A Bedford/Source Advisors Special Report
There are credits and provisions aplenty if you know where to look. Expert panel shares insights about using the team approach to navigate the new tax landscape and the latest provisions impacting your real estate and construction clients.
With a new tax landscape on the horizon, there’s never been more pressure (and more opportunities) for CPAs to help their real estate and construction clients maximize deductions and increase cash flow.
“We’re looking at some of the biggest changes to the tax regulation, code and stimulus in a generation,” observed panelist Rick Telberg, Founder and CEO of CPA Trendlines at the recent Virginia Society of CPAs Virtual Real Estate & Construction Mini-Conference produced in association with Bedford Cost Segregation /Source Advisors.
Top row from left: Max Vignola, Greg Bryant, Josh Malancuk
Middle row from left: Karen Koch, Blake Christian, Rick Telberg
Bottom row from left: Stephen Lukinovich, Andy Ackermann
“If it takes a village, it takes a team approach more than ever,” noted Telberg. “No individual CPA and very few firms can do it on their own. It’s just too complicated, too vast, too far-reaching, too fast-changing. You need to enlist specialist partners to help you,” added Telberg.
Green Book Impact on Energy Provisions
When it comes to the Treasury Department’s new Green Book detailing the Biden Administration’s tax proposals, Greg Bryant, CCSP Senior Managing Director of Bedford/Source Advisors said he is excited about the proposed changes on the energy front. He’s optimistic that the 45L residential tax credit will increase to $2,500 per dwelling unit from the current $2,000. And he thinks it’s very likely the 179D energy efficiency tax credit could be increased to $3 per square foot on commercial buildings from the current $1.80. “It’s a really good shot in the arm,” observed Bryant. “Even $1.80 is a great incentive for people to plan with energy efficiency in mind. It’s a great time to consider energy retrofits and use tax strategies to fund those retrofits.”
Panel moderator Karen Koch, CPA, MT, Senior Director of Bedford/Source Advisors, said it’s all about how we fund the process of making buildings energy efficient. “CPAs and their clients really have to understand the application and design to qualify for these tax incentives to make the dollars work. Otherwise, it is difficult get the financial payback,” noted Koch.
One attendee asked: “How do you pair these credits with cost segregation?”
Cost Seg with Historic and Low-Income Housing Tax Credits
Andy Ackermann, CPA, CVA, a partner of MCM CPAs and Advisors said the Historic Tax Credit (IRC Section 47) is an incentive for developers to rehabilitate (rather than demolish) historic property and make it income producing. The Low-Income Housing Tax Credit (IRC Section 42) is an incentive for real estate developers and other industries to build affordable rental housing. Limited partners that contribute the funding dollars for construction are rewarded with significant tax credits.
Ackermann said that on many of the projects he’s done, especially on the low-income housing side, cost segregation is an important tool for helping investors get their money back quickly and for improving their ROI. “With cost seg, the eligible basis included in the low-income housing credit–whether it’s in the five, seven or fifteen year lives–still counts as part of the credit.” Ackermann added that by using cost seg, a property that normally would be depreciated over 27-1/2 years is dropped into the lower depreciation buckets, so investors get their return a lot faster. “We’ve done this on several projects and certainly with EPAct included also,” Ackermann added.
On the historic credit side, Ackermann said cost seg can be used, but it has limited application. The historic credit is based on the qualified rehabilitation expenses, which are generally costs with 20+ year lives. Moving costs into the shorter-lived buckets would have an adverse effect on the amount of credit a project earns.
Whenever new construction is involved, Ackermann said: “definitely don’t leave cost seg off the table” if you’re talking to developer clients, seeking incentives for projects to help close funding gap, or for improve returns for investors.
Koch said it’s harder than it used to be to combine cost segregation with historical tax credits. You still can still “double dip,” but you must do it in the year the property is placed into service. “Before, we could let it run its five years and come in and do cost segregation. But the IRS no longer allows you to double dip. You just need to be a little creative in your planning on the front end,” Koch added.
Blake Christian, CPA/MBT, tax partner of HCVT, LLP said the potential doubling of the long term capital gain rate is weighing heavily on clients’ minds. He believes the prospect of higher rates will make the federal Opportunity Zone program even more attractive since investors can defer their gains until 2026. “And with general income tax rates going up on businesses, cost segregation is obviously a very helpful strategy that your clients should consider – it can be very beneficial inside an OZ,” Christian added.
That being said, one attendee said he’s had many middle market clients investigate federal Opportunity Zones, but they’re concerned about losing control if they go into a public fund.
