KROST Quarterly: The Real Estate Issue - Volume 3, Issue 3

VOLUME 3, ISSUE 3

KROST QUARTERLY M A G A Z I N E

THE REAL ESTATE ISSUE CHALLENGES FACING THE REAL ESTATE INDUSTRY IN THE WAKE OF COVID & THE ELECTION A DEEPER DIVE INTO THE UNINTENDED CONSEQUENCES OF THE PROPOSED SECTION 1031 REGULATIONS

OPPORTUNITY ZONES & COST SEGREGATION NOT SURE WHERE TO FIND REAL ESTATE DIVERSIFICATION?

GOING GREEN FOR THE GREEN: FEDERAL TAX INCENTIVES FOR ENERGY EFFICIENT BUILDING

WWW.KROSTCPAS.COM KROST QUARTERLY VOL. 3 ISSUE 3 - THE REAL ESTATE ISSUE

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KROSTCPAs.com

CONTENTS

Volume 3, Issue 3 / October 2020 Offices Pasadena (Headquarters) West LA Woodland Hills Phone: (626) 449-4225 Fax: (626) 449-4471 Principals Gregory A. Kniss, CPA Managing Principal Lou Guerrero, CPA, MBT Jason C. Melillo, CPA Jean Hagan So Sum Lee, CPA Douglas Venturelli, Esq. Richard Umanoff, CPA, MBA Christopher H. Gaynor, CPA, MS Production, Copy, and Design Bethany Wolfe, Editor-in-Chief Anna Chen, Editor Mayra Silva, Graphic Designer Diana Vu, Assistant Editor Jackie Do, Assistant Editor Inquiries may be sent to: admin@KROSTCPAs.com Stock Photography Adobe Stock - Used with permission Copyright © 2020 by KROSTCPAs.com All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law.

Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM. Placing business through Avantax Insurance AgencySM and Avantax Insurance ServicesSM CA# 0M36260

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Challenges Facing the Real Estate Industry in the Wake of COVID & the Election

By So Sum Lee, CPA

A Deeper Dive into the Unintended Consequences of the Proposed Section 1031 Regulations

By Jonathan Louie, CPA, MST

Opportunity Zones and Cost Segregation Guest Contributor: Artur Babaian

Qualified Improvement Property (QIP) Technical Correction and Bonus Depreciation

By Elvira Frencillo, CPA and So Sum Lee, CPA

Not Sure Where to Find Real Estate Diversification?

By Phil Clark, CFP®

Going Green for the Green: Federal Tax Incentives for Energy Efficient Building

By So Sum Lee, CPA

T H E REA L ESTAT E ISS U E KROST Quarterly is a digital publication released by KROST CPAs & Consultants headquartered in Pasadena, California. Established in 1939, this full-service Certified Public Accounting and Consulting firm serves clients across a variety of industries. With a focus on recognizing opportunities and creating value, KROST equips clients with tools to make better business and financial decisions for the future.

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INTRODUCING KROST’S REAL ESTATE TEAM Our team, led by industry expert So Sum Lee, has devoted a tremendous amount of time dedicated to this space to provide solutions to clients nationwide. Our areas of expertise include a wide range of tax, audit, and advisory services. We have extensive experience working with all property types, including commercial, residential, and multi-family. Our clients include developers, as well as investment, construction, and property management companies.

LEARN MORE 

Our team produces regular KROST Insights posted to our website. This issue will highlight some of the hot topics in real estate including Opportunity Zones, Delaware Statutory Trusts, Cost Segregation, 1031 Exchange, Green Building Tax Incentives, and Qualified

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Improvement Property.

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KROST QUARTERLY VOL. 3 ISSUE 3 - THE REAL ESTATE ISSUE

Greg Kniss, CPA Managing Principal

REAL ESTATE Team at KROST Tax Planning and Compliance Services

So Sum Lee, CPA Principal - Tax

Jonathan Louie, CPA, MST Senior Manager - Tax

Tax planning is important to the success of your business and as experts, we provide the best tax planning strategies to help minimize tax impact and boost your cash flow. As all real estate businesses rely heavily on capital investment, our professional team has in-depth knowledge on various tax strategies to help you achieve your goals: • • • • • •

Federal and State Tax Compliance and Consulting Cost Segregation Studies and Consulting Green Energy Tax Credit Consulting (45L & 179D) 1031 Exchange Consulting & Compliance Delaware Statutory Trust (DST) Opportunity Zones

Advisory and Consulting Services

​​E lvira Frencillo, CPA Manager - Tax

Philip Clark, CFP®

Besides tax planning, having accurate and timely financial data is crucial for business owners to make smart and sensible business decisions. Our professional team has the necessary skills to help analyze your business' financial situation and develop internal controls to safeguard your assets.

