CARES Act Benefits and Other COVID-19 Considerations for the Real Estate Industry
April 07, 2020
By the EisnerAmper Real Estate Tax Team
UPDATED: 4/10/2020, 2:15 PM
Normally, economists and lawmakers look at historical data for guidance as to how to predict market rebounds or create stimulus packages to boost or provide relief. In these unprecedented times, there are no guidelines or historical indicators that provide such guidance. All sectors and asset classes of the real estate and hospitality industry are being greatly impacted by the economic disruption caused by the coronavirus. Even if lenders show more leniency with violations of loan covenants or landlords provide rent adjustments or deferrals, government will be the main source of assistance to those affected. With that in mind, on March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act” or the “Act”), intended to provide economic stimulus at this time of great need.
This guide is intended to summarize provisions of the Act that impact the real estate community as well as certain provisions of existing law that may be particularly impacted by the coronavirus situation.
THE CARES ACT
Paycheck Protection Program Loans
The Act provides for loans to small businesses that employ500 or fewer employees or, if applicable, the amount set by the Small Business Administration for the business industry. For these loans, the definition of small business includes sole proprietorships and independent contractors. Hospitality and restaurant businesses are among the many businesses that may benefit from this program with a 500-employee limitation by location as opposed to the broader affiliated party rules.
The maximum loan amount is 2.5 times the average monthly payroll costs incurred in the previous year ending on the date of the loan or $10 million. Alternate computations are provided for seasonal employers and those not in business for twelve months prior to the loan date. So, for example: ABC’s average payroll costs for the previous twelve months is $30,000. The maximum loan amount is equal to $75,000.
Payroll costs include:
- vacation and sick pay
- severance pay
- health benefits
- retirement benefits
- payments of state and local taxes assessed upon employee compensation
Generally, the following expenses are excluded in the calculation of payroll costs: the compensation of an individual employee in excess of an annual salary of $100,000, certain payroll taxes, compensation to employees whose principal residence is outside the United States and qualified sick or medical leave for which a credit is claimed under coronavirus legislation. The length of the loan is two years, with an interest rate of 1%. Payments of principal and interest will not be required for six months following the date of disbursement of the loan. However, interest will continue to accrue during the six-month deferment.
Important note: Proceeds from loans may be used for the payment of payroll costs, group health care benefits and premiums, employee salaries and commissions, mortgage interest payments, rent, utilities and interest on debt obligations incurred before February 15, 2020, and certain re-financings.
Loan proceeds used to pay payroll costs, mortgage interest (but not principal payments), rent or utilities in the eight-week period after receiving the loan proceeds will be forgiven. Not more than 25% of the forgiven amount may be non-payroll costs. And, from a tax perspective, importantly, the amount of loan forgiveness will not be includible in the gross income of the borrower.
The maximum loan forgiveness will be reduced if there is a reduction in the number of employees or a wage reduction of greater than 25%. This reduction can be eliminated if the reduction in employees and/or wages is restored.
To be eligible for this program, the borrower must certify that due to current economic conditions, the loan proceeds are being used to support ongoing operations and the proceeds will be used for eligible costs. These loans do not require personal guarantees.
For many businesses and especially those in hospitality, this may be a powerful tool to cover most, and in some cases all, of payroll and rent expenses for two months and could be the difference in many businesses making it to the other side of the current circumstances. This is also an important provision for real estate owners since it will allow many struggling businesses to essentially have the government fund their operations for two months and offer a bridge to, hopefully, better times in the second half of the year.
The Small Business Administration published interim guidance April 2, 2020, and some important points impact the real estate community. Most notably, independent contractors are not includible in the calculation of payroll costs. Additionally, the type of companies eligible for loans was limited under the definition, excluding the following:
- “Passive businesses owned by developers and landlords that do not actively use or occupy the assets acquired or improved with the loan proceeds (except Eligible Passive Companies under 120.111).”
- Business engaged in subdividing real estate.
- Businesses that are engaged in owning or purchasing real estate and leasing it for any purpose.
- Business that lease land for cell phone towers, solar panels, billboards, or wind turbines.
- Businesses that enter into management agreements with a third party that give management company sole discretion to manage the operations.
- Apartment buildings.
- Residential facilities that do not provide health care and/or medical services.
We are monitoring these rules daily and expect further clarification as loans are processed and further guidance is issued. Please refer to our Coronavirus Knowledge Center for updates.
Employee Retention Credit
The Act provides a refundable payroll tax credit for 50% of “qualified wages” paid or incurred by eligible employers to employees after March 12, 2020 and before January 1, 2021. The credit can be claimed on a quarterly basis. The credit is available to employers carrying on a trade or business during calendar year 2020 and whose (i) operations are fully or partially suspended due to a COVID-19 related shutdown order or (ii) gross receipts decline more than 50% as compared to the same calendar quarter in the prior year. Tax-exempt organizations are eligible where their operations are fully or partially suspended due to COVID-19.