Christian confirmed that loss of control is a risk factor for smaller investors in public Opportunity Funds. “Of the 120 or so funds our firm has helped set up, I’d say 100 are family-office types of investment funds. They’re not raising public money,” noted Christian. “There are some very good funds out there, but you really have to look at who the promoters are and see if they purchased the properties out of their own portfolio. Did they change the fair market value? Also look at the annual fees. In many cases fees can be high, which eat into all the tax savings you’re earning through the OZ program,” he added.
In some situations, Christian said your client will be better off setting up their own OZ funds, especially if their client is a developer or has business associates who are solid developers. “Your client will have full control. You can also set up your own Opportunity Fund for operating businesses. That way you can control the cost, the entry, the exit and what you pay for everything,” Christian added.
OZ + Cost Seg
Either way, Christian said a cost segregation study dramatically enhances an OZ project because you’re never going to recapture the depreciation you claim if you hold it for the 10-year period. According to Christian, uninformed skeptics think cost seg it’s just a timing difference, but in an OZ project, it’s a permanent tax savings. “By the end of the 10-year period, if you do an effective cost seg study, half the building could be depreciated and you’re going to walk away from that investment with no recapture. That really enhances the internal rate of return on the project,” added Christian.
MCM’s Ackermann said you can “really blow an investor’s mind” by combining OZ benefits with historic tax credits. “We’ve done several projects that utilized both,” related Ackermann. “The historic investor gets out at the end of the five-year compliance period and the OZ investor gets the residual benefit of the historic tax credit investment.”
Christian said you can take it a step further by integrating solar into the project. That way you can expense depreciation and claim a nice tax credit on the front end with no recapture. “You’re really front-loading all of those benefits in terms of credits and depreciation. As long as you get across that 10-year finish line, you’re golden,” Christian added.
When it comes to solar, Koch said the Green Book addressed the possibility of taking the solar credit up to 30 percent through 2027. That’s a huge opportunity she said, since there are also going to be credits for investing in battery backup power. “If you can incorporate all of this into an Opportunity Zone, what a beautiful picture that would be. However, it takes some planning, and you’ll need a team of people around the table to make that happen,” Koch added.
Speaking of tax savings on real estate, one attendee asked the panel if there was anything he could do to help her clients reduce their ever-rising property taxes in Virginia.
“The biggest opportunities I’ve seen around property taxes in Virginia center around refund opportunities for manufacturers,” noted Josh Malancuk, CPA, CMI – President, JM Tax Advocates, particularly when manufacturers are not treating themselves as manufacturers for the personal property tax. Those savings can be significant.”
Malancuk said the calendar period year-end is your deadline for several years back for those refunds. “Generally, the valuation notices come out in the early spring, so the timing for most the jurisdictional real estate appeal periods is short in Virginia. We are seeing big-time opportunities for hotels and senior care facilities to reduce their taxes due to COVID-driven issues. Also, personal property can be a big-ticket item for manufacturers,” Malancuk added. He also said manufacturers in Virginia should not overlook pollution control breaks. As a CPA, the first step is to identify them, then quantify them and then document them on the filings, Malancuk added.
Don’t forget about property taxes even when a cost segregation study is being performed, advised Malancuk. “What you’re doing is bringing transparency to asset groups, that if interpreted correctly, can actually be a planning item for property taxes,” Malancuk said. Koch agreed. “Some states don’t have personal property taxes, but they have real property taxes. How you allocate your building costs to those particular assets can certainly impact your property taxes.” So, treating your fixed assets correctly is critical for lowering your tax liability, Koch added.
For more about property tax planning opportunities, see Malancuk and Koch’s recent article Property tax relief planning during times of COVID.
Partial Asset Disposition
Speaking of deductions, several attendees asked about determining the adjusted basis for partial asset disposition (PAD). According to Bryant, it’s essential to understand the process for identifying assets that are coming out of service. Take HVAC for example. That’s generally a 39-year asset. But according to Bryant, “you want to make sure that the certain components related to that unit of property are either coming out of service or staying in place.”
For example, Bryant said that if your client is taking out a building’s package rooftop but keeping all the duct work intact, then that’s a 39-year asset. “If you’ve been depreciating it for two years because you just acquired the property, you’ve got another 37 years left to go with respect to the PAD. It’s just as simple as making sure you identify the components in your cost segregation study related to the unit of property,” added Bryant. “That’s why it’s important to understand upfront what your plans are going to be for the property over the ownership period of the asset.”
According to Bryant, it’s less concerning if you have newer property. But if you’re acquiring a 20- or 30-year-old property, Bryant said there’s a good chance you will be deploying the partial asset disposition strategy throughout your ownership period. “You need a description of that asset, and you need a unique identifier assigned to the asset that’s coming out of service,” Bryant added.