• • • • •

Financial Reporting Internal Control Financial Modeling Audits, Reviews, and Compilations Transaction Due Diligence and Structuring

Director - Wealth Management Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory Services SM. Placing business through Avantax Insurance AgencySM and Avantax Insurance ServicesSM CA# 0M36260.

“The experienced, multi-disciplined teams at KROST can provide services for very specific needs relating to real estate, as well as a holistic approach to tackling multiple challenges as a true partner in the development of your business.”

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CHALLENGES FACING THE REAL ESTATE INDUSTRY IN THE WAKE OF COVID & THE ELECTION

By So Sum Lee, CPA | Principal - Tax

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t’s no question that the economy as a whole was (and continues to be) stressed by the COVID-19 pandemic. Now with the coming election, more uncertainties could be on the horizon. 2020 is shaping up to be one of the most unique and challenging times in recent history. Unfortunately, the real estate industry was not spared this year with accumulating hurdles due to new regulations, changes in consumer demands, and state-specific legislation.

TEMPORARY EVICTION BAN PUTS CASHFLOW STRAIN ON CALIFORNIA LANDLORDS In August, Governor Newsom signed legislation to protect tenants from eviction and property owners from foreclosure due to unpaid rent or mortgage as a result of hardships faced related to COVID-19. While the new law brings welcome relief to tenants, landlords are now faced with resulting cashflow issues that extend into 2021 because of the statewide ban on evictions. Specifically, no tenant can be evicted before February 1, 2021, for rent owed in the event of COVID-19 related financial constraints accrued between March 4 – August 31, 2020, as long as the tenant provides a declaration of said hardship in accordance with the legislation. Additionally, tenants who are unable to pay rent between September 1, 2020 – January 31, 2021, must pay at least 25 percent of rent due to avoid eviction.

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"The National Home Builders Association believes that the pandemic has caused a lack of inventory, as new homes are not being developed at a rate to meet demand."

The legislation creates a ripple effect for landlords who may be in dire need of increased cashflow due to hardships of their own during this time. Specifically, landlords will still be tasked with maintaining water, repairs, insurance, taxes, and mortgage payments on their properties.

COVID-19 PROTOCOLS CREATE CONSTRUCTION DELAYS THAT VARY BY CITY AND STATE While Homeland Security deemed construction an essential service, many local governments imposed varying degrees of delays, closures, and increased safety protocols upon the industry. Many Californian municipalities adopted restrictive guidelines, impacting some geographic areas and types of construction projects differently.

For example, California faced major delays in affordable housing developments. The inconsistent regulations by city and state not only has made it difficult for construction companies to stay on top of rapidly changing regulations, but it has also increased costs across the board to comply with requirements for social distancing and personal protective equipment needs to mitigate health risks at job sites.

BUILDERS & DEVELOPERS STRUGGLE TO GET FINANCING WITH RIPPLE EFFECT FOR HOMEBUYERS As lenders become more risk-averse as a result of the pandemic and economic uncertainties, builders have had an increasingly difficult time securing financing for projects. This financing issue could have a ripple effect on home buyers and the market’s return to better days, as many suggest that housing is a significant factor in economic recovery. According to Barrons, the National Home Builders Association believes that the pandemic has caused a lack of inventory, as new homes are not being developed at a rate to meet demand. This, in turn, has driven up home prices.

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OTHER CHALLENGES ON THE HORIZON As we embark on the next election, it would be remiss not to mention the impact of this political outcome on the industry. While we do not have a strict outline of the incumbent’s platform, many suspect much of the same going into a second term, which overall would appear beneficial to the real estate sector. However, we cannot know for sure without a platform guideline.

Democratic candidate Joe Biden has included several changes to current tax and financial policies in his platform outline, including a repeal of Like-kind Exchange (1031 Exchange). This tax strategy allows real estate investors to avoid capital gains when profits are used or “exchanged” for the purchase of new property of equal or greater value (see page 7 for more information). While presidential hopeful, Joe Biden, has considered a repeal as a means to improve the budget in light of the pandemic, the change would likely impact the real estate industry and is worth noting.

"Outside of politics, there’s been an overall reduced demand for commercial real estate spaces, as Americans shift to a work from home environment."

