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The Effect of Tax Reform on Real Estate and Professional Service Firms (Part 1)

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Roger Royse's presentation on the effects of tax reform on real estate and professional service firms. This is part 1 of 2.

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The Effect of Tax Reform on Real Estate and Professional Service Firms (Part 1)

  1. 1. THE EFFECT OF TAX REFORM ON REAL ESTATE AND PROFESSIONAL SERVICE FIRMS Roger Royse rroyse@rroyselaw.com www.rroyselaw.com Research Assistant: Natalie Ryang The Santa Clara County Bar Part I. Tax Cuts and Job Acts (TCJA) Part II. Foreign Partners in the U.S. Partnerships Part III. Foreign Investment in the U.S. Real Estate
  2. 2. No information contained in this presentation is to be construed as legal advice. No information contained in this presentation is intended or related to any particular factual situation. Nothing herein forms an attorney-client relationship. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Part II. Cryptocurrency Regulation 2 Disclaimer
  3. 3. Summary of Tax Cuts and Jobs Acts (TCJA) 1. Rate change: TCJA reformed both individual income and corporate income taxes • Top Corporate income tax rate reduced from 35% to 21% • Top Individual income tax rate reduced from 39.6% to 37% 2. Section 199A Deduction: Established a 20% deduction of qualified business income in the U.S. Part I. Tax Cuts and Jobs Acts 3
  4. 4. Summary of Tax Cuts and Jobs Acts (TCJA) 3. Interest Deduction: Limits the deductibility of net interest expense to 30% of earnings • Adjusted taxable income based on EBITDA until 2022, then EBIT 4. Interest Deduction in Real Property Business: Election out for real estate • Election is irrevocable and requires use of straight line method depreciation and longer recovery period than under usual depreciation method Part I. Tax Cuts and Jobs Acts 4
  5. 5. Summary of Tax Cuts and Jobs Acts (TCJA) 5. 100% expensing for qualifying property including real property improvements 6. Limit NOL deductions to 80% of taxable income 7. Business losses for individuals limited 8. Like-Kind Exchanges: Retains the current 1031 Like-kind exchange rule for real property 9. Carried interest: 3 year capital gains holding period for carried interests in partnerships Part I. Tax Cuts and Jobs Acts 5
  6. 6. 10. Technical Termination: termination of partnership after material ownership change is repealed 11. 10% withholding on sales proceeds of non-resident aliens (NRAs) from a disposition of interest in a partnership that owns a US business or real property Part I. Tax Cuts and Jobs Acts 6 Summary of Tax Cuts and Jobs Acts (TCJA)
  7. 7. 1. Tax Rates Individual Income Tax Rates Corporate Income Tax Rates • Maximum rates lowered from 39.6% to 37% • 3.8% Net Investment Income Tax (NIIT) retained for unearned income • Rate reduction set to expire after 2025, unless renewed • Corporate tax rate permanently reduced from 35% to 21% • Graduated corporate tax rate structure is eliminated • Corporate AMT (Alternative Minimum Tax) is eliminated Part I. Tax Cuts and Jobs Acts 7
  8. 8. 2. Section 199A: 20% Deduction • Deduction of up to 20% of domestic “qualified business income” (QBI) from a partnership, S corporation, or sole proprietorship – sunsets after 2025 • Reduces top marginal rate to 29.6% for QBI [(100%-20%) * 37%] • QBI is income effectively connected with a qualified U.S. business, but excluding professional services businesses, including investing services • Deduction is subject to limitation based on wages paid, or on wages paid plus a capital assets factor (i.e., value of tangible, depreciable property) Part I. Tax Cuts and Jobs Acts 8
  9. 9. 3. Interest Deduction • Deduction for business interest expense limited to 30% of “adjusted taxable income” • Adjusted taxable income based on EBITDA until 2022, then EBIT • Utilization in future years subject to applicable interest deductibility limitations • Limitation applies at entity level • Exception from 30% limitation: • Small Business Exception: revenues of less than $25M • Electing Real Property Trade or Business Exception (RPTB Exception) Part I. Tax Cuts and Jobs Acts 9
  10. 10. 163(j) • Applied at partnership level • Carryforward of excess interest expense • No carryforward of excess limitation • Corporate and non corporate taxpayers Part I. Tax Cuts and Jobs Acts 10
  11. 11. 4. Interest Deduction for Real Property Business • Real property trade or businesses (RPTB) may elect to be excluded from the interest deductibility limitation • RPTB includes real property development, redevelopment, construction, rental, management, leasing trade or business. IRC 469(c)(7)(C) • Election is irrevocable • Election generally requires use of straight line method depreciation and longer recovery periods than under usual depreciation method • Recovery periods extended • Nonresidential depreciable real property: 40 years • Residential depreciable real property: 30 years • Qualified improvements are extended: 20 years Part I. Tax Cuts and Jobs Acts 11
