Impact of Fiscal Cliff Legislation on Construction and Real Estate
Brian Buwalda died accidentally in the wake of hurricane Irma. He will be deeply missed by our CLA family. Brian’s writing skills provided readers with informative, relevant, and interesting articles. Month after month his stories were the most viewed on the construction industry web page. His life and his writing have impacted many, and we are grateful to have known him and his work.
On January 1, 2013, Congress passed the American Tax Relief Act of 2012 (ATRA), which eliminates many of the fiscal cliff tax effects that would have dramatically altered the tax landscape for the construction and real estate industries. Many of the bill’s provisions are favorable, but they should all be considered when planning tax strategies for 2013 and beyond.
“This legislation is as important for what doesn’t change as it is for what does change,” notes Brian Buwalda, a construction and real estate partner.
What stays the same as a result of ATRA?
Retention of 50 percent bonus depreciation
Bonus depreciation applies to the purchase of new construction assets that are purchased and placed in service by December 31, 2013. It provides property owners, investors, and tenants with an enhanced deduction for many new assets.
Enhanced Section 179 deduction
Section 179 deductions that allow for immediate expensing of equipment purchases were scheduled to be limited to $139,000 for 2012 and $25,000 for 2013. Under the new law, the maximum Section 179 deduction has been retained at the $500,000 level for tax years beginning in 2012 and 2013. The $500,000 level begins to phase out when qualifying purchases exceed $2 million. Section 179 deductions may be applied to the purchase of both new and used property.
The enhanced section 179 deductions on construction equipment purchases will continue to provide a tax incentive for capital investment, and will allow property owners, investors, and tenants to more quickly recover their investments in assets.
Shortened depreciation lives for certain real property
Qualified leasehold improvements, qualified retail improvements, and qualified restaurant improvements continue to be eligible for 15-year depreciation (rather than 39-year depreciation applicable to other types of real property) for property acquired through 2013.
“These provisions will continue to provide tax incentives for restaurant construction and for remodeling of existing structures,” says Buwalda.
Permanent AMT relief
The IRS estimated that more than 25 million additional taxpayers would have been subject to the alternative minimum tax (AMT) in 2012 if Congress had not passed an AMT patch. The patch increases the AMT exemption to reflect the amount of inflation that has occurred between 1986 and 2012. Congress went one step further and made this inflation adjustment permanent.
Inflation-indexed estate and gift tax
Most important to long-term succession planning for owners of construction and real estate companies is the permanent extension of the lifetime estate and gift exemption at $5 million. The exemption is now indexed to inflation, increasing to $5.25 million in 2013.
Debt cancellation on principal residences
Homeowners who have up to $2 million of debt cancelled through loan workouts on their principal residences will be able to continue to exclude that amount from their taxable income through the end of 2013. This will allow the residential housing market to continue working through pricing issues.
Miscellaneous credits and energy incentives
The research and development tax credit will still be available through the end of 2013, as will the energy-efficient home credit (of up to $2,000 per home) for construction starting by the end of 2013. A variety of other federal tax incentives for the solar energy industry are also available.
What changes as a result of ATRA?
Higher top-end income tax rates
Almost all of the ordinary income tax rates that were set to expire on January 1, 2013 were maintained. The only change is that the highest rate of 39.6 percent (up from 35 percent) is now reinstated and imposed on taxable income of more than $400,000 for singles and $450,000 for married couples.
Capital gains and dividend tax rates rise
ATRA raises the maximum long-term capital gains (and qualified dividends) rate from 15 percent to 20 percent for single taxpayers whose income exceeds $400,000, and for married couples whose income exceeds $450,000. However, due to the phase-out of certain itemized deductions and personal exemptions, as well the 3.8 percent tax on net investment income (applied to single taxpayers with more than $200,000 in gross income, and couples with more than $250,000 of gross income), many taxpayers will see an effective maximum capital gains tax rate near 25 percent.
Itemized deduction and personal exemption phase-out
Congress has now increased the applicable adjusted gross income threshold levels to $300,000 for married couples and $250,000 for singles. Above these income levels, 3 percent of itemized deductions will phase out, and for every $2,500 of income above these amounts, 2 percent of personal exemptions will be eliminated.
Top estate and gift tax rate of 40 percent
As an offset to the permanent extension of the estate tax exemption amount (to $5 million), the top estate tax and gift rate increases from 35 percent to 40 percent. Although higher than the old rate, the new rate is still lower than the 55 percent rate that would have taken effect on January 1, 2013, and lower than the 45 percent rate proposed earlier in 2012.
Marriage penalty for high income earners
Due to the imbalance of higher tax rates starting at almost the same rate for married couples and singles, higher-earning couples will pay more tax than if they were not married. If two singles make $400,000 each, neither will pay the maximum tax rate. If a married couple earns $800,000, $350,000 is taxed at the highest rate. This can easily result in an increased tax liability exceeding $20,000 annually.
Tax planning is important
Due to the retroactive nature of many provisions in ATRA, taxpayers in the construction and real estate industries should revisit their tax planning for 2012 (as well as 2013).
“In many cases, we are recommending that contractors or taxpayers owning real property shift deductions until 2013 or later years when tax rates will be higher,” notes Buwalda. “But tax planning always needs to be tailored to the specific needs of each business and its owners.”
How we can help
Tax planning has some certainty this year that didn’t exist last year, but it will require planning to steer clear of the maximum income and capital gains tax rates. Owners of companies or properties who have a taxable estate of at least $5.25 million should continue using annual estate planning tools. Now is a good time to get started.