CLA professionals discuss the impact COVID-19 has had on real estate assets, development projects and investors and what to expect over the months ahead. We will also touch on the tax changes and other relief available for owner/operators of various real estate asset classes.
- George Kotridis, Principal, CLA
- Tony Hallada, Managing Principal Wealth Advisor Strategy, CliftonLarsonAllen Wealth Advisors, LLC
- Carey Heyman, Principal, CLA
In case you missed it:
Questions and Answers:
My forgivable expenses reached our PPP loan amount at week 10. Do I have to wait for week 24 to expire to file for forgiveness?
You do not need to wait for the 24 week to expire to file for forgiveness. You can file as soon as you have spent all the funds that you are going to include in the forgiveness calculation.
Given the extended 24 weeks provided is it better to utilize all possible sources of expenses to accumulate the maximum forgivable amount sooner or use, for instance, wages to employees where there is little doubt if it was eligible.
We would suggest using all expenses to accumulate the maximum amount eligible for forgiveness. Don’t forget, that non-payroll costs are limited to 40% of the requested forgiveness amount. We recommend you only include costs that are clearly eligible for forgiveness, as there are some costs that are questionable.
I have been researching whether or not our PPP loan is qualified for safe harbor forgiveness following guidance from the PPPFA. We are a hospitality company in Minnesota with restaurants that were ordered closed for a significant period, then to only open up with minimal capacity. Under the PPPFA it states that there is only a safe harbor for employers who were unable to operate their businesses at the same level of activity as before February 15, 2020, refers only to requirements or guidance from HHS, CDC or OSHA. It does not include restrictions or guidance issued by state, county, city or other local authorities.
Didn’t the Federal government give authority to all states to make their own decisions on opening, thus we would not qualify for forgiveness? We certainly will not meet our FTE levels from January-February 2020.
Another question. Do we need to have the FTE count back at the average during the comparison period at a point in time for forgiveness; or, does this average of the loan period need to be back up to the average of the comparison period?
The interim final rule that was published on June 22nd (https://home.treasury.gov/system/files/136/PPP--IFR--Revisions-to-Loan-Forgiveness-Interim-Final-Rule-and-SBA-Loan-Review-Procedures-Interim-Final-Rule.pdf) broadened the safe harbor beyond just the requirements or guidance from HHS, CDC or OSHA, but also state and local government ordered shutdowns based on the guidance from those federal agencies (see wording below):
The Administrator, in consultation with the Secretary, is interpreting the above statutory exemption to include both direct and indirect compliance with COVID Requirements or Guidance, because a significant amount of the reduction in business activity stemming from COVID Requirements or Guidance is the result of state and local government shutdown orders that are based in part on guidance from the three federal agencies. Example: A PPP borrower is in the business of selling beauty products both online and at its physical store. During the covered period, the local government where the borrower’s store is located orders all nonessential businesses, including the borrower’s business, to shut down their stores, based in part on COVID–19 guidance issued by the CDC in March 2020. Because the borrower’s business activity during the covered period was reduced compared to its activity before February 15, 2020 due to compliance with COVID Requirements or Guidance, the borrower satisfies the Flexibility Act’s exemption and will not have its forgiveness amount reduced because of a reduction in FTEs during the covered period, if the borrower in good faith maintains records regarding the reduction in business activity and the local government’s shutdown orders that reference a COVID Requirement or Guidance as described above.
Regarding your second question, the FTE retention test is based on average FTE’s during the covered period, not at a point in time during the covered period.
Is the guidance still unclear regarding if the FTE and wage reduction test can be less than 24 weeks, if for example, a company spends the entire loan in 10 weeks and would like to apply for forgiveness before the end of the 24 week period?
