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Real Property Trade or Business: Advantages and Disadvantages

Nov 28, 2023

In this episode of Breaking Ground, EisnerAmper and Capstan Tax Strategies discuss the significance of being designated a "real property trade or business”, what this classification means, the pros and cons of having this status, and how it can influence the timing of financial elections. Additionally, we analyze the impact of Qualified Improvement Property (QIP) on businesses operating within the real property trade.

Understanding the Complexities of Real Property Trade or Business

On this episode of Breaking Ground, the EisnerAmper podcast dedicated to the real estate market, our hosts cover the impact of the timing for making the election to officially classify a business as a real property trade or business, and the advantages and disadvantages of making the election. They also delve into the impact of the election with respect to qualified improvement property, better known as QIP.

Who Classifies as a Real Property Trade or Business

Thanks to the Tax Cuts and Jobs Act (TCJA) of 2017, businesses involved in real property development, construction, acquisition, or rental can designate themselves as a real property trade or business. This classification allows them to bypass the interest limitations of IRC 163(j), providing a significant advantage, particularly in highly leveraged property scenarios.

Advantages and Disadvantages of a Real Property Trade or Business 

While there are clear benefits to this classification, such as avoiding interest limitations, there are also drawbacks. Businesses opting for this status must use longer depreciable lives for real property, switching from General Depreciation System (GDS) lives to Alternative Depreciation System (ADS) lives. The initial uncertainty surrounding residential properties' depreciable lives under TCJA was addressed by the Consolidated Appropriations Act in 2020, restoring the treatment to a 30-year period.

Impact of Qualified Improvement Property (QIP)

Due to a technical correction in the CARES Act of 2022, Qualified Improvement Property (QIP) for commercial properties is now classified as 20-year ADS property, making it ineligible for bonus depreciation. This change introduces complexity in decision-making for businesses considering the real property trade or business classification, especially when large renovation projects or tenant improvements are in the pipeline.

Timing of Elections

Businesses need to carefully assess when to make the election, especially if significant renovation projects are planned. 

According to our hosts, “Planning is everything, if you know there's a large renovation coming down the pipeline in the early years of the asset, you have to evaluate with your tax preparers.” They can help you look at the limitations of interest and how you evaluate the limitations of that interest versus the amount of bonus depreciation you would be foregoing on potential QIP assets. 

This can help you determine whether the election makes sense at this time or if your organization should forego the election for a few years. 

Listen to the full episode for more insights into classifying as a real property trade or business.

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Avi Jacob

Avi Jacob is a Compliance Tax Manager in the Real Estate Services Group.

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