Real Estate Developer Forum – 2017 Tax Reform and Impacts on Real Estate Sponsored by: Baker Hostetler’s Tax Credit Finance and Economic Development Incentives Team Co-leaders: Alexander Szilvas and Nathan Ware Presenters: Hon. Michael Ferguson, Jeffrey Paravano, Alexander Szilvas, Nathan Ware, Edward Ptaszek, Jr., Michelle Hervey, Christina Novotny and Lucas Witters May 9, 2018
Washington Update and Overview of 2017 Tax Reform Hon. Michael A. Ferguson and Jeffrey H. Paravano 2
The Honorable Mike Ferguson • Leader of BakerHostetler’s Federal Policy team • Provides clients with public policy consulting and lobbying services in Congress, Trump Administration • Former Member of Congress, 2001-2009 • Served on House Financial Services Committee and House Energy and Commerce Committee • Leader on healthcare, telecommunications and financial services policies Contact Mike: (202) 861-1663 mferguson@bakerlaw.com 3
Jeffrey Paravano Jeff Paravano has a broad-based tax practice involving tax controversy and tax litigation; corporate, partnership, and venture capital transactions; and domestic and cross-border tax planning. He also represents clients' interests before enforcement officials, federal policy makers, and on Capitol Hill. Jeff also serves as Managing Partner of BakerHostetler's Washington, D.C., office and previously served as firmwide Chair of the firm's Tax Group, which is among the largest law firm tax practices in the United States. Before returning to the firm from Treasury in 2003, Jeff served as Senior Advisor to the Assistant Secretary, Tax Policy, at the United States Department of Treasury. jparavano@bakerlaw.com (202) 861-1770 4
Tax Cuts and Jobs Act • Official title: “An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” 5
Changes in Business Tax Rates, Loss Limitations and Impacts on Real Estate Michelle Hervey and Edward Ptaszek, Jr. 6
Business Provisions Choice of Entity 7
Tax Rates - Corporations • Lowers rate to flat 21% • Doesn’t distinguish between investment income and business income • Corporate AMT (20% rate) repealed 8
Effective Rates • Pass throughs: 33.4% to 40.8%, depending on whether QBI deduction applies • C corporations: 39.8%, considering second level of tax on dividends 9
Corporate v. Pass-through Rates C Corporation Pass-through Entity-level tax on $100 $21.00 n/a Tax on net distribution ($79) $15.80 n/a Individual tax on income n/a $37.00 Effect of QBI deduction (20% n/a ($7.40) of 37%) Net Investment Income Tax $3.00 $3.80 Total Tax Burden $39.80 $33.40 Without QBI Deduction $40.80 10
Corporate v. Pass-through Rates: Reinvestment of Earnings C Corporation Pass-through Entity-level tax on $100 $21.00 n/a Individual tax on income n/a $37.00 Effect of QBI deduction n/a ($7.40) (20% of 37%) Net Investment Income Tax $-0- $3.80 Cash Distributed to Pay $-0- $33.40 Taxes Reinvested Cash $79.00 $66.60 11
New Life for Old Rules • Accumulated earnings tax – 20% of accumulated taxable income – Intended to discourage corporations from retaining earnings without a business purpose, solely to avoid shareholder-level tax • Personal holding company tax – 20% of undistributed personal holding company income – Imposed on certain types of undistributed passive income earned by a closely held C corporation 12
Corporate Net Operating Losses • NOLs are limited to 80% of taxable income – Applies to losses arising in taxable years beginning after 12/31/17 • Carried forward indefinitely, but no carrybacks – Limited exception for certain farming losses – Exception for property and casualty insurers – Applies to losses arising in taxable years ending after 12/31/17 13
Loss Limitation for Noncorporate Taxpayers • Excess business losses limited to $250,000 ($500,000 for joint filers) • Aggregate trades or businesses 14
Deduction for Qualified Business Income of Pass-Thru Entities New Section 199A 15
Deduction for Qualified Business Income of Pass Through Entities • 20% of qualified business income • Subject to limitations – Taxable income: losses/deductions will offset qualifying income – Not applicable to reasonable compensation or guaranteed payments for services – Not applicable to specified service business – Limitations based on wages paid or property owned by the business • Service business and wage/property limitations do not apply if taxable income is less than $315,000 for joint filers (deduction is phased out between $315,000 and $415,000) 16