Koch said that whenever she has clients who are acquiring property that’s at least 20 years old, she talks to them about any major renovations they’re planning down the road. “We’ll ask them in their baseline study if they want to break out the detail of their 39-year assets when it comes to lighting, HVAC, building envelope, changing out the windows, etc. Generally, they are all considered a 39-year asset.” Koch added that it can be a valuable write-off because if you’ve only owned the property for three years, that’s a significant value on the books. “Depending on whether you paid a premium for the property or bought it at a discount, that will determine your adjusted basis for write off.”
The key, said Koch, is to keep it simple. “When re-lighting a building for example, you are either replacing the lamps or the whole fixture. You’re not replacing the wiring and the conduit related to the lighting. Generally, your lighting cost is buried in the total electrical cost of the building.” According to Koch, having a provider who can break out the detail of what you’re throwing away is the best way to determine the assets disposed of and to get to the write-off. A robust cost segregation study can be the “support you need for claiming an additional layer of expense related to write offs,” Koch added, “Suppose you’re replacing the membrane of your roof. Is it a repair, or is it something you must capitalize? There are lots of questions like these that you should be asking your clients along the way because the treatment can be very different,” Koch explained.
Grouping Elections and Income Tax Planning
When it comes to structuring entities for income tax planning purposes, Stephen Lukinovich, CPA, PFS, CVA – MCM CPAs & Advisors, LLP walked attendees through the four types of grouping elections you can use to mitigate client taxes on their real estate activities:
- Economic Unit Election—can help with self-rental activities. “This election can convert passive losses, which can be limited, into non-passive losses,” said Lukinovich.
- Rental Real Estate Professional Aggregation Election— According to Lukinovich, this election permits qualifying rental real estate professionals (750+ hours) to treat passive (non-deductible) rental losses as ordinary non-passive losses (i.e., deductible) to offset wages or other income.
- Passive Rental Activity Analysis: Five 100-hour analysis grouping— Frequently overlooked by practitioners, it’s an annual analysis to determine if five or more of the taxpayer’s trade or business activities exceed 500 hours in total, enabling them to deduct the losses as non-passive, said Lukinovich.
- 199A Qualified Business Income (QBI) Aggregation Election— This election “helps clients maximize of the free 20% deduction that real estate ventures have been entitled to since 2018,” added Lukinovich.
Tax credits for your client’s R&D
More clients than you think can qualify for valuable R&D credits. For instance, many people in the construction, architecture and engineering professions don’t think about applying for R&D credits for regular activities they conduct. But in many cases, they’re leaving money on the table.
Take the burgeoning trend toward energy-efficient LEED certified construction. According to panelist Max Vignola, CCSP, Director Technical Sales R&D, Bedford/Source Advisors, this orientation has flowed into architecture, engineering, and construction because it involves looking at new materials and new ways to design for energy efficiency or reaching LEED certifications. “Suppose you are experimenting with new types of concrete foundations due to the coastal environment or other conditions related to the site?” asked Vignola. “When a company is experimenting and proving out the foundation model, you will have some wage and material expenditures for the development of a new compound or new mixture of concrete. That’s a form of innovation that can quality for R&D credit,” noted Vignola. However, it’s all based on the unique facts and circumstances to pass the four-part test. Further, professional expertise–usually from an independent provider–can determine what qualifies. Vignola explained.
As we get closer to year end, Bryant said now is a great time of year to ask clients what they’ve done in terms of improvement to their buildings during this tax year. “You may be able to identify opportunities to either expense items under general property regulations, or to “tee some things up for partial asset disposition.” Bryant advised getting a jump on that process so you can get a sense of what your clients have done in terms of capital improvements. “You want to realize the various safe harbors and strategies available to add value to your client relationships,” said Bryant.
Interested in contact the presenters directly?
- Andy Ackermann, CPA, CVA
MCM CPAs and Advisors | firstname.lastname@example.org
- Greg Bryant, CCSP
Bedford/Source Advisors | Greg.email@example.com
- Blake Christian, CPA/MBT
HCVT, LLP | firstname.lastname@example.org
- Karen Koch, CPA, MT
Bedford/Source Advisors | Karen.email@example.com
- Stephen Lukinovich
MCM CPAs & Advisors | firstname.lastname@example.org
- Josh Malancuk, CPA, CMI
JM Tax Advocates | email@example.com
- Rick Telberg
CPA Trendlines | Rickt@telberg.com
- Max Vignola, CCSP
Bedford/Source Advisors | Max.firstname.lastname@example.org