Outside of politics, there’s been an overall reduced demand for commercial real estate spaces, as Americans shift to a work from home environment.

In addition to business space, retail is experiencing a shift away from brick and mortar, as people remain quarantined and opt for e-commerce options.

This is not the first time, nor will it be the last time, this industry has had to weather an economic storm, but this unique environment is pressuring the real estate industry to pivot quickly. There are business strategies that can be employed to lessen the blow some of these challenges have presented this year. KROST offers business consulting specific to the real estate industry to determine what opportunities could be leveraged in these situations. 

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CONTACT SO SUM 

A DEEPER DIVE INTO THE UNINTENDED CONSEQUENCES OF THE PROPOSED SECTION 1031 REGULATIONS Jonathan Louie, CPA, MST Senior Manager - Tax

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n 2017, the Tax Cuts and Jobs Act (TCJA) amended Internal Revenue Code (IRC) Section 1031 to limit nonrecognition treatment to exchanges of real property for 1031 Exchanges completed after December 31, 2017. The current Section 1031 Regulations do not provide a definition as to what constitutes real property, but instead provides guidance as to what property is “like-kind.” On June 12, 2020, the IRS issued Proposed Regulations 1.1031(a)-3 (REG-117589-18) for Section 1031 to include a definition of real property in response to the TCJA’s statutory changes that limited 1031 exchanges to real property. For many taxpayers, these Proposed Regulations will be a welcome addition as they help to provide clarity for defining “real property” in 1031 exchanges. However, if these Proposed Regulations are finalized as they currently stand, they may cause many unintended consequences for taxpayers.

When the TCJA was passed, Congress specifically noted in Footnote 726 of the Committee Report that, “it is intended that real property eligible for like-kind exchange treatment under present law will continue to be eligible for like-kind exchange treatment under the provision.” These changes in the current Proposed Regulations are inconsistent with Congressional intent, and if unaltered, could place a significant compliance burden and result in an increase in taxable income for taxpayers involved in 1031 exchanges.

The Proposed Regulations require that the function of a distinct asset that is not machinery be considered in determining whether the asset is real property for the purposes of Section 1031. The Proposed Regulations provide that property that is machinery or equipment is not an inherently permanent structure and therefore, is not real property under Section 1031 with one exception. If an inherently permanent structure such as a building includes machinery as a structural component, the Proposed Regulations clarify that the machinery may be considered real property. The machinery must serve the permanent structure and it cannot produce or contribute to the production of income other than for the use or occupancy of space. For assets that are interconnected and work together to serve an inherently permanent structure, the assets should be analyzed together as one distinct asset component.

GAS LINE EXAMPLE The Proposed Regulations provide an example of a gas line in which real property is separated from personal property based on its use, instead of its physical nature or character. The example indicates that a gas line installed for servicing the building is treated as real property, whereas a gas line installed to service a restaurant within the building is treated as personal property since it contributes to the production of income. The Proposed Regulations 1.1031(a)-3(a)(2)(iii)(A) and (B) define a structural component as being a “constituent part of, and integrated into, an inherently permanent structure.” Based KROST QUARTERLY VOL. 3 ISSUE 3 - THE REAL ESTATE ISSUE

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on this definition, and contrary to the conclusion reached in the Proposed Regulations, both gas lines should be considered real property regardless of whether they are used to heat the restaurant oven or the building furnace. Both gas lines contain the same physical characteristics and are permanently affixed to the structure. In CCA 201238027, the IRS previously determined that a pipeline that was characterized differently amongst two states was determined to be real property regardless of state law characterization because it had the same physical characteristics.

The conclusion reached in the gas line example provided in the Proposed Regulations seems to contradict what the Proposed Regulations define as a structural component, as well as the determination made previously by the Chief Counsel Advice (CCA). Prior to the Proposed Regulations, the gas line servicing the restaurant oven would have been considered real property based on legislative history. The Proposed Regulations now define the gas line for the oven as personal property and not eligible for like-kind exchange. If the underlying building is acquired in a 1031 exchange, the gas line servicing the oven would be considered incidental personal property and taxable as boot to the taxpayer. If a taxpayer sold a property in a 1031 exchange that included the gas line for the oven, then the gas line would need to be carved out and disposed of separately from the exchange as a sale of personal property. The taxpayer would recognize gain resulting from depreciation recapture on the gas line.