Combined QBI Amount • “Deductible amount” for each trade or business – 20% of QBI, subject to limitations • 20% of qualified REIT dividends • 20% of qualified publicly traded partnership income 17
Not QBI • Capital gains or losses • Dividends • Interest income not allocable to trade or business • Commodities transactions, foreign currency gains • Notational principal contracts • Reasonable compensation or guaranteed payments for services with respect to the trade or business • Qualified REIT dividends • Qualified cooperative dividends • Qualified publicly traded partnership income 18
Not Applicable to Specified Service Trades or Businesses Winners Losers • Health • Architects • Law • Engineers • Accounting • Actuarial science • Performing arts • Athletics • Financial services • Brokerage services • Consulting • Principal asset = reputation or skill of one or more owners or employees 19
Deductible amount for each trade or business • 20% of QBI • Limited to the greater of: – 50% of W-2 wages with respect to qualified trade or business; or – 25% of W-2 wages, plus 2.5% of unadjusted basis of qualified property, as determined immediately after acquisition 20
Qualified Property • Tangible • Subject to depreciation and the ‘depreciable period’ has not ended prior to the close of the taxable year • Depreciable period is the later of: – 10 years after placed in service, or – Applicable recovery period under Section 168 (disregarding ADS) • Used in the production of QBI at close of taxable year 21
Applies at partner or S corporation shareholder level • Allocable share of each item of income, gain, deduction, loss • W-2 wages determined based on allocable share of wage expenses • Qualified property basis determined based on allocable share of depreciation • S corporation allocable share = shareholder’s pro rata share 22
Impact of limitations Retailer: Real Estate Company: • $15 million QBI, eligible • $15 million QBI, eligible for for $3 million deduction $3 million deduction – $16 million W-2 wages – $1 million W-2 wages – $500,000 qualified – $100 million qualified property property – Limited to greater of: – Limited to greater of: $8,000,000 wages; or $500,000 wages; or $4,000,000 wages + $250,000 wages + $12,500 property = $2,500,000 property = $4,012,500 $2,750,000 • Deduction not limited • Deduction limited 23
Loss Carryovers • If net qualified business income is less than zero, the loss is carried forward to the succeeding taxable year • Loss carryover reduces qualified income in the subsequent year, effectively applying the deduction on a cumulative basis. • Differs from excess business loss; must be separately tracked 24
Loss Carryover Comparison 199A 461(l) Year 1 QBI loss ($750,000) ($750,000) QBI deduction -0- Deductible ($500,000) business loss Carryover to year 2 ($750,000) ($250,000) Year 2 QBI $2,000,000 $2,000,000 Eligible for QBI $1,250,000 Taxable business $1,750,000 deduction income 25
Tax Reform Provisions Affecting Real Estate and Planning Opportunities Alexander Szilvas, Nathan Ware, Michelle Hervey, Christina Novotny and Lucas Witters 26
Qualified Opportunity Zones 27
Gain Deferral for Investments in Qualified Opportunity Zones (IRC §1400Z-2) New Gain Deferral and Potential Exclusion Opportunity • Deferral – A taxpayer may elect to defer gain from the sale of property to an unrelated person to the extent the amount of such gain is reinvested in a “qualified opportunity fund” within 180 days of the sale. • Gain Recognition – General Rule – 100% of the deferred gain shall be included in the taxpayer’s gross income the earlier of: (i) the date the investment is sold; or (ii) Dec. 31, 2026. – Reduced Gain Options 5-Year Hold – If the investment is held for at least 5 years, 10% of the gain is permanently excluded from gross income. 7-Year Hold – If the investment is held for at least 7 years, 15% of the gain is permanently excluded from gross income. 10-Year Hold – If the investment is held for at least 10 years, any post-acquisition appreciation is excluded from gross income. 28
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