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More sustainable and ‘green’ buildings are in increasing demand from tenants in the commercial real estate sector. Developers should keep tax incentives for such buildings and improvements in mind when installing energy efficient systems to attract tenants.
On August 16, 2022, President Joe Biden announced that the Internal Revenue Code (IRC) Section 179D Energy Efficient Commercial Buildings Exemption (179D) for real estate placed in service after December 31, 2022 would be increased to reduce inflation. signed the law. The exemption now includes designers of commercial buildings owned by real estate investment trusts (REITs) and tax-exempt entities (previously government agencies only).
Changes to 179D accelerate deductions for energy efficient buildings and improvements. If you reduce your energy usage by 25%, you’ll get a basic deduction of $0.50 per square foot. As energy savings exceed 25%, deductibles increase on a sliding scale, capped at $1.00 per square foot for 50% savings. Bonus deductions are also available for businesses that meet local general wage and apprenticeship requirements. Prior to this change, only one deduction was allowed per building. This deduction can now be made every three years for commercial property.
The new provision could allow property owners to accelerate the deduction for energy efficient buildings from the previous 39 years.
Bonus depreciation for certain assets will begin to be phased out
One of the largest TCJA bonuses for property owners is a provision that allows 100% bonus depreciation for assets with a payback period of 20 years or less. Examples of eligible assets include vehicles, furniture, manufacturing equipment, and heavy equipment. Of most importance to the commercial real estate industry, it also includes an asset class identified as ‘qualified improvement properties’. This means that upgrades to the interior of a building may qualify for this hefty deduction even after the building is operational.
Eligible properties that entered service before January 1, 2023 will continue to enjoy all benefits. A property owner who can’t close a deal and can’t bring their property online will have to take his 80% deduction in 2023. The deduction will be reduced by a further 20% each year until it is fully abolished in 2027.
Calculating Business Interest Expense Limits for Changes
Another TCJA provision that will change for tax years beginning January 1, 2022 is the calculation of adjusted taxable income (ATI) related to the Section 163(j) limit on interest expense on business. Prior to 2022, ATI was determined by adding depreciation, amortization and depreciation (DAD adjustments) to taxable income. For tax year 2022, the DAD adjustment will be phased out. Interest expense is capped at 30% of ATI, so the interest expense deductible may be lower for highly leveraged real estate investors.
To illustrate the impact, assume that the taxpayer has provisional taxable income of $1,000, depreciation of $400, and interest expense of $700.
2021 Regulations | 2022 Regulations | |
---|---|---|
provisional taxable income | $1,000 | $1,000 |
Addback – Depreciation | $400 | none |
adjusted taxable income | $1,400 | $1,000 |
30% of ATI (Allowable Interest Expense) | $420 | $300 |
Unauthorized interest expense | $280 | $400 |
Small business exemption and RPTOB
ATI’s rules have changed, but the Small Business Exemption and Real Estate Transaction or Business Choice (RPTOB) have not. To apply for the 2022 small business exemption, the average annual gross income of the taxpayer in the past three years must be less than $27 million (previously he was $26 million in 2021 and he was $26 million in 2020). There must be This is an annual test and taxpayer status may change from year to year.
If the taxpayer does not meet its exemption level, it may be eligible for an irrevocable, one-time RPTOB election. To make such an election, the taxpayer must be in the real estate business. This option allows the taxpayer to deduct all interest paid. However, real estate businesses that choose to use RPTOB must depreciate their assets using an Alternative Depreciation System (ADS) rather than the more commonly used General Depreciation System (GDS). I have. This results in a slightly longer depreciation period, as shown in the following illustration.
Property type | GDS life | ADS Life | Reduction in annual depreciation expense |
---|---|---|---|
non-residential real estate | 39 | 40 | 2.5% |
residential real estate | 27.5 | 30 | 9.091% |
Certified Remediation Property | 15 | 20 | Eligible for bonus depreciation on GDS but not on ADS |
Personal property such as furniture and fixtures are subject to bonus depreciation regardless of whether RPTOB elections are in place.
Business interest expense not permitted as a tax year deduction may, subject to certain limitations, be carried forward indefinitely and treated as business interest expense paid or incurred in the next tax year. I have.
There are many changes on the horizon for taxpayers investing in real estate. Each item highlighted above impacts others and should be carefully considered as the end of the year approaches.
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