What are qualified wages is a function of the average number of full-time employees during 2019? In the case of employers with greater than 100 full-time employees, qualified wages are wages paid to employees when they are not providing services due to the COVID-19 circumstances noted above. In the case of employers with 100 or less full-time employees, all employee wages qualify for the credit, whether the business is subject to a shutdown order or is open during the covered time period.
The amount of wages, including group health plan expenses, taken into account in determining the credit is limited to $10,000 per employee (i.e., a maximum credit per employee of $5,000).
To the extent the credit exceeds the employer portion of social security taxes reduced by paid sick leave and paid extended FMLA established by earlier coronavirus legislation, the excess will be treated as an overpayment available for refund.
Employers with a Paycheck Protection Program loan are not eligible for the employer retention credit. For employers that qualify, the benefits of such a loan may outweigh the combined loss of this credit and the deferral of employer payroll taxes noted below; each situation should be carefully evaluated on its specific facts and circumstances.
The Act provides that Treasury will issue forms, instructions, regulations and guidance as are necessary to implement the employment retention credit provisions.
Delay of Payment of Employer Payroll Taxes
Employers and self-employed individuals are allowed to defer payment of Social Security (Old Age, Survivors, and Disability Insurance) taxes for the period from the date of enactment of the Act through December 31, 2020. All of the employer portion of the Social Security tax and 50% of such taxes incurred by self-employed persons qualify for the deferral. Half of the deferred tax is to be paid by December 31, 2021; the other half is to be paid by December 31, 2022.
This could reduce the amount of quarterly estimates for 2020 and 2021.
Employers that have had indebtedness forgiven with respect to a Paycheck Protection Program loan are not entitled to this deferral. Again, for employers that qualify, the benefits of such a loan may outweigh the combined loss of this deferral of employer payroll taxes and the employee retention credit.
Please note that if the deferred payroll taxes are not ultimately paid in accordance with this provision, the employer (and not, for example, a professional employer organization (“PEO”) acting on behalf of the employer), is solely liable for the payment of such taxes and subject to any applicable penalties.
Net Operating Losses
Under the Act, a net operating loss (“NOL”) arising in a tax year beginning in 2018, 2019 or 2020 can be carried back for five years. It also allows for NOLs arising before January 1, 2021 to fully offset income.
Accordingly, the Act temporarily removes limitations put in place by the 2017 Tax Cuts and Jobs Act (“TCJA”) where, for taxable years beginning after December 31, 2017, NOLs were limited to 80% of taxable income and could not be carried back to reduce income in a prior tax year. Under the Act, losses must be carried back to the earliest year available for offset. As losses will be carried back to pre-2018 tax years, corporate taxpayers may benefit from a tax refund at favorable rates of up to 35%.
NOLs of a taxpayer may not be carried back to any year in which the taxpayer was a real estate investment trust (“REIT”); NOLs of a REIT may not be carried back to any tax year, regardless of whether the taxpayer was a REIT in that tax year.
For tax years beginning after December 31, 2020, the limitations imposed by TCJA will remain, but deductions for qualified business income under IRC Sec. 199A and for foreign-derived intangible income (“FDII”) and global intangible low-taxed income (“GILTI”) under IRC Sec. 250 will not be taken into account.
The changes to the utilization of NOLs, including the five-year carryback and the full income offset, generally apply to pass-through entities and sole proprietorships. Therefore, suspending the implementation of IRC Sec. 461(l), described below, becomes exceedingly important.
Taxpayers carrying back an NOL to a year with IRC Sec. 965 (transition) income from foreign subsidiaries will automatically be treated as having made an IRC Sec. 965(n) election, which excludes IRC Sec. 965 income from determining the NOL for that year. As a result, taxpayers will only be able to carry back NOLs to offset non-965 income, which may impact foreign tax credit calculations and subsequent transition tax installments. In the alternative, a taxpayer may affirmatively elect to exclude IRC Sec. 965 years from the carryback period.
Limitation on Losses for Taxpayers Other than Corporations
TCJA contained a provision (IRC Sec. 461(l)) for tax years beginning after December 31, 2017 that limited the deductibility of current-year business losses for pass-through businesses and sole proprietorships. The limitation was $500,000 on a joint tax return and $250,000 for all other filers. A business loss in excess of these amounts was disallowed in the year in which it was incurred and was converted into an NOL that could be utilized in a future tax year.
The Act suspends the implementation of IRC Sec. 461(l) until tax years beginning after December 31, 2020, thus allowing non-corporate taxpayers to deduct excess business losses arising in 2018, 2019 and 2020. It also makes a number of technical corrections to that code section retroactively as if included in TCJA. One such amendment now excludes from the calculation of excess business losses “any deductions, gross income, or gains attributable to any trade or business of performing services as an employee.”
