Below is a list and description of the real estate-related tax extenders in the one-year tax extender bill that passed the Senate last week (76-16). It now goes to the President for his signature. All of the provisions below will be extended retroactively, effective January 1, 2013. All of the provisions will expire again in 14 days, at the end of calendar year 2014.
15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements
A tax policy priority of The Real Estate Roundtable, the legislation includes an extension of 15-year depreciation for leasehold improvements. Congress first modified the depreciation period for leasehold improvements in the American Jobs Creation Act of 2004 to more closely reflect the economically useful life of tenant “build outs.” Previously, the tax law made the cost of constructing tenant improvements artificially high by requiring real estate owners to recover the expense over 39 years – a period that is more than four times longer than the average life of the improvements. Section 168(e)(3)(E)(iv) provides a statutory 15-year recovery period (using the straight-line method and a half-year convention) for qualified leasehold improvement property, defined as an improvement to an interior portion of a building that is nonresidential real property, as long as certain requirements are met. Qualifying leasehold improvement property is also eligible for bonus depreciation (restaurant and retail property do not qualify, unless they are also leasehold improvements). The 15-year recovery period also applies to restaurant and retail improvements, and new restaurant construction. The bill extends the 15-year depreciation provision to property placed in service in calendar year 2014. Cost: $2.382 billion
Energy efficient commercial buildings deduction
Another Real Estate Roundtable priority, section 179D encourages building owners to install high performance, energy-efficient heating, lighting, windows, roofs, and other systems by accelerating the cost recovery of the upfront investment. Taxpayers may deduct the cost of their energy-efficient commercial building property expenditures. The maximum allowable deduction with respect to a building is $1.80 per square foot, and partial deductions can be claimed for separate building systems that meet system-specific savings targets. For expenditures made by tax-exempt public entities, such as a public school, the deduction may be allocated to the person primarily responsible for designing the property. The bill extends the deduction to property placed in service in calendar year 2014. Cost: $127 million. The bill does not include changes included in the Senate EXPIRE Act that would have updated the efficiency standards and allowed tax-exempt nonprofit organizations to allocate the deduction to the person primarily responsible for designing the property, nor does it include Roundtable-supported amendments proposed in S. 2189, which would facilitate taxpayers’ ability to use the deduction when retrofitting existing commercial and multifamily buildings.
The bill extends “bonus depreciation” under section 168(k) to property placed in service in calendar year 2014. The additional first-year depreciation deduction is equal to 50 percent of the adjusted basis of qualifying property. With the exception of a two-year period (2006-07), some form of bonus depreciation – either 30%, 50%, or 100% – has been in effect since 2002. As noted above, qualified leasehold improvement property is eligible for the 50 percent bonus depreciation election. Cost: $1.21 billion The bill does not include a proposal that passed the House in H.R. 4718, which would have made 50% bonus depreciation permanent.
Mortgage Debt Forgiveness
The bill extends a provision that allows taxpayers to exclude from income up to $2 million of cancelled mortgage indebtedness ($1 million in married filing separately) on a principal residence. Section108(a)(1)(E) was originally enacted in the Mortgage Debt Relief Act of 2007 to shield distressed taxpayers from having to pay taxes on discharged mortgage debt during the wave of mortgage modifications, work-outs, and short sales that occurred during and after the financial crisis. It has been extended on multiple occasions. The bill applies to discharges of indebtedness occurring in calendar year 2014. Cost: $3.143 billion
Deduction for Mortgage Interest Premiums
The bill extends taxpayers’ ability to deduct the cost of mortgage insurance on a qualified personal residence or second home. The mortgage insurance deduction, codified in section 163(h)(3) and in effect since 2007, phases out ratably by 10% for each $1,000 by which the taxpayer’s adjusted gross income (AGI) exceeds $100,000. Thus, the deduction is unavailable for a taxpayer with an AGI in excess of $110,000. The provision applies to amounts paid or accrued in calendar year 2014. Cost: $919 million
Minimum 9 Percent Credit Rate for the Low-Income Housing Tax Credit Program
The low-income housing tax credit program (LIHTC) provides credits over a period of ten years after a housing facility occupied by low-income tenants is placed-in-service. The credit earned generally depends on three factors – the investment in the building, the portion of the building devoted to low-income units, and a credit rate (called the “applicable rate”). When the program was created, the applicable rate was 9%. As interest rates have declined, so has the amount of tax credits that can be used to build a LIHTC project. Since 2008, in the case of low-income housing that is not federally subsidized, Congress has adjusted the formula and set a minimum credit amount of 9%, which is based on the original credit rate when the program was created. The bill extends the provision to LIHTC credit allocations made in calendar year 2014. Cost: less than $500,000. The bill does not include a provision in the Senate EXPIRE Act which would have also established a 4% minimum credit rate for the acquisition of existing housing that is not federally subsidized.