100% BONUS DEPRECIATION The Proposed Regulations point out that 100% bonus depreciation can be claimed on any incidental personal property acquired with replacement property in an exchange, in order to alleviate the tax burden placed on taxpayers resulting from the depreciation recapture on the disposal of the relinquished personal property. While claiming bonus depreciation on personal property carved out from the replacement property is beneficial, the Proposed Regulations fail to specify that many states do not conform to the federal bonus depreciation provisions. Hence, taxpayers in those states will have to report depreciation recapture on their state tax returns and will not be able to take bonus depreciation on the incidental personal property received in the exchange to offset the state tax burden. Furthermore, the 100% bonus depreciation provision will expire after 2022, increasing the tax burden for taxpayers and rendering the IRS’s point obsolete in the long run. For many taxpayers who engage in a 1031 exchange that spans multiple years, a timing difference may exist. The taxpayer would have to recognize depreciation recapture in the first year when the relinquished property is sold, and would not be able to claim bonus depreciation on the incidental personal property until it is received and placed in service in the second year. This timing difference would place a significant cash flow burden on taxpayers who would have to pay the tax in year one and wait to claim the benefits of any bonus depreciation on the following year’s tax return.

FEDERAL VS. STATE Another important issue that may be overlooked is the increased complexity that would be added if the Proposed Regulations are finalized. The IRS has historically included state law as one of the factors considered in determining whether a property is real property for the purposes of Section 1031. The Proposed Regulations ignore decades of precedent in favor of eliminating state case law as a factor in addressing the nature of property in a 1031 exchange. If enacted, then 1031 exchanges for federal and state purposes would look completely different. The amount of real property in federal 1031 8

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exchanges would likely be lower than the amount of real property reported on state tax returns, resulting in a substantial increase in the complexities of reporting these exchanges on a taxpayer’s tax return.

NEW PROVISION TO THE PROPOSED REGULATIONS The Proposed Regulations include a new provision addressing the treatment of a taxpayer’s receipt of personal property that is incidental to the taxpayer’s replacement real property received in a 1031 exchange.

The provision requires that personal property must be:

1.

Incidental to the real replacement property,

2.

That it has an aggregate fair market value of no more than 15% of the fair market value of the real estate, and

3.

That it must be typically transferred with the real property in standard commercial transactions.

This new rule, if not satisfied, can potentially disqualify certain 1031 exchanges if the incidental personal property received with the replacement property exceeds 15% of the entire property’s fair market value. If the IRS’ intent is to provide certainty as to what happens when true personal property is included in an exchange, then the language in the Proposed Regulations should be modified to clarify that any incidental non-like-kind property received in an exchange is treated as taxable boot rather than implementing a rule to disqualify the exchange if it isn’t met. Another alternative would be for the IRS to clarify that the 15% threshold is a safe harbor, so that acquisition of incidental personal property valued in excess of 15% of the real property will not disqualify the exchange and cause the sale of the relinquished property to become fully taxable. If the Proposed Regulations are finalized, then the 15% incidental property rule will place a burden on taxpayers, as they will need to have a valuation prepared for every property involved in an exchange in order to confirm that the incidental rule is satisfied and validate the non-taxable nature of the exchange.

If left unchanged, the Proposed Regulations will have an adverse effect on taxpayers by potentially increasing their taxable income when executing 1031 exchanges and placing a burden on them to have to identify these individual building components for both the relinquished and replacement properties in the event of an exchange. It is unreasonable for the IRS to expect taxpayers to be able to quantify these values for 1031 exchange purposes without having to hire a specialist to do it for them. If Congress’ objective was to keep 1031 exchanges the same after the enactment of the TCJA, then these Proposed Regulations and the potential increase in taxes, disqualifications, and CONTACT JON  taxpayer burden that could result are certainly not in line with the original intent.  KROST QUARTERLY VOL. 3 ISSUE 3 - THE REAL ESTATE ISSUE

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OPPORTUNITY ZONES AND COST SEGREGATION Guest Contributor: Artur Babaian

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pportunity Zones are garnering increased interest across the country. Created by the Tax Cuts and Jobs Act (TCJA) in December 2017, taxpayers who meet the requirements for investing in an Opportunity Zone can potentially defer taxable gain on their current year gain and eliminate any gain on the new Opportunity Zone investment.

Deferring gain into an Opportunity Zone investment differs from a 1031 exchange deferral, which is familiar to most real estate investors. The 1031 exchange is limited to like-kind real estate and requires the entire sales proceeds to be reinvested into the likekind replacement property. Any sales proceeds not reinvested create taxable gain. Alternatively, capital gain from the sale of any capital asset can be deferred by investing the amount of the gain into an Opportunity Zone investment. Sales proceeds equal to the basis in the capital asset sold can be retained by the taxpayer tax-free.