Unfortunately we don’t have all the guidance we would like regarding the process to file an application for forgiveness before the end of the 24 week period. We do have clarity on how the wage reduction test is applied (see below), but that is it. No clarity on FTE reduction test, how the $100k limitation on cash comp would work, etc. We are helping borrowers with applications and making some assumptions on how the calculations should work, but there is obviously some risk filing for forgiveness now in advance of more definitive guidance from the SBA. Please stay tuned to future Livestreams and our COVID relief page where we will continue to publish information on new developments as it arises. Frank and your CLA team are available to assist with any other questions you might have. Guidance on wage reduction test when applying before the end of the 24 week period is in the IFR released on June 22nd as follows:
When must a borrower apply for loan forgiveness or start making payments on a loan? A borrower may submit a loan forgiveness application any time on or before the maturity date of the loan—including before the end of the covered period—if the borrower has used all of the loan proceeds for which the borrower is requesting forgiveness. If the borrower applies for forgiveness before the end of the covered period and has reduced any employee’s salaries or wages in excess of 25 percent, the borrower must account for the excess salary reduction for the full 8-week or 24-week covered period, as described in Part III.5
In a nutshell, even if you are only using costs incurred during a shorter period than the full 24-week covered period (say a 10 or 11-week period), if you had a decline in wages by more than 25% then you get penalized (i.e., your forgiveness amount is reduced) based on the impact extrapolated as if you were using the full 24-week. This does not mean that you won’t get 100% forgiveness, it just means the eligible costs are reduced by an inflated number, so you may need to accumulate costs for an extra week to ensure that the eligible costs less the wage reduction amount still exceeds your loan amount.
What you missed:
Leslie Boyd: Good afternoon to our CLA family members, clients, community partners and friends. Welcome back to our livestream! Today, we are discussing the impact COVID-19 has had on real estate assets, development projects, and investors and what to expect over the months ahead. We will also touch on the tax changes and other relief available for owner/operators of various real estate asset classes. Our guests today are Carey Heyman, George Kotridis, and Tony Hallada from CLA.
Carey is a principal in our Century City office providing accounting, assurance, tax, and consulting services to real estate industry owners, operators, family offices, developers and syndicators. George is a principal joining us from our Plymouth Meeting office who devotes most of his time serving clients in the real estate and private equity industries. Finally, Tony is a managing principal in Minneapolis with CLA Wealth Advisors and a member of the private investment committee. Welcome, guys!
We have a few PPP updates before we dive into our topic today. Please continue the dialogue with us today at email@example.com. We have Jack and Jen among others in that inbox to respond to your questions. You may also contact us for program developments, tools, and more specific consultation at claconnect.com on our COVID landing page using our contact us button.
With regard to PPP, we’re continuing to follow the legislative proposals in the House and Senate and will plan to do a deep dive into finalized legislation on the livestreams in the coming weeks. Today we want to let you know about the FAQs dropped on Tuesday of this week. While the August 4 FAQs don’t answer every question, they do provide us with some valuable insights.
Here’s what we know…
- Payroll and non-payroll costs incurred before but paid during the covered period are eligible for forgiveness.
- Group health care benefits seem to have greater flexibility. Prepayments of group health benefits are not allowed.
- Prepayments for employer contributions for retirement benefits are not allowed.
- Allowable costs
- Mortgage interest seems to be a broad category. The FAQs state “Payments of interest on business mortgages on real or personal property (such as an auto loan) are eligible for loan forgiveness.” Note, however, that interest on unsecured credit is ineligible for loan forgiveness.
- Transportation is limited to “a service for the distribution of transportation refers to transportation utility fees assessed by state and local governments.” Unfortunately, it would seem to exclude something like gas for a company vehicle.
- Forgiveness reductions
- Wage reduction test is only based on decreases in salaries or wages.
Unfortunately we are still left with some big items that aren’t addressed…
- How should borrowers apply before the end of the covered period?
- Would the cap on cash compensation be modified if applying early?
- Will documentation requirements be modified?
- How will certifications be assessed by SBA? Three certifications of note include:
- How will SBA review economic necessity for loans over $2 million?
- What is meant by the Form 3508 certification that states “The dollar amount for which forgiveness is requested was used to pay costs that are eligible for forgiveness (payroll costs to retain employees; business mortgage interest payments; business rent or lease payments; or business utility payments)…”? Specifically what are “payroll costs to retain employees”?
- How will SBA review FTE Reduction Safe Harbor 1 related to a reduction in the level of business activity?
- Are prepayments of payroll costs, rent, and utilities eligible for forgiveness?
We’ll keep you updated with more information as it becomes available. Now I’d like to turn the discussion to our focused topic of the day. I’d like to start with Tony.
