As the market rebounds from the COVID-19 pandemic, builders, buyers and owners of real estate may be able to reduce their tax bills with these credits and tax planning strategies.
By James Su, Managing Director, Tax
The Covid-19 pandemic continues to deliver unpredictable impacts on U.S. markets, commercial real estate included. According to Forbes magazine, in 2020, about one billion hotel room nights were left unsold due to travel restrictions. Foot traffic was down 70% at shopping malls on Black Friday 2020. Because of the rise in online shopping and remote work, demand for office property is down, while warehouses are in greater demand.
But one thing we can rely upon, for good or for ill, is taxes. This article provides an overview of some credits and strategies that can ease the commercial real estate (CRE) business’s tax burden.
Since the passage of the Energy Policy Act of 2005, many tax incentives have been focused on incorporating green energy technologies in the construction or renovation of commercial buildings. The Commercial Buildings Energy-Efficiency Tax Deduction (Section 179D), created under the 2005 act, provides up to $1.80 per square foot in a tax deduction for construction or renovation of commercial properties that demonstrate energy efficiencies in lighting systems, building envelope, heating ventilation and air conditioning (HVAC) systems, and hot water systems. In 2021, Section 179D was made permanent and will be indexed to the rate of inflation going forward.
Newly constructed or installed green energy properties may be eligible for tax breaks under the IRC. Section 48 Investment Tax Credit. This includes the installation of solar panels, geothermal systems, fuel cells, microturbine and small wind installations, and combined heat and power (CHP, also known as co-generation) systems. Newly built single-family or multi-facility residential units or ones with extensive rehabilitation are also eligible for tax credits under the Section 45L Energy Efficient Home Tax Credit program, worth up to $2,000 per dwelling unit. It requires a third-party evaluation to show the unit's heating and cooling power consumption is 50% less than a comparable unit. The 25D Residential Energy Efficient Property Credit also helps offset the cost of green energy systems like solar panels, wind turbines, geothermal heat pumps and now biomass fuel property. However, this credit will expire by 2024.
While the federal Investment Tax Credit (ITC) was initially set at 30% of eligible costs, the credit is being phased out. Projects begun in 2022 are eligible for a 26% credit; projects started in 2023 will receive a 22% credit. Projects that start in 2024 and 2025 would only be eligible for only a 10% tax credit, after which the program sunsets. However, the Biden administration is proposing an extension of the program beyond 2025 and a restoration of the value of credits to 30%.
As an incentive to restore historic buildings and sites and adapt their use, the federal government issues tax credits for the rehabilitation of buildings listed in the National Parks Services’ Register for Historic Places. If a property is not listed in the register, the owner can apply online for designation.
Properties must meet certain criteria to be included in the registry. The property must:
Be associated with important events that have contributed significantly to the broad pattern of our history. Or,
Be associated with the lives of persons significant in our past. Or,
Embody the distinctive characteristics of a type, period, or method of construction; or represent the work of a master; or possess high artistic values; or represent a significant and distinguishable entity whose components may lack individual distinction. Or,
Have yielded, or may be likely to yield, information important in prehistory or history.1
The federal government offers a 20% tax credit for rehabilitation costs to be taken over five years, including the first year of service. An alternative 10% credit for pre-1936 building was available in prior years but has since been eliminated. States, too, often offer a tax incentive for preservation and restoration; 36 states currently offer tax breaks for such buildings. California’s Historic Tax Credit program begins in 2022, with $50 million in credits currently allocated to the program.
There are many ways that valuation studies can return meaningful tax savings when applied to commercial real estate acquisitions. Here are just a few:
For building acquisitions, valuations can improve the purchase price allocation between the land and the building itself. Allocating more of the cost to building improvements and less to land opens the door to increased depreciation deductions.
For hotel purchases, valuation studies can identify intangible assets—workforce, contracts, licenses, management agreements and the like—that are not typically separately identified in a purchase agreement. These intangibles can be amortized for tax purposes or even stricken from the property tax assessment rolls.
Vineyard purchases offer a unique valuation challenge and opportunity. Land used to grow vines cannot be depreciated as an expense. However, vineyards associated with a particular American Viticultural Area (AVA) can possess hidden intangible value. The AVA designation can be treated like a trademark, an intangible asset that can be amortized and deducted over time. A valuation study can carve out the intangible value from the underlying land value, offering significant tax benefits.
Valuation studies, along with property tax classification schedules, can also be used to identify costs associated with construction rework and repair costs that could be treated as non-assessable for property tax reporting.
Housing and New Market tax credits
The Federal government has also established a pair of tax credits explicitly designed to spur the development of low-income dwellings or investments into disadvantaged communities. They are the Low-Income Housing Tax Credit (LIHTC) and the New Market Tax Credit Program (NMTC).
The LIHTC helps developers finance the construction or substantial renovation of residential units (single-family homes, apartment buildings, duplexes) by attracting private investors. It is a federal credit administered at the state level, requiring developers to promise that a percentage of units will have tenants earning less than 50% of the Area Median Income (AMI). There is also a gross rent requirement that states these tenants' rent is less than 30% of their income. The landlord must keep this rate for at least 15 years. Private investors who back these projects get a dollar-for-dollar credit they can use over 10 years on their federal income taxes.
The NMTC program is intended to help stimulate the development of commercial and industrial properties in economically distressed areas by making Federal tax credits available to developers. The U.S. Treasury Department's Community Development Financial Institutions Fund (CDFI Fund) requires developers to apply for the credit from a Community Development Entity (CDE). The credit works out to 39% of the investment, paid out over seven years. Projects need to be located in a designated low-income community, but the structure can house a variety of businesses, including manufacturing, retail, technology, education and healthcare.
Don’t Miss Out on Opportunities to Claim Tax Credits for Commercial Real Estate
BPM’s tax and valuation professionals have the knowledge and experience help real estate businesses navigate the many tax planning opportunities available to them. Contact James Su, Managing Director in our Tax practice, today to see how our teams can help you identify the best tax solution for your particular needs.