INSIGHT: Capital gains are deferred if a 1031 exchange is completed successfully.

The basis in the replacement property is reduced by the gain deferred, reducing future depreciation deductions. Any gain realized in the new property, in addition to the gain deferred from the initial property, is taxable in the year the new property is sold.

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In a Qualified Opportunity Fund, there are three tax incentives for reinvesting capital gains which are significantly different than the 1031 exchange incentives:

1.

Recognition of capital gains are deferred until the Qualified Opportunity Fund is sold or exchanged or December 31, 2026, whichever occurs earliest.

2.

If the Qualified Opportunity Fund is held for at least five years, then the basis in the investment is increased by 10% of the amount of gain deferred.

3.

If the Qualified Opportunity Fund is held for at least 10 years, then there is no gain recognized on any appreciation in the Qualified Opportunity Fund (over and above the invested capital gains).

In addition to the tax incentives relating to the gain deferral and elimination, a cost segregation study can be used to accelerate the depreciation deductions on an asset by moving costs to shorter recovery periods.

The benefit of performing a study is that it reduces taxable income in the first years of the life of the property, which frees up cash flow immediately. If the Opportunity Zone investment property is held for at least 10 years, then the increased deductions in the first years become permanent since any decrease in basis from the depreciation realized will be added back to basis.

INSIGHT: The cost segregation technique in its current form is based on the tax court case, “Hospital Corporation of America v. Commissioner, 109 T.C 21,” decided in 1997. In 2017, the tax reform changes (TCJA) made cost segregation studies more valuable than before. Under the new law, any building components with a tax recovery period of 20 years or less are eligible for 100% bonus depreciation. These components can be easily identified with the help of a cost degregation study.

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A Qualified Opportunity Fund is, commonly, an investment vehicle that is organized as a corporation or a partnership for the purpose of investing in a Qualified Opportunity Zone property and which holds at least 90% of its assets in a Qualified Opportunity Zone property.

Qualified Opportunity Funds, which only reinvest the investor’s capital gains, typically cannot benefit from cost segregation. This is because in a partnership, the taxpayer’s initial basis is zero. If the basis remains zero, then the losses from a cost segregation study cannot be used. However, a taxpayer can benefit from a cost segregation study if there is debt and/or any additional (non-Opportunity Zone) investment on top of the capital gains. Understanding the nuances of each type of debt is critical. Investors who utilize either recourse and/

"Investors who utilize either recourse and/or qualified non-recourse debt can potentially benefit from the cost segregation study as they may have increased basis."

or qualified non-recourse debt can potentially benefit from the cost segregation study as they may have increased basis. Investors and professionals involved with real estate are aware that development projects generally have significant debt. Thus, most Opportunity Zone investors can benefit from adding cost segregation to their tax planning.

The Opportunity Zone rules only apply for Federal tax purposes; therefore, if a taxpayer purchases a property with no debt, they have no basis for Federal purposes. However, this is not true for state purposes. All income would be taxable, and the entire purchase would have basis for state tax purposes. As a result, a cost segregation study may have significant benefit for state purposes.

There has been a lot of investor interest in Opportunity Zones.

Hence, taxpayers and tax preparers should be aware of how they interact with other tax incentives such as cost segregation. Careful planning is vital to ensure that maximum benefits can be realized.

The KROST team is well versed in the nuances and interactions of 1031 Exchanges, Opportunity Zones, and Cost Segregation. Please feel free to reach out to us if you are in a position to utilize any of these LEARN MORE  strategies. 

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QUALIFIED IMPROVEMENT PROPERTY (QIP) TECHNICAL CORRECTION AND BONUS DEPRECIATION

By Elvira Frencillo, CPA | Manager - Tax

By So Sum Lee, CPA | Principal - Tax

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he coronavirus has turned the world upside down. It has cost so many lives and caused agony to individuals and businesses.

To help stimulate the economy and U.S. citizens and business to get over this devastating pandemic, the “Coronavirus Aid, Relief, and Economic Security Act” (CARES Act) was enacted in March 2020, providing many tax provisions that favor taxpayers. Within the CARES Act is the long-waited technical correction related to Qualified Improvement Property (QIP).