Welcome to our Livestream, Tony! Could you please kick us off with some general insights into the impact we’ve seen by asset class?
Tony Hallada: As most folks know, hospitality and retail have been hit hardest and in many cases devastated. ADR and RevPAR are at levels not seen since 9/11 or even at all. Retail is experiencing many bankruptcies.
Commercial office and multi-family apartments are currently fairly stable on rent collections. We are seeing collections on multi-family down on average in the range of 93%-95% compared to 98%+ pre COVID-19. Industrial properties also continue to perform.
Boyd: Thanks, Tony. What does that mean for current development projects?
Hallada: Current development, while in some cases delayed, continues in most areas, but of course is affected by asset class. Multi-family have seen less effect, but office and hotel that were not started has stalled in some cases.
Related to investor activity over past four months:
- Some slowing in new capital committed, but certainly not stopped
- A lot of dry powder in vehicles and investors looking for investment
Boyd: I think that really helps us understand the investment impacts in real estate. I’d like to pivot our discussion now to tax matters in the CARES Act and other regulations impacting real estate. We have Carey with us for a deep dive into the topic. Welcome, Carey! I was hoping you could kick us off with some conversation around Qualified Improvement Property (QIP).
Carey Heyman: As we have discussed for some time, the Tax Cuts and Jobs Act (TCJA) passed in December 2017 contained a “glitch” that moved qualified improvement property (QIP) from the 15-year depreciable life category to the 39-year depreciable life category. Not only did this affect the depreciable life, but it also eliminated the ability to take bonus depreciation.
The CARES Act provides a “fix” — QIP is again considered 15-year depreciable property and is bonus eligible for Federal tax purposes. This is retroactive to assets placed in service after December 31, 2017.
Since the QIP provision is retroactive and has effectively been out of the law for two years, this is an opportunity to review how the reintroduction of this provision could affect your tax strategy. You may be able to claim bonus depreciation for QIP-eligible assets from the 2018 and 2019 tax years by filing an amended tax return or a Form 3115 (Application for Change in Accounting Method).
Boyd: Thanks, Carey. We also need to take a look at 163(j) considerations. George, can you help us understand what the CARES Act did in this space?
George Kotridis: Section 163(j) considerations – CARES Act increased the business interest limitation for taxpayers that do not meet certain exclusions (small business, real property, etc.) to 50% of adjusted taxable income for tax years 2019 and 2020 vs. the 30% limit previously in place. A special rule applies just for 2019 and specifically for partnerships that makes this change even more advantageous.
Real estate companies were given the option to make an election out of these rules eliminating the interest limitation, but in return had to adopt an ADS, or slightly longer depreciation life on their real property. They also perhaps inadvertently gave up the ability to take advantage of the QIP fix by making the 163(j) real property election and the ability to take bonus depreciation on QIP.
Companies can undo their elections under Rev Proc 2020-22 to take advantage of the fixed QIP regulations, if they find that they would benefit more from such a change and do not have interest expense in excess of the 50% limit.
Boyd: Of course, no conversation would be complete without a discussion of net operating loss (NOL) carrybacks. Carey, can you walk me through the highlights?
Heyman: Following 2017 tax reform, NOLs generated in tax years ending after December 31, 2017 could not be carried back. NOLs generated in tax years beginning after December 31, 2017 could only offset up to 80% of taxable income in carryover years.
The CARES Act permits NOLs from the 2018, 2019, and 2020 tax years to be carried back five tax years (beginning with the earliest year first). The CARES Act also suspends the 80% of taxable income limitation through the 2020 tax year.
Two planning notes here:
- You can elect to waive the loss carryback. For losses generated during the 2018 and 2019 tax years, you must elect the waiver before the extended tax return due date for the first year ending after the CARES Act is enacted. For example, a calendar year corporation with an NOL in 2018 that wants to forgo the carryback to 2013 would need to waive the carryback for the 2018 year by the 2020 tax return due date. You cannot elect a reduced carryback period (i.e., there is no election available to use a two-year carryback in lieu of the five-year carryback).
- Aside from the cash flow benefits, NOL carrybacks present an opportunity to secure permanent tax savings by using losses to offset income generated prior to tax reform, when the top federal corporate tax rates were higher. Corporate NOLs can really benefit from this change because of the larger rate differential of the top rate of 35% vs 21%.
