genders, races, ethnicities, religions and economic statuses to have equal access to spaces and participate in the community is important. Providing affordable housing generates social benefits and can also provide financial returns since these units are more likely to stay occupied during an economic downturn. The IRS also provides a low-income housing tax credit for the acquisition, construction and rehabilitation of affordable rental housing. Placing affordable housing in mixed-use buildings can also allow better access to grocery stores, schools and hospitals for the tenants.
Investors are expecting more and more transparency. They want evidence that ESG metrics are being monitored. Data such as indoor air quality, water usage, waste management and power consumption are factors that will influence investors. As a property is being developed, investors will want regular communication so they can be confident that there is effective management of the property. Technology is key in providing ESG data, so make sure that you are up-to-speed with the platforms that effectively monitor and streamline this information.
Takeaways for Purchasing Your Next Development
As you look to develop your next property, make sure to monitor the ESG performance. As ESG regulations and benchmarking are becoming more robust, investors will expect to be provided information to ensure that the property is sustainable throughout its life cycle. Effective management and implementation of ESG criteria will not only lead to a larger pool of investors, but also will ensure that you are making a positive environmental and social impact.
Related Read: DOL Alert: Proposed Regulation on Environmental, Social and Governance Investing and Shareholder Rights
For more information, please contact Tamara Partridge at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.
Tax Issues with Failed Like-Kind Exchanges
Thomas M. Kosinski, CPA, MST
In recent years, the tax law has encouraged like-kind exchanges of real property by providing an incentive to defer taxable gain on the sale and using a replacement property to rollover gain. Some of the steps needed for a like-kind exchange include a 45-day period to identify any replacement property, completing a reinvestment transaction within 180 days and using a QI (qualified intermediary) to maintain any proceeds from the property sale in an escrow account. With the real estate market becoming volatile and mortgage rates increasing with inflation, it may not be a surprise it is becoming more difficult to complete an exchange with these limits.
Recent tax legislation has added some more issues upon the sale of personal and real property, making tax results more unclear if the exchange is not completed. Beginning January 1, 2018, Section 1031 like-kind exchange tax deferral no longer applies to exchanges of tangible personal property. Under the Tax Cuts and Jobs Act, only real property will qualify for tax deferral in a like-kind exchange, and whether the gain on the sale is taxable now or deferred by reinvestment.
Regardless of the timing of the sale and the scope of the gain, this summary provides some issues if the exchange fails and the taxable gain must be reported. Your preparation and careful tax planning may help determine whether the closing of the sale has significant tax issues.
Related Read: Related Parties’ Property Exchange Does Not Qualify as Like-Kind
Need to determine the taxable gain
The gain on real estate is based on the original purchase price and related improvements and capitalized costs, and the original tax basis may need to be adjusted for the depreciation over the asset life. If the sale is simply for the real estate alone, then the seller may have a choice whether the proceeds are all realized and the gain will be taxable at lower tax rates. If the seller is either a pass-through entity or an individual, taxable gain may be eligible for long-term capital gain rates (15 or 20%) if the property was held for longer than a one-year period and some gain created from depreciation deductions may be eligible for a 25% tax rate as Section 1250 gain. In this example, the tax rate on the sale may be favorable enough to accept current tax consequences.
Need to review tax reporting rules
Most tax returns have a special form to disclose a calculation of gain on a like-kind exchange. Form 8824 is attached to the income tax return for the year in which the transfer of real estate occurs. The form includes both the taxable gain on the sale and any deferred gain that will be used to adjust the cost of the replacement property for a future sale. There are additional issues if property is sold to a related party or if the property may have been used as a personal residence. In order to complete the form, replacement property needs to be received either 180 days after you gave up your property, or by the filing due date of the tax return for the year you transferred your property, whichever is earlier. This includes any extensions. By doing so, the IRS expects you to report the proper gain on the exchange even if you need to file an extension to complete the exchange.
Need to evaluate installment sale issues
Many taxpayers assume that a transaction is fully taxable in the year of sale if no exchange occurs. If all of the gain is from real estate, then there may be a choice to reinvest all or part of the proceeds into like-kind real property and defer the gain until a subsequent sale occurs. If the like-kind exchange fails, then it is possible that proceeds held in escrow may not have been available until the next tax year. The timing of any sales proceeds may be delayed and eligible for an installment sale method. An installment sale occurs when at least one payment is not received until after the end of the year in which the taxable disposition occurs.
Certain taxable transactions may be recognized on an installment method basis to report gain as the proceeds are received. The installment gain is allowed to be deferred to match the timing of the proceeds. Since the deferral does not apply to ordinary gains, the tax consequences of the character and timing of gain are very critical to qualify for any tax deferral and benefits of a sale.
Consider the benefits of tax straddling
However, if that exchange fails and is not completed, some taxes will be due. The benefit for those taxpayers is that they may still qualify for a “smaller deferral” (via tax straddling) where they can report and pay some taxes on their following tax return instead of immediately on their current tax return. The portion eligible for deferral is the amount reported as an installment gain. For example, most mortgage balances are settled at the sale closing date, so any proceeds used to pay off a mortgage will not qualify for a deferral and reinvestment into a replacement mortgage. The receipt of taxable “boot” includes any “unlike” property received in any taxable exchange. Cash, personal property or a reduction in the mortgage owed after an exchange are all boot and subject to tax. The ordinary gain on a sale will also be taxable in the same year as the sale. For this reason, it will be important to compute the tax benefit under either method and assess results. The benefit may be less helpful if the tax will otherwise be payable through estimated tax or if the tax rates in the next year are greater due to reporting more income in the future.
Consider the scenarios and options
Of course, choosing the best option is important if you have a real estate transaction that requires negotiation for both the sale and the reinvestment. It is best to determine how much time and help is needed to work through the process, and whether you have considered all of your options.
Related Read: Properly Structuring a Like-Kind Exchange
For more information, please contact Tom Kosinski at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.
Health Care GroupLaw Firm GroupManufacturing and Distribution GroupNot-For-Profit GroupReal Estate Group