BACKGROUND Historically, building improvement had a long useful life for depreciation purposes. Commercial real estate is depreciated over 39 years on a straight-line basis. Therefore, it takes years for businesses to recover their investment. To help stimulate the real estate sector after September 11, 2001, Congress put in place various provisions that allowed certain qualified real property to be depreciated over 15 years instead of 39 years. Furthermore, certain real property also qualified for bonus deprecation, which allowed businesses to fully depreciate such property in the placed-in-service year.

The Tax Cuts and Jobs Act (TCJA) enacted in 2017, consolidated the three categories of real property into what is now called Qualified Improvement Property (QIP): qualified leasehold improvements, qualified retail improvements, and qualified restaurant property. QIP is defined as any improvement made by the taxpayer to an interior portion of a building that is nonresidential real property as long as that improvement is placed in service after the building was first placed in service by any taxpayer. Qualified improvement property specifically excludes expenditures for (1) the enlargement of the building; (2) elevators or escalators; and (3) the internal structural framework of a building.

The introduction of QIP is meant to simplify and streamline the various provisions introduced throughout the years while KROST QUARTERLY VOL. 3 ISSUE 3 - THE REAL ESTATE ISSUE

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maintaining the same benefits that have been provided to taxpayers. However, the TCJA was written in such a hurry that a major oversight caused qualified improvement property, to be depreciated over 39 years instead of 15 years as intended

by Congress. Such oversight also caused qualified improvement property to be ineligible for bonus depreciation. We have been waiting for technical corrections on this issue ever since TCJA came out.

BONUS DEPRECIATION In 2002, Congress enacted bonus depreciation through the Job Creation and Worker Assistance Act as a tax incentive measure to stimulate the economy. Bonus depreciation is a method of accelerated depreciation that allows businesses to deduct the cost of an eligible property in the first-year of service. Depreciable business assets with a recovery period of 20 years or less and other types of property are generally eligible. For example, machinery, equipment, computers, appliances, and furniture generally qualify.

As time goes by, the rules and limits for bonus depreciation continue to change. The Tax Cuts and Jobs Act (TCJA) of 2017 made favorable changes to bonus depreciation that impacted all industries, including real estate.

The major changes are:

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Increased first-year depreciation deduction from 50% to 100% for eligible property acquired and placed in service after September 27, 2017 and before January 1, 2023.

•

Available not only to new assets but was also expanded to include used qualified property that meets the following requirements: Ê

The taxpayer or its predecessor didn’t use the property at any time before acquiring it.

Ê

The taxpayer didn’t acquire the property from a related party.

Ê

The taxpayer didn’t acquire the property from a component member of a controlled group of corporations.

Ê

The taxpayer’s basis of the used property purchased is not figured in whole or in part by reference to the seller or transferor’s adjusted basis.

Ê

The taxpayer’s basis of the used property is not figured under the provision for deciding basis of property acquired from a decedent.

Ê

The cost of the used property eligible for bonus depreciation doesn’t include the basis of property determined by reference to the basis of other property held at any time by the taxpayer (for example, in a like‐kind exchange or involuntary conversion).

•

The law added certain film, television, and live theatrical productions as types of qualified property that may be eligible for 100% bonus depreciation.

•

The 100% bonus depreciation is also allowed for specified plants planted or grafted after September 27, 2017 and extended to before January 1, 2027.

•

The 100% bonus depreciation will decrease by 20% per each taxable year beginning after 2022 and expires January 1, 2027.

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TECHNICAL CORRECTION ON QIP UNDER CARES ACT The CARES Act provides a $2 trillion support relief package to help stabilize the American economy. Within the Act is the technical correction to the QIP provision, which designates qualified improvement property as 15-year property for depreciation purposes. As such, QIP is eligible for 100% bonus depreciation treatment. More importantly, this correction is retroactive for property placed in service after December 31, 2017.

To help taxpayers implement the change, the IRS released Rev. Proc. 2020-25, allowing taxpayers to file a change of accounting method using Form 3115 with the current year of income tax return filing to catch up on the missed depreciation on qualified improvement property. Alternatively, taxpayers can amend 2018 returns (and possibly 2019 returns if the 2019 returns have been filed) to claim the missed deduction.

INSIGHT: The CARES Act also provides a special five-year net operating loss carryback. This provision allows net operating losses (NOLs) generated in tax years beginning after December 31, 2017, and before January 1, 2021 to be carried back five years. Hence, if the catch-up depreciation deduction created a net operating loss, taxpayers can carry the loss back five years. For example, if a taxpayer amended a 2018 tax return to catch up on a missed deduction that resulted in NOLs, they could carry the loss as far back to 2013 to obtain a tax refund on taxes paid in the prior five years. For businesses suffering under COVID, this is a quick way to increase cash flow.