Boyd: Thanks so much for that. George, the IRS recently issued proposed regulations that provide guidance on the carried interest rules of Section 1061. What was included in the proposed regulations?
George: Newly proposed regulations on carried interest include the following details:
- Historically, fund managers granted profits interests for providing services have been taxable as capital gains vs. ordinary income.
- TCJA added Section 1061 providing for a 3 year holding period instead of 1 year to determining LTCG treatment on such interests.
- Proposed regulations issued last month clarify many areas including what types of partnership interests and which businesses are subject to Sec 1061.
- In general, the interests included are interests that are transferred or granted to a taxpayer (or a related party) in connection with the performance of substantial services for a business subject to these regulations.
- The proposed regulations include the types of interests that are excluded, such as capital interests and interests granted to C corporations, as well as rules covering related party transactions, computations of re-characterized gains and reporting requirements.
Boyd: Thanks so much, George. That was incredibly insightful. I’d like to guide us through to our final point of the conversation today, which is to talk about how things might look in the future. The 2020 United States elections are scheduled for Tuesday, November 3, 2020. Carey and George, what are some of the potential changes we could see under a Biden administration? Tony, please feel free to add your color commentary to the discussion.
U.S. individual taxes
Current highest rate is 37%. Tax at top ordinary income rate (39.6%) for taxpayers with over $1 million income.
Current highest rate is 21%. 28% with 15% minimum book tax on companies reporting more than $100 million in the U.S. but paid zero or negative federal income taxes. Credit for foreign taxes paid and carryovers allowed.
- Trump: fiscal year 2021 budget would extend 2017 TCJA provisions past 2025
- Biden: Would reverse 2017 TCJA provisions
Qualified Business Income Deduction
- Trump: fiscal year 2021 budget does not include any planned change to current law
- Biden: end special qualifying rules, including those for real estate investors. Limit deduction for taxpayers making $400,000 and under.
Reform Opportunity Zones
- Incentivize Opportunity Funds to partner with nonprofit or community-oriented organizations, and jointly produce a community-benefit plan.
- Direct the Department of Treasury to ensure Opportunity Zone tax benefits are only being allowed where there are clear economic, social, and environmental benefits to a community.
- Introducing transparency.
- Trump: fiscal year 2020 federal budget would end funding for the Community Development Financial Institutions Fund discretionary grant and direct loan programs.
- Biden: expand the new markets tax credit program to provide $5 billion in support every year, and make the program permanent. Enact a manufacturing community tax credit.
Both Biden and Trump want to eliminate carried interest.
Section 1031 exchanges
Last week, there was word that Biden was looking to eliminate the Section 1031 exchange. No further detail was provided. Section 1031 exchanges have been targeted before. Most recently, Republican House members had proposed eliminating the benefit in the lead-up to the 2017 tax reform bill. Lawmakers ultimately chose a middle ground and agreed to eliminate personal property from Sec. 1031 exchanges
Current law puts the exemption amount at $11.58 million (for 2020). Assets passed through at death get a basis step-up to fair market value for the recipient. Increased exemption amount reverts back to $5 million after 2025.
- Trump: fiscal year 2021 budget would extend 2017 TCJA provisions past 2025
- Biden: eliminate stepped-up basis rule that allows people to pass capital gains to heirs without tax after death
State and Local Tax Deductions
Currently, taxpayers are allowed to take eligible deductions and credits against their income tax liability. The itemized deduction for state and local taxes (SALT) is capped at $10,000.
- Trump: fiscal year 2021 budget would extend 2017 TCJA provisions past 2025
- Biden: end SALT cap
Boyd: Wow, that’s a lot. Unfortunately, that’s all we have time for today. Thank you to our wonderful guests today, to our moderators in the inbox, and to you, our audience for your wonderful questions and engagement. Please continue to reach out to us through our Livestream Inbox and our contact us button on claconnect.com. In the coming weeks, we plan to extend our session time to one hour to unpack the various elements of the proposed legislation as it is finalized. We look forward to seeing you next Thursday. Until then, please stay safe and healthy and have a wonderful weekend!