Though 2017’s Tax Cuts and Jobs Act was generally seen as a boon for real estate companies, it also confronted them with a few difficult choices that required careful thinking about their plans for the future.

“2019 was an interesting year for taxpayers,” Baker Tilly Tax Partner James McCann said. “We spent all of 2018 wrapping our arms around the theory behind the changes. Now we have finally put those changesinto practice and we get to see the results.”

With October’s extended filing deadline in the rearview mirror, real estate companies can now take stock of the year and begin to think proactively about 2020. Here are four of the biggest tax takeaways for the real estate industry from 2019.

1. Interest Expense Limitation

While the TCJA slashed corporate taxes, it also placed a cap on interest expense deductions. Companies are now only able to deduct interest expenses equal to 30% of theirAdjusted Taxable Income, which is a concept similar to EBITDA, thru 2021. Beginning in 2022 depreciation and amortization will no longer get added back, resulting in a further limitation on deductible business interest. This was a potential blow for real estate developers and owners, who regularly borrow large sums of capital and thus pay a great deal of interest.

Small businesses — those with gross receipts that average less than $25M over the preceding three years — were exempt from the limitation, known as 163(j), but that exemption was not always easy to apply to real estate.

“There are so many partnerships and commonly controlled entities, and depending on their structure, an owner might have to aggregate gross receipts from all their holdings,” McCann said. “Even though each LLC might individually qualify as a small business, all the receipts combined could push them over the $25M limit and mean none of the businesses would be exempt.”

Companies in the real estate industry could permanently elect out of the limitation, but they face a trade-off. Electing to be treated as a “real property trade or business” would bar them from using the newly created bonus depreciation rules, which could save hundreds of thousands in construction and renovation tax costs ifCongress makes a technical correction to the TCJA that is uncertain to occur. Companies who make this election must also use a longer depreciation schedule for certain other assets, including the building shell.

“Whether they made that election really came down to their future plans for each individual property, their portfolio as a whole and their outlook on politics,” McCann said.

2. Depreciation for Qualified Improvement Property

With the TCJA, Congress intended to simplify the depreciation system for leasehold property and certain building improvements, creating the sweeping category of “qualified improvement property” and making these costs eligible for bonus depreciation, which would have allowed for 100% expensing on 2018 tax returns. However, Congress mistakenly omitted QIP from the definition of qualified property, and while legislation was introduced in March 2019 to make that technical correction, it still has not passed.

“Some clients wanted to delay as long as possible to see if the legislation would go through before the October deadline,” McCann said.

It is not clear if any technical correction would be retroactive. In the meantime, real estate companies must pay careful attention to what work counts as a “repair” — which can be fully deducted the year that it happens — and what qualifies as an “improvement,” which must be depreciated over a much longer schedule.

3. 199A Pass-Through Deductions

Since the TCJA gave corporations such a large tax cut, Congress tried to even the playing field by creating the 199A deduction. The rule generally allows individuals, estates and trusts that own pass-through businesses to deduct up to 20% of the qualified business income on their individual tax returns.

The 199A deduction does have a limitation using 50% of the yearly wages paid out by the business. However, given that many real estate businesses pay exactly $0 in wages — individual buildings set up as their own LLCs may use a management company to pay out wages -the IRSinstead allowed owners to modify the deduction limitation using 2.5% of their basis in depreciable assets plus 25% of the yearly wages.

That change especially benefits developers and institutional capital sources thatactively buy, renovate and resell properties, since they have a higher unadjusted basis in their properties than an owner or family of owners who have held onto assets for many decades.

However, the new rule does provide entities with common ownership the opportunity to combine some or all of their holdings, giving tax professionals like McCann the ability to optimize his clients’ 199A deductions

This feature was produced in collaboration between Bisnow Branded Content and Baker Tilly. Bisnow news staff was not involved in the production of this content.