Dodging COVID-19 with a Cash Solution
Guest Blogger: Fred W. Clapp, Cost Segregation Services, Inc.
Commercial Real Estate (CRE) is historically a reasonably stable component of our economy. Most CRE investors, coming off a profitable 2019 were eagerly looking at an even better 2020.
Enter the Corona Virus and the CRE market is suddenly like the movie Jaws. A memorable scene involved the Chief of Police, who, after a startling glimpse of the monster great white shark terrifying his peaceful beach town, solemnly states to the shark hunter, “We’re gonna need a bigger boat!” From then on, the monster proceeds to attack, destroy, and devour the boat.
So it is with COVID-19. Social distancing, lay-offs, shelter-in-place, and retail shutdowns have lead to an economic landslide few CRE investors were (are) prepared to overcome. Unfortunately, right in the middle of this challenge, everybody has a tax liability which will drastically impact liquidity. Forget the bigger boat; many CRE owners are worried about staying afloat.
Prudent asset managers have combed through their balance sheets anticipating COVID-19’s market effects on short-term investments (a loss), accounts receivable (less rent roll), and other potential liquid assets to find cash and weather the onslaught. Conclusion,“We’re gonna need a bigger bank roll!”
Uncle Sam’s CARES Act has tossed out some life preservers, but they leave many CRE owners caught in a rip-tide and the great white is still out there looking for his next meal.
Enter four cash flow solutions that can have an immediate, helicopter type, US Coast Guard rescue.
All of them favor CRE and are, surprisingly, found in the US Tax Code. In fact, the just passed CARES Act contains the following two:
1. Qualified Improvement Property (QIP) Fix – When the Tax Codes and Jobs Act increased bonus depreciation to 100% of qualified costs and included used property acquisitions, Congress failed to include QIP as eligible. Retail building and restaurant owners (some of the CRE users severely affected by COVID-19) and others who improved the interior of nonresidential buildings can now retroactively capture 100% bonus for QIP and apply the benefits to their 2019 taxes.
2. Net Operating Losses (NOL) – The act allows for a five-year carry back or NOLs arising in 2018, 2019, and 2020 to offset 100% of income. When sizable depreciation deductions create a NOL in 2019, that loss can be carried back to a 2014 return, roll it forward by applying against gains, and potentially receive a tax refund on a 2019 tax return.
The next two tax code solutions can be found on your Income Statement and involve how building costs are depreciated. If your tax advisor utilizes a straight-line schedule, they typically miss them and are leaving a lot of tax savings on the table. Under the tax code approved method of accelerated depreciation, CRE investors have the option to utilize it and dramatically impact taxes owed. Anytime you increase depreciation expenses, you off-set taxable income. For example:
3. Look back and Catch-up – Utilizing an accelerated depreciation method requires restructuring building costs by asset component and class life. CRE owners can go back fifteen years, qualify, value, and document assets eligible to be accelerated and apply their depreciable costs to a 2019 tax return. Called catch-up, it is not uncommon for 8% to 15% of a building’s assets to be eligible. An $850,000 building owned for six years could potentially deliver additional 2019 savings between $68,000 and $127,000.
4. Cost Segregation – Taxpayers have used cost segregation studies for many years and have resulted in advantageous depreciation deductions.Typically, a building owner would receive $35,000 to $50,000 of additional depreciation deductions for every $500k of building costs. As the tax code recommended method to classify building assets by component, system, and class life, an engineering based study will deliver the input document a tax advisor needs to implement every one of these cash flow solutions.
America will overcome COVID-19 and the economy will recover as this challenge plays out. Regardless if any of these suggestions make sense with your CRE business, stay safe, be healthy.
Thanks to Fred Clapp from Cost Segregation Services Inc. for writing this blog post and sharing this important knowledge.
(c) Fred W. Clapp 4.1.2020
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