On March 27th, 2020, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (“CARES”), a more than $2 trillion stimulus package as unparalleled in scale and scope as the crisis itself. At its core, the stimulus aims to support the economy through measures including checks and loans providing direct relief to individuals, businesses, and local governments.
This stimulus has also provided relief to many in the real estate sector, primarily in the form of Small Business Administration loans, and multifamily loan forbearance if certain conditions are met. In addition to these headline provisions, one less obvious component of the CARES Act relates to the depreciation of non-residential interior renovations under the Qualified Improvement Property (“QIP”) provision of the Internal Revenue Code. Examples of qualified improvements include upgrades to lighting, HVAC system, bathrooms, furniture, and other fixtures that have a depreciable life. The updated QIP provision under CARES states that qualified improvements made in non-residential assets are now eligible for an accelerated depreciation schedule. Specifically, qualified improvements previously depreciable over 39 years or 40 years can be depreciated over 15 years or 20 years, respectively, implying potential tax savings if pursued.
CARES Act - QIP Tax Savings
What QIP means for investors
One of the core benefits of owning private real estate is that investors can often use depreciation, a non-cash “expense”, to offset taxable income. By providing an accelerated depreciation schedule, the CARES QIP provision, when applied to qualified assets, amplifies the annual depreciation that can be used to offset an eligible asset’s taxable income, which ultimately could translate to lower taxes paid by investors. Notably, this adjustment to QIP depreciation spans tax years 2018 and onward, meaning investors might retroactively save on 2018 and 2019 taxes, in addition to future taxes.
To evaluate whether this updated QIP provision would benefit our assets, Cadre’s Fund Accounting team engaged with our operating partners and tax advisors to review, on a case by case basis, the impact of an updated QIP depreciation schedule on each applicable asset. Summarized below are some of our key takeaways. Though individual investors should always consult with their own tax advisors and accountants, we feel that investors who own assets outside of the Cadre ecosystem may find value in assessing this provision.
What’s eligible for QIP?
The updated QIP provision under CARES accelerates the depreciation schedule of capital expenditures spent on qualified interior improvements in non-residential properties. As such, assets where it may make sense to pursue this updated provision include (1) office, hotel, and retail assets that (2) have undergone qualified interior improvements and (3) have materially positive taxable income, in any tax year starting 2018.
How material are the tax savings?
Using an existing Cadre asset that qualifies for the QIP provision as an example, the following illustrates how the updated QIP provision may result in tax savings:
In early 2019, Cadre acquired a well-occupied Class A office asset located in suburban Boston. After acquisition, Cadre spent roughly $5.5mm on tenant improvements, interior renovations that qualify for depreciation under QIP.
Consider an individual investor who made a $100k investment in the Cadre fund formed to hold this asset. The asset’s rental income, net of operating expenses, other “expenses” like depreciation, and fund level expenses, resulted in net taxable income of approximately $5,300 for the investor in 2019.
But if we were to apply the amended QIP depreciation schedule, amplifying the depreciation expense, the investment now results in a net taxable loss of approximately ($23,700) for the investor in 2019:
If you assume this individual has a personal income tax rate of 37% (the highest federal tax rate), this could translate to nearly $2,000 in 2019 tax savings. Depending on other financial factors, the investor could also potentially use the ~($23,700) net taxable loss to offset passive income elsewhere in 2019, and/or carry forward the (remaining) net taxable loss, creating a tax shield on passive income for future years.
How to claim these tax savings
Owners or managers who have already filed returns for the 2018-2019 tax years may elect to file an amended tax return. Alternatively, for assets where the owner/manager chooses not to file a 2018 or 2019 amendment, the asset can still catch up on 2018-2019 savings through a Form 3115 (“Application for Change in Accounting Method”) that the owner/manager can file in calendar year 2021, in conjunction with the 2020 tax return.
Managers can pass along the tax savings to investors via an amended 2019 K-1 or 2020 K-1, depending on the course of action mentioned above. While it is ultimately up to each individual investor how he or she wants to treat an amended K-1, investors who seek to benefit from the updated tax savings will need to then amend their individual tax returns, after consulting with a tax advisor.
Please note: Given limitations on qualifying asset and expense types most of Cadre’s assets will not obtain additional benefits under the QIP provisions. We always encourage investors to consider the specific attributes of each investment and their own goals before making an investment decision. ↩︎
Asset Operating Expenses include: General and administrative, repairs and maintenance, utilities, property management fee, real estate taxes, and property insurance. ↩︎
Asset Other Expenses include: Interest expense, depreciation, amortization. ↩︎
Fund Level Expenses include: Management fees and professional fees. ↩︎
The views expressed above are presented only for educational and informational purposes and are subject to change in the future. No specific securities or services are being promoted or offered herein.
This communication is not to be construed as investment, tax, or legal advice in relation to the relevant subject matter; investors must seek their own legal or other professional advice.
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Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections are not guaranteed and may not reflect actual future performance.
Risk of Loss
All securities involve a high degree of risk and may result in partial or total loss of your investment.
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Investments offered by Cadre are illiquid and there is never any guarantee that you will be able to exit your investments on the Secondary Market or at what price an exit (if any) will be achieved.
Not a Public Exchange
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Opportunity Zones Disclosure
Any discussion regarding “Opportunity Zones” — including the viability of recycling proceeds from a sale or buyout — is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the “Jobs Act”) and relevant guidances, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist and various uncertainties remain as to the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any, additional guidance, including future legislation, administrative rulings, or court decisions will have and there is risk that any investment marketed as an Opportunity Zone investment will not qualify for, and investors will not realize the benefits they expect from, an Opportunity Zone investment. We also cannot guarantee any specific benefit or outcome of any investment made in reliance upon the above.
Cadre makes no representations, express or implied, regarding the accuracy or completeness of this information, and the reader accepts all risks in relying on the above information for any purpose whatsoever. Any actual transactions described herein are for illustrative purposes only and, unless otherwise stated in the presentation, are presented as of underwriting and may not be indicative of actual performance. Transactions presented may have been selected based on a number of factors such as asset type, geography, or transaction date, among others. Certain information presented or relied upon in this presentation may have been obtained from third-party sources believed to be reliable, however, we do not guarantee the accuracy, completeness or fairness of the information presented.