While the pandemic is causing a lot of grief and uncertainty, the technical correction on qualified improvement property is wellreceived. Taxpayers should review their depreciation schedule and discuss with their tax advisor to get the most benefits in a time when it is needed most.  CONTACT ELVIRA 

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ROST

WEALTH

MANAGEMENT

KROST Wealth partners, Inland Private Capital Corporation, provide guidance and services related to Delaware Statutory Trusts (DSTs). For information on DSTs, contact Phil Clark, CFP® at KROST Wealth to set up a meeting with Inland.

NOT SURE WHERE TO FIND REAL ESTATE DIVERSIFICATION?

By Phil Clark, CFP® Director - KROST Wealth Management

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wning property in an investment portfolio provides a complementary source for potential return and income; however, most investors are not professionally trained with robust insights on real estate markets and sectors.

A Delaware Statutory Trust, or DST, is an investment structure in which multiple investors own fractional interests in a single property or portfolio of properties. Investors can gain access to institutional-quality property that may otherwise be out of reach. Using DSTs, investors can allocate assets to one or more DSTs, providing a more diversified real estate portfolio across geographic areas and property types.

DST offerings may be structured as a single property, a single geographic region or a combination of properties in a focused geography. For example, self-storage properties in multiple locations, apartments, medical offices, or a regional-based portfolio of properties.

Beneficial interests in DSTs are considered “like-kind” property for purposes of 1031 exchanges. In order to successfully execute a Section 1031 tax-deferred exchange, the replacement property must be like-kind to the relinquished property.

Any real estate held for productive use in a trade or business or for investment purposes is considered like-kind. A primary residence would not fall into this category; however, vacation homes or rental properties may qualify.

Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM. Placing business through Avantax Insurance AgencySM and Avantax Insurance ServicesSM CA# 0M36260.

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Inland Private Capital Corporation, is recognized as the industry leader in 1031 exchange transactions.* *Source: Mountain Dell Consulting

6.72%

Weighted Average Annualized Rate of Return on Full-Cycle Programs**

Results by Asset Class Multifamily Number of programs

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Cumulative Sales Price

$815,706,108

Weighted Avg. ARR

8.04%

Retail 45

Office 14

$646,678,911 $402,664,165 6.3%

4.47%

Student Housing

Industrial

Healthcare

1

7

1

$81,721,250

$118,170,041

$45,775,000

10.62%

5.98%

11.23%

**Explanation of Terms & Calculations

Full-Cycle Programs are those programs that no longer own any assets. However, in certain limited situations in which the subject property(ies) were in foreclosure, IPC has negotiated with the lenders and advanced funds to the investors to allow the investors to exchange their beneficial interest in the original program for a proportionate beneficial interest in a new program, in order to continue their Section 1031 exchanges and avoid potential capital gains and/or forgiveness of debt tax liabilities. Because such exchanges result in an investment continuation, the original programs are not considered full-cycle programs for these purposes.

Weighted Average Annualized Rate of Return (ARR) For each full-cycle program, the ARR is calculated as the sum of total cash flows distributed during the term of the investment program, plus any profit or loss on the initial offering price, divided by the investment period for that program. To determine the weighted average for all programs, the ARR for each program is Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM. Placing business through Avantax Insurance AgencySM and Avantax Insurance ServicesSM CA# 0M36260.

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multiplied by the capital invested in that program, divided by the total capital invested in all full-cycle programs since inception (2001). To determine the weighted average in each asset class, the ARR for each program within that asset class is multiplied by the capital invested in that program, divided by the total capital invested in all full-cycle programs within that asset class since inception (2001). For a full list of program dispositions, see “Prior Performance of IPC Affiliates” set forth in the applicable Private Placement Memorandum. 

This article is neither an offer to sell nor a solicitation of an offer to buy any security which can be made only by a prospectus, or offering memorandum, which has been filed or registered with appropriate state and federal regulatory agencies, and sold only by broker dealers and registered investment advisors authorized to do so.

These investments are suitable for accredited investors only.

Additionally, we cannot offer any of our open offerings unless we have a pre-existing relationship with a customer. Once we have obtained sufficient information to perform an evaluation of our new customers’ financial circumstances and sophistication in determining his or her status as an accredited investor, we would be able to discuss future offerings once they become available.