  12. 12. 5. 100% Expensing: First Year Bonus Depreciation • 100% of cost basis of qualifying property placed in service can be expensed in that tax year from September 2017 through 2022 • After 2022, percentage phases down to 80% for property placed in service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026 • No “original use” requirement – applies to purchases of used and new equipment • Excludes property acquired from affiliate or in a tax free transaction (i.e., like kind exchange) • Qualified property generally includes assets with recovery periods of 20 years or less • Real estate related property eligible for 100% expensing includes heating, lighting, plumbing, cooling, fire protection, and alarm systems Part I. Tax Cuts and Jobs Acts 12
  13. 13. 179 Deduction - Taxpayer can deduct cost of 179 property - Increased deduction from 500K to 1Million - Includes: Qualified Improvement property, roofs, HVAC fire systems, alarm + security systems Recovery Periods Real Property - TCJA- Keeps 39 years for non residential real-estate - 27.5 years for residential rental from 40 to 30 years - Qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property given 15 years life Part I. Tax Cuts and Jobs Acts 13
  14. 14. Part I. Tax Cuts and Jobs Acts 14
  15. 15. 6. NOL Limitation • Corporate NOLs arising in a taxable year after 2017 can offset up to 80% of current year taxable income • No NOL carry-back, but unlimited carry-forwards Part I. Tax Cuts and Jobs Acts 15
  16. 16. 7. Individual Losses • “Excess business losses” (business loss in excess of $500k for married/$250k for individuals) now disallowed, but can be carried forward as an NOL for future years Part I. Tax Cuts and Jobs Acts 16
  17. 17. 8. Like-Kind Exchange • “Like-kind” exchange provisions are limited to real property • No dealer property (property primarily held for sale) • No domestic-foreign property exchanges • Personal property transferred as part of a larger like-kind exchange of real property no longer qualifies for tax deferred treatment Part I. Tax Cuts and Jobs Acts 17
  18. 18. 9. Carried Interest • 3 Year Holding Period for Long Term Capital Gain rates • Partnership interests held by individuals in exchange for performance of substantial services for an “applicable trade or business” (“carried interest”) must be held for at least 3 years to qualify for long term capital gain rates • Applicable trade or business includes one conducted regularly, continually, and substantially and may include real estate development for rental or investment • Holding period applies not just with respect to sale of the partnership, but also regarding the flow through gains upon sale of assets by the partnership • Holding partnership interest through a S-corporation Part I. Tax Cuts and Jobs Acts 18
  19. 19. 10. Technical Termination • Termination of partnership after material ownership change is repealed for partnership tax years beginning after December 31, 2017 • Under prior law, technical termination resulted from sale or exchange of 50% or more of the total interest in partnership capital and profits during a 12-month period • Partnership ownership changes will no longer restart partnership depreciation or allow new partnership level tax elections to be made Part I. Tax Cuts and Jobs Acts 19
  20. 20. 11. Residential Real Estate • Deduction for state and local property (and income and sales) taxes is limited to $10,000 per year • Limitation does not apply to taxes incurred in connection with a trade or business • Deduction for interest incurred on debt used to acquire, construct or improve a principal residence is limited to interest on up to $750,000 of debt (down from $1,000,000) • Deduction for interest on home equity debt eliminated • Exception for home equity loans used to buy, build or substantially improve the taxpayer’s qualified residence • Caps apply beginning in 2018 and expire after 2025, unless renewed Part I. Tax Cuts and Jobs Acts 20
  21. 21. ROYSE LAW FIRM, PC For questions , Contact PALO ALTO 1717 Embarcadero Road Palo Alto, CA 94303 LOS ANGELES 11150 Santa Monica Blvd. Suite 1200 Los Angeles, CA 90025 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Palo Alto Office: 650-813-9700 CONTACT US www.rroyselaw.co m @RoyseLaw MENLO PARK 149 Commonwealth Drive, Suite 1001 Menlo Park, CA 94025 SANTA MONICA 520 Broadway Suite 200 Santa Monica, CA 90401 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Menlo Park Office: 650-813-9700 CONTACT US www.rroyselaw.com @RoyseLaw ORANGE COUNTY 135 S. State College Blvd Suite 200 Brea, CA 92821 Research Assistant: Natalie Ryang nryang@rroyselaw.com 21Part I. Tax Cuts and Jobs Acts

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