Real estate properties typically receive large depreciation deductions, including bonus depreciation. Prior to the enactment of IRC Sec. 461(l) in the TCJA, taxpayers qualifying as real estate professionals were able to utilize their business losses to offset their other types of income, such as portfolio and investment income. The loss limitation put in place by the TCJA eliminated the ability for taxpayers to fully use business losses to offset current income and it ensured that they would pay current year tax on other non-business income in excess of the loss limitation threshold.
A possibly unintended consequence of the loss limitation was particularly onerous to taxpayers in the real estate and hospitality industry who were residents of New York State. The starting point for computing New York State taxable income for a New York resident is federal adjusted gross income, which does not include a deduction for the excess business losses noted above. A taxpayer is then required to adjust federal income by certain items, one of which is bonus depreciation deductions (New York State has not adopted federal bonus depreciation.) If a taxpayer did not get a current federal tax benefit for bonus depreciation deductions, New York State taxable income was nonetheless adjusted as if a federal benefit had been received for it. The result of this adjustment, therefore, was that a taxpayer paid New York State tax on items that were not deductible currently for federal income tax purposes.
The Act temporarily eliminates this problem. Impacted taxpayers may be able to file amended tax returns and receive refunds paid as a result of the delayed implementation of IRC Sec 461(l).
Minimum Tax Credits
As part of TCJA, the corporate alternative minimum tax (“AMT”) was eliminated, effective for tax years beginning after December 31, 2017. Taxpayers that had AMT credit carryforwards were able to use them against their regular tax liability and also able to claim a refundable credit equal to 50% of the remaining AMT carryforward in years beginning in 2018 through 2020 and 100% for years beginning in 2021.
Under the Act, a fully refundable credit can be claimed in 2019, and a corporation can elect to claim the fully refundable credit amount in 2018.
Business Interest Expense Limitation
Under TCJA, for taxable years beginning after December 31, 2017, the deduction for business interest was limited (under IRC Sec.163(j)) to the sum of business income, floor plan financing interest, and 30% of the “adjusted taxable income” of the taxpayer for the taxable year, with the amount of disallowed interest generally carried forward indefinitely. One notable exception to the application of this limitation was for taxpayers that qualify to make a “real property trade or business” election (IRC Sec. 163(j)(7)(B)). While hotels are generally eligible to make the election since their main product is the provision of real estate for occupancy, restaurants are not eligible because food services are the main product.
The Act increases that limit to 50% of adjusted taxable income for taxable years beginning in 2019 and 2020, thus allowing taxpayers to deduct more of their business interest. In addition, a business can elect to use its 2019 adjusted taxable income in computing its 2020 limitation if that would produce a greater interest deduction. In the case of a partnership, that election is made by the partnership.
Special rules apply to partnerships. The 50% limitation does not apply to partnerships for tax years beginning in 2019. Rather, if a partnership allocates excess business interest in 2019 to a partner (determined under the 30% adjusted taxable income limitation), then, generally (i) 50% of such excess is treated as business interest paid or accrued by the partner in the partner’s first taxable year beginning in 2020 and is not subject to the limitation in that year for such business interest and (ii) the other 50% of the excess business interest is subject to the general excess business interest limitation rules (i.e., only allowed in a future year to the extent of excess taxable income from the same partnership).
A taxpayer can elect to not have the 50% rule apply to the 2019 and/or 2020 taxable years. If such election is made, the original 30% rule would apply. The election is only revocable with the consent of the IRS. Partnerships can only make the election for taxable years beginning in 2020.
As noted, many real estate entities are eligible to make a real property trade or business election which would already exempt such entities from the business interest limitation. For those entities that did not make the election, or were unable to do so, the change from 30% to 50% may provide additional deductions which may provide cash flow benefits. Furthermore, non-real estate entities, including restaurants, will significantly benefit from this new provision.
Qualified Improvement Property
The Act corrects a drafting error in TCJA, which unintentionally resulted in “qualified improvement property” being depreciated as 39-year property and therefore not qualifying for bonus depreciation (currently 100%). Qualified improvement property generally is any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date the building was first placed in service (excluding expenditures attributable to the enlargement of the building, any elevator or escalator or the internal structural framework of the building).
As corrected by the Act, qualified improvement property is treated as 15-year property, and, therefore, bonus depreciation eligible. The change is made as if included in TCJA, and thus is effective for property placed in service after December 31, 2017. This may necessitate the filing of an automatic change of accounting method or amending a previously filed tax return. However, taxpayers that made the real property trade or business election, may not be able to claim bonus depreciation on qualified improvement property, unless the IRS provides administrative relief.
