Hiring a Property Manager? Consider Lodging as a Fringe Benefit
RYAN A. KERTES, CPA
Most businesses today are struggling to attract and retain quality employees and the real estate industry is no exception. If you are looking to hire a property manager, consider providing lodging as part of the compensation package. Not only is free (or discounted) lodging a valuable perk, but if certain requirements are met, its value can be excluded from the employee’s wages for federal (and, usually, state) tax purposes. The value of the lodging is still deductible as a business expense, but it is income tax-free to the employee, and both employee and employer avoid payroll taxes on that amount.
If you are interested in providing free lodging to property managers, plan carefully to ensure that the lodging qualifies as a tax-free fringe benefit. Generally, that means it is:
- Furnished on the employer’s business premises;
- Provided for the employer’s convenience; and
- A condition of the property manager’s employment.
On the Business Premises
To meet this requirement, the lodging must be at the employee’s place of work. Typically, it is easy for property managers to meet this requirement. For example, if an apartment building manager is provided an apartment in the building, clearly the lodging is on the business premises. In some cases, it may be possible to meet this requirement if the lodging is very close to the building being managed. For example, in one case, a hotel manager was provided a house across the street from the hotel (on hotel-owned property), adjacent to the hotel parking lot. Because the house was within the perimeter of the hotel property — and the manager, who was on call 24 hours a day, performed a significant portion of his duties in the house — the U.S. Tax Court found that the house was on the business premises.
Provided for the Employer’s Convenience
This means that the employer furnishes the lodging for a substantial business reason other than providing the employee with additional compensation. For property managers, this requirement is usually satisfied if the business reason for providing lodging is to ensure that managers are available to perform their duties at all times.
Condition of Employment
This requirement is closely related to the “employer’s convenience” requirement. Lodging qualifies if property managers must live on the business premises to properly perform their duties — for example, because they are on call 24 hours a day. It does not qualify if you give the employee a choice between free lodging and additional cash compensation. In that case, if the employee chooses free lodging, it is not considered a condition of employment and its value must be included in the employee’s taxable wages.
Keep in mind that whether lodging is provided for the employer’s convenience and as a condition of employment depends on all the facts and circumstances. The terms of an employment contract or applicable state law are not determinative, at least for federal tax purposes. If you are considering offering free lodging to property managers as a fringe benefit, work closely with your ORBA advisors to be sure that you avoid unpleasant tax surprises.
Real Estate Businesses: How Much Interest Expense Can You Deduct?
ANITA S. WESCOTT, CPA
The deduction limit for business interest expense can have a big impact on a real estate firm’s tax bill and the limit is even more stringent starting in 2022. If your firm has significant interest expense, it is important to: (1) Determine whether the deduction limit applies to you; (2) Assess the limit’s impact on your tax liability; and (3) Evaluate the costs and benefits of opting out.
The Tax Cuts and Jobs Act of 2017 amended Internal Revenue Code Section 163(j) to impose a limit on deductions of business interest expense, with an exception for “small businesses” (see below). For tax years beginning after December 31, 2017, Section 163(j) provides that a taxpayer’s deduction of business interest expense in a given tax year cannot exceed the sum of:
- The taxpayer’s business interest income (which does not include investment income);
- 30% of the taxpayer’s adjusted taxable income (ATI); and
- The taxpayer’s floor plan financing interest.
Disallowed interest expense may be carried forward indefinitely to succeeding tax years.
Floor plan financing is typically used by auto dealers and certain other retailers. So, for real estate firms, deductions are generally limited to their business interest income, if any, plus 30% of ATI. ATI means taxable income, computed without regard to:
- Nonbusiness income, gain, deduction or loss;
- Business interest income or expense;
- Net operating loss deductions;
- The qualified business income deduction; and
- Depreciation, amortization or depletion (for tax years beginning before 2022).
To provide businesses with temporary relief during the COVID-19 pandemic, the CARES Act of 2020 increased the deduction limit to 50% of ATI for 2019 and 2020 and allowed businesses to calculate the 2020 limit based on their 2019 ATI. Now, however, the limit is back to 30% of ATI. In addition, for tax years beginning after 2021, businesses may no longer add back depreciation, amortization and depletion in computing ATI. As a result, many real estate firms will see their interest deductions reduced this year, some for the first time.
Related Read: CARES Act Issues Facing Real Estate Clients
Does the Limit Apply to You?
Section 163(j) contains an exception for “small businesses,” defined as businesses, other than tax shelters, with average annual gross receipts for the preceding three years of $25 million or less. This threshold is adjusted annually for inflation and currently stands at $27 million. Keep in mind that to determine whether your firm qualifies as a small business, you may need to aggregate your gross receipts with certain related businesses.
Even if your firm’s gross receipts are below the threshold, it is disqualified from claiming the small business exception if it is considered a tax shelter. A tax shelter includes a partnership or other pass-through entity if more than 35% of its losses during the tax year are allocable to limited partners or “limited entrepreneurs” (owners who do not actively participate in management). If your firm meets this definition, there may be strategies you can use to avoid tax shelter status, such as reducing the amount of losses allocated to limited partners or limited entrepreneurs, or having those owners actively participate in the management of the firm.
Should you opt-out?
If you are ineligible for the small business exception, you can still avoid the business interest limit by filing an election to opt-out. This option is available to real property businesses, which include development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing and brokerage businesses. However, opting out comes at a cost; once you make the election, which is irrevocable, you must use the alternative depreciation system (ADS) for nonresidential real property, residential rental property and qualified improvement property. Depreciation periods are longer under ADS, which results in lower depreciation deductions. Also, qualified improvement property loses its eligibility for bonus depreciation.
Whether opting out is the right choice depends on your firm’s particular tax circumstances. You will need to weigh the benefits of fully deducting business interest against the cost of lower depreciation deductions.
For more information about the business interest limit and strategies for minimizing its impact, please contact Anita Wescott at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.