This is a brief and general description of certain 1031/DST guidelines.

Prospective investors should consult with their own tax advisor.

The actual amount and timing of distributions is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital.

Investments in real estate are subject to varying degrees of risk, including, among other things, local conditions such as oversupply of space or reduced demand for properties, an inability to collect rent, vacancies, inflation and other increases in operating costs, adverse changes in laws and regulations applicable to owners of real estate and changing market demographics.

Changes in tax laws may occur and may adversely affect an investor’s ability to defer capital gains tax and may result in immediate penalties.

CONTACT PHIL 

Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM. Placing business through Avantax Insurance AgencySM and Avantax Insurance ServicesSM CA# 0M36260.

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KROST QUARTERLY VOL. 3 ISSUE 3 - THE REAL ESTATE ISSUE

GOING GREEN FOR THE GREEN: FEDERAL TAX INCENTIVES FOR ENERGY EFFICIENT BUILDING

By So Sum Lee, CPA | Principal - Tax

There are several tax incentives available to the real estate industry. Whether you invest in, build, design, or make significant renovations to real estate, a closer look at these opportunities could increase cash flow and/or reduce tax burden. Most are familiar with Cost Segregation, but may reap the benefits of other unique incentives that are lesser known.

Early this year, two valuable provisions were extended by Congress through 2020: Sections §45L and §179D. While the benefits can be retroactively claimed if missed on previous tax returns, many miss out on the credit or deduction due to the temporary nature of the provisions. Each year, real estate professionals anxiously await Congress’ decision to extend these temporary incentives. Even though these extenders make it difficult for tax planners, their value is what drives real estate developers, builders, and architects to seek out the benefit year after year. Here’s why.

"Even though these extenders make it difficult for tax planners, their value is what drives real estate developers, builders, and architects to seek out the benefit year after year."

$2,000 PER QUALIFIED DWELLING UNIT: 45L TAX CREDIT FOR RESIDENTIAL REAL ESTATE Offering $2,000 per qualified dwelling unit, this federal tax incentive creates huge returns for homebuilders and multi-family developers. Apartments, condos, affordable housing (LIHTC), assisted living facilities, residential condos, student housing, and production homes are great candidates for the credit, but must provide a certain level of heating and cooling in order to qualify. Buildings must also be three stories or less above grade in height. Reconstruction and rehabilitation for improved “green building” standards that decrease energy consumption should also be assessed for possible benefits as well. There

are no minimum or maximum requirements for number of units, as long as each unit meets the Section 45L requirements. In order to substantiate the credit, a third-party study is typically performed. Any unused credits can be carried back back one year or forward for up to twenty years.

EXAMPLE: An apartment building with 50 units that meet requirements under Section 45L will get a credit equals $100,000 ($2,000 x 50 units).

WHAT ABOUT COMMERCIAL REAL ESTATE? Section 179D is a federal deduction offering up to $1.80 per square foot on energy-efficient lighting, HVAC systems, and building envelopes. Building owners of both commercial or residential spaces, tenants who make significant improvements, architects, and designers of government-owned buildings can benefit from this deduction. Any projects aimed at reducing energy and power costs, such a as lighting retrofits, should be reviewed for possible eligibility.

EXAMPLE: A building with 100,000 sq. ft. that meets that energy-efficiency requirement will get a deduction equals $180,000 ($1.80 x 100,000 sq. ft.). At a 37% tax rate, this deduction translates to a tax savings of $66,600.

CLAIMING 45L AND 179D The IRS requires that taxpayers substantiate these benefits with a third-party provider that will perform a supporting study. The study involves a detailed engineering analysis that will require a site visit to review qualified units and energy improvements. A tax preparer can assist with the coordination of the study, and ensure that any missed benefits are retroactively claimed. 

LEARN MORE

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So Sum Lee, CPA

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K R O S T C PA S . C O M

KROST QUARTERLY MAGAZINE

For over 80 years, KROST has assisted businesses and individuals to reach their financial goals through their in-depth knowledge of Tax, Accounting, Assurance and Advisory, M&A, and Wealth Management Services. KROST also provides specialty tax services such as Cost Segregation Studies, R&D Tax Credits, Transfer Pricing, Green Building Tax Incentives, Repair vs. Capitalization, Fixed Asset, IC-DISC, and more.

Pasadena • Woodland Hills West Los Angeles Phone: (626) 449-4225 Fax: (626) 449-4471 KROSTCPAs.com