OTHER COVID-19 RESPONSE CONSIDERATIONS
Accounting and Financial Statement Considerations
The current outbreak of COVID-19 has resulted in various financial statement implications that real estate companies need to consider as they operate in this changing environment. Please read our article “COVID-19 and CARES Act Financial Statement Implications for Real Estate Businesses” for more information.
IRC Sec. 1031 Exchanges
If you are in the process of completing an IRC Sec. 1031 exchange and deferral, there are a few safe harbor timelines that are generally followed for conventional exchanges and even more stringent ones for forward exchanges. Specifically --
- Within 45 days of the sale of relinquished property, replacement property must be identified.
- Within 180 days of the sale of relinquished property, replacement property must be acquired.
The IRS has been granting extensions for IRC Sec. 1031 exchanges due to the numerous weather-related disasters, such as hurricanes and wild fires, in the past few years. In Rev. Proc. 2007-56, the IRS sets forth guidelines in which certain deadlines can be extended. In the event investors are impacted by a federally declared disaster, act of terror or military action, an extension of time is provided. In order to be granted an extension, the IRS either needs to issue a notice or other guidance to provide relief. Please note that the IRS has yet to issue a formal notice and it is unclear whether President Trump declaring disaster zones for states is sufficient.
If a notice is issued, the timeline for the exchange is extended by the later of 120 days or the date in the IRS tax relief notice, but not beyond the due date (including extensions) for filing the tax return for the year of transfer or one year. UPDATE: The IRS issued Notice 2020-23 on April 9, 2020 which grants relief with respect to specified time-sensitive actions. This Notice addresses the concerns raised above with respect to the 45-day identification period and the 180-day exchange period. The notice provides an automatic extension until July 15, 2020 BUT only if your exchange deadlines were in the period April 1 - July 15, Unfortunately, this notice does not help if the deadlines were in February and March. There may be additional guidance offered in light of the stay at home orders.
In order for Rev. Proc. 2007-56 to apply, the following as well as other qualifications must be met:
- The relinquished property must have been transferred on or before the date of the federally declared disaster AND the exchanger must be an affected taxpayer as defined OR have difficulty meeting the exchange deadlines due to one of the disaster reasons indicated in the revenue procedure.
- The exchange agreement must also explicitly provide for an extension in the event of a federally declared disaster.
As of the present, it is unclear whether the March 13, 2020 presidential emergency declaration under the Stafford Disaster Relief and Emergency Assistance Act is sufficient to trigger the extension provided in Rev. Proc. 2007-56.
Qualified Opportunity Funds
The TCJA provided for another significant tax benefit and deferral for the real estate community with the enactment of the qualified opportunity zone (“QOZ”) program. This program has received a tremendous amount of press and interest. Please see our dedicated resource page for the basic rules and comprehensive analysis of the program. Investors and qualified opportunity fund (“QOF”) managers need to be cognizant of timed deadline provisions in the QOZ program --
- Investors have 180 days from the sale of capital gain property from an unrelated party to make an investment in a QOF. UPDATE: The IRS issued Notice 2020-23 which grants investors whose deadline falls between April 1 and July 15, 2020 automatic relief of the 180 day investment requirement.
- Fund managers must comply with an asset test -- 90% of the QOF’s assets must be in qualifying assets at the QOF level (there is additional testing at the qualifying opportunity zone business (“QOZB”) level). This test is performed semi-annually.
- The relief provisions do provide a six-month period to cure a defect that causes an entity to fail to qualify as a QOZB. This period corresponds to both the testing period for a QOF and a QOZB. Be aware – the final QOF/QOZ regulations specify that a QOZB can only utilize the cure period once.
- A “working capital safe harbor” allows a QOZB to hold cash, cash equivalents or debt instruments for up to 31-month prior to investing in qualifying assets.
- If a QOZB is located in a QOZ within a federally declared disaster, the QOZB may receive up to an additional 24 months to utilize its working capital assets. Exceeding the 31-month period does not violate the safe harbor if the delay is attributable to waiting for government action, the application for which is completed during the 31-month period.
Without an explicit extension from the IRS or declaration of federally declared disaster zone, if not met, these provisions could provide unintended consequences for investors and funds looking to make investments that are intended to revitalize communities and create jobs.
One of the potential impacts on the real estate industry will be to its lifeline: rental income. Whether in the form of late rents, unpaid rents, or rent deemed uncollectible/forgiven, the main source of revenue for rental real estate businesses may be at risk of being affected by COVID-19. A brief overview of the tax implications of the various situations may be helpful for property owners looking to analyze their future cash flows. Please review our article “The Impacts of COVID-19 on Rental Revenue and the Resulting Tax Implications” for more information.
EisnerAmper will continue to keep you informed of relevant new developments regarding the real estate implications of the COVID-19 pandemic.