New Markets Tax Credit
The New Markets Tax Credit (NMTC) program awards tax credits to qualified community development entities (CDEs) operating in low-income areas. The credits are transferred by the CDEs to equity investors and claimed over a 7-year period. Treasury allocates the credits to CDEs on a competitive basis through annual allocation rounds. Many of the projects funded through the NMTC program involve major, mixed-use urban redevelopment initiatives. The bill authorizes the Treasury Department to allocate an additional $3.5 billion in New Markets Tax Credits, the same amount that has been authorized in each of the past four years. Cost: $978 million. The bill does not include a provision in the Senate EXPIRE Act which would favor NMTC investments in areas that have suffered major manufacturing job losses.
Real Property and the Small Business Expensing Allowance
Under the so-called “small business expensing allowance,” certain taxpayers may elect under section 179 to deduct (rather than capitalize) the cost of qualifying property purchased for use in an active trade or business. The Small Business Jobs Act of 2010 extended the expensing allowance, for the first time, to certain investments in real property (section 179(f)). The real property must meet the definition of leasehold improvement, restaurant, or retail improvement property for purposes of 15-year depreciation. In 2013, taxpayers could deduct up to $500,000 of qualifying property (including $250,000 of qualifying real property) placed in service, with the deductible amount gradually reduced to the extent the taxpayer placed in service more than $2 million of qualifying property. The bill extends these dollar limitations, including the authority to deduct up to $250,000 in real property investment, through 2014. Cost: $1.434 billion. The bill does not include modifications that passed the House in H.R. 4457, which would have made permanent the higher dollar limitations and the authority to expense real property, as well as repealed the rule that made the dollar limitation on real property lower than the maximum deductible amount.
Reduced built-in gains recognition period for S corporation and REIT conversions
If a taxable corporation converts into an S corporation, the conversion is not a taxable event. However, following such a conversion, an S corporation must hold its assets for a certain period in order to avoid a tax on any built-in gains that existed at the time of the conversion. The American Recovery and Reinvestment Act reduced that period from 10 years to 7 years for sales of assets in 2009 and 2010. The Small Business Jobs Act reduced that period to 5 years for sales of assets in 2011. According to the Joint Committee on Taxation, the holding period for S corporation conversions also applies to REIT conversions through the application of Treas. Reg. § 1.337(d)-7(b), unless the REIT elects “deemed sale” treatment. The bill extends the reduced 5-year holding period for sales occurring in calendar year 2014. Cost: $94 million. The bill does not include a proposal that passed the House in H.R. 4453, which would have made the 5-year holding period permanent.
Credit for Construction of New Energy Efficient Homes
Since the Energy Policy Act of 2005, section 45L has provided a tax credit of up to $2,000 to the contractor or manufacturer of a new home that meets specific energy efficiency standards. The bill extends the credit to new homes that are acquired, for use as a residence, from an eligible contractor or manufacturer in calendar year 2014. Cost: $267 million.