Our tireless leaders, physicians, scientists, and fellow citizens are doing everything imaginable to fight the pandemic, find a cure, treat those who have become ill, and save as many lives as possible. All of this while keeping the wheels from falling off our economy.
Now down to business:
- The December holiday season has arrived early. Thank you, Mr. Trump, Mr. Mnuchin, Mr. Powell and all members of Congress. Especially Mr. Powell this week…(nice mortgage backstop)…I figure he listened to Tom Barrack’s plea for relief. Tom is a brilliant real estate investor and was quick to raise the bar on this most important issue…keeping mortgage debt viable while tenants are unable to pay rent.
- The real estate benefits included in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), signed into law by Mr. Trump on March 27, 2020, are generous gifts to real estate investors.
- Depreciation and amortization of buildings and personal property are non-cash expense deductions from real estate income. This is based upon the theory (somewhat true) that these physical assets lose value as they age. Hopefully, the opposite is true for humans as we age! I like to think that we age like fine wine…better as we get older.
- You may have heard the phrase “the Lord giveth, and the Lord taketh away.” This may be true in certain respects, but as to real estate tax benefits, a much more applicable phrase is “what the government gives us, the government takes back, and then gives to us again.” Such is the case now.
- The poorly and hastily written 2017 Tax Cuts and Jobs Act (TCJA), which slashed corporate taxes, was designed as a major giveaway to corporations, just in time for Christmas and Hanukkah. That Mr. Trump, what a guy! Perhaps he believed the huge flow of new corporate cash would increase memberships at his golf clubs. It probably did…and provided even more jobs…bravo!
- As might be expected, corporate after-tax profits stemming from the TCJA were dramatic. The stock market boomed as corporations saw their bottom-line profits grow. All major indexes reached new highs, and investors were just giddy. More people were working (albeit for less wages) than ever before, and consumer spending (and confidence) reached all-time highs. Wow…beyond amazing. Mr. Trump could say anything, and even avoid being removed from office…a majority of our elected representatives in Congress couldn’t fathom letting the party end.
- Now comes the good stuff.
- The TCJA increased the life of “qualified improvement property” to 39 years, meaning less depreciation expense each year. Somehow this non-real estate friendly provision got by Mr. Trump…probably distracted with that darn Mueller stuff. The net result meant increased taxable income. The new CARES Act reverses that provision of the TCJA. It not only allows for immediate 100% write off of “qualified improvement property”, it is also retroactive to 2018 and 2019. Real estate investors filing amended tax returns will reduce their prior year taxes and receive tax refunds for having overpaid. Going forward, depreciation expense will be much higher, and non-cash losses will increase. Simply put, income earned from real estate goes into your pocket without your paying federal income tax. Yes, that’s how it works. No surprise that we haven’t seen Mr. Trump’s tax returns, as this long established and completely legal concept well known by real estate investors would be a hard pill for the majority of Americans to swallow.
- So, now you see why all this fuss about depreciation. You purchase investment real estate at what you believe to be an attractive value with the expectation of generating actual cash profits from operations and future profitable disposition. But, for tax purposes, you report losses to offset your income. Yes, this is true. Nothing quite as good in my view. Even better, when you profitably sell your investment real estate, you are taxed at a lower capital gain tax rate. Hold on…it gets even better. If you are invested in other real estate that is generating losses, you can avoid most of the tax on your profits. The reason I say most is because there is a minimum tax that is supposed to ensure that you pay at least something, but it’s a pittance compared to ordinary tax rates.
- The lousy TCJA (for most of us) limited our ability to carry back losses from current years to previous years. This precluded us from obtaining refunds of the federal taxes we paid in good years as had been the case prior to the TCJA. The CARES Act eliminated this provision. Net operating losses accrued in 2018, 2019, and 2020 can now be carried back for five years.
- Hopefully, the next round of stimulus will allow all losses generated from real estate investments to offset all forms of income, just like the old days (pre-1986 tax “deform” act). Remember, Mr. Trump is a real estate investor. So, what’s good for him will likely be pushed through. Fingers crossed.
- Stocks were on a tear upward this past week. Rightly so. Printing money like never before and doing everything possible to get us through the economic calamity that has befallen us is exactly what our great country is doing and we are all the luckier for it.
Disclaimer: I am not a CPA, or a lawyer. Please don’t rely on my discussion of the tax and legal issues as being absolute gospel. Confirm the details with your advisors. As for my real estate advice, that is a sure bet. Luck and timing count of course, but as my dear wife says, my long nose exists for a reason…I can smell a good deal.
Lawrence N. Taylor