Although it’s already tax filing season, it seems as if tax law changes are still being ironed out. Even with the IRS shutdown, there were funds made available to the IRS agencies tasked with implementing tax reform. As a result, we are seeing new developments on an almost daily basis. Here are a few highlights we would like to share as we begin to file 2018 business tax returns.
QBI Deduction Clarification for Real Estate Ventures
The IRS recently provided eagerly awaited guidance on whether real estate ventures can qualify for the QBI deduction. Remember, the QBI deduction is only allowed if the enterprise is considered a “trade or business”. Whether the activities of a real estate venture are sufficient to be considered participation in a trade or business has always been up for debate.
The IRS has provided a “safe harbor” that real estate ventures can use in order to qualify for the QBI deduction. Under the safe harbor, for tax years beginning prior to 2023, if 250 hours or more of rental services are performed with respect to the rental enterprise, the enterprise may qualify for the QBI deduction. There are strict recordkeeping requirements in order to utilize the safe harbor, and real estate investors will need to consider the complicated aggregation rules in order to determine if an irrevocable grouping election should be made in order to meet the safe harbor requirements.
The guidance also clarifies that triple net leases are specifically exempted from the QBI deduction.
New Audit Rules for Partnerships
The audit rules specific to partnerships have changed dramatically. In prior years a “Tax Matters Partner” was designated to manage the tax affairs of the partnership. Now, partnerships elect a “Personal Representative (PR)”, who is designated on the 2018 tax form. The PR will receive all federal tax correspondence and will have broad authority to bind the members in audit matters. Under the new centralized partnership audit regime, adjustments to partnership-related items are now determined at the partnership level. The tax attributable to those adjustments is also now assessed and collected at the partnership level.
A partnership’s PR may elect the alternative to “push out” the adjustments determined at the partnership level, in which case the tax attributable to the adjustments is assessed and collected from the partnership’s partners. If the election is available and made, newer partners would be protected from partnership tax liabilities from prior tax years. Given the change in the audit rules, we believe it is important for partnerships to thoughtfully consider the PR designation and perhaps adjust their partnership/LLC agreements to account for the changes.
The New Excess Business Loss
There is now another layer of loss limitations under the new tax regime. We have been dealing with passive loss limitations and at-risk loss limitations for years and now have a new limitation to consider for tax years beginning after 12/31/2017 – the limitation on “excess business loss”. An excess business loss for the tax year is the amount by which the total deductions from all trades or businesses exceed a taxpayer’s total gross income and gains from those trades or businesses plus a threshold amount. The threshold amount for a tax year is $500,000 for married individuals filing jointly and $250,000 for others. Excess business losses over these thresholds are carried over as a net operating loss to the following taxable year.
Changes to Section 179
The Section 179 deduction has also experienced some changes under the new regime. For property placed in service in a year beginning after 2017, you can take Section 179 deduction on Qualified Improvement Property (QIP). QIP is any improvement to a nonresidential building’s interior as long as they are NOT attributable to:
- The enlargement of the building
- Any elevator or escalator
- The internal structural framework of the building.
QIP was supposed to receive 15-year treatment and be eligible for 100% bonus depreciation under The Tax Cuts and Jobs Act. Due to a drafting error, QIP has a depreciable life and is NOT eligible for bonus depreciation. Therefore Section 179 is the only option for accelerated depreciation for QIP property.
New for years after 2017, you can also take Section 179 deduction on roofs, HVAC, fire protection systems, alarm systems and security systems for nonresidential buildings.
Please note that Section 179 deduction cannot be taken by an estate or trust. Additionally, for an individual to take a Section 179 deduction, they have to be engaged in the active conduct of the company’s trade or business.
We continue to be mindful of changes that will affect business tax returns and see the need for businesses to lean on their tax advisors more than ever as annual tax decisions are made. Should you want to discuss any of the above, please contact your trusted advisor at Cray, Kaiser Ltd.