By Shelly B. LaGroue, CPA, and C. William Barnhill, CCIM
In the wee hours of Jan. 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 and the tax changes that resulted will drastically alter the way commercial real estate professionals plan for major transactions. Additionally, tax provisions written into the Patient Protection and Affordable Care Act, which went into effect Jan. 1, 2013, will affect some taxpayers’ real estate decisions. This synopsis focuses on the impact of ATRA and the Affordable Care Act on real estate-related tax issues.
Tax Rates
For most taxpayers, ATRA makes permanent the individual income tax brackets and capital gains and dividends rates that were previously in place. Ordinary income tax rates remain the same and the tax rate on capital gains and dividends for most taxpayers stays at 15 percent.
Individuals and married couples with adjusted gross incomes greater than $400,000 and $450,000 respectively will be subject to a top marginal rate of 39.6 percent on ordinary income and 20 percent tax rate on capital gains and dividends.
Depreciation Changes
From a business standpoint, ATRA extends several popular tax breaks that relate to real estate, most notably, the 50 percent bonus depreciation allowance under Internal Revenue Code Section 168(k) for qualified property acquired and placed in service prior to Jan. 1, 2014 (Jan. 1, 2015, for certain longer-lived and transportation property). Qualified property is generally defined as new property with a useful life of less than 20 years, computer software, water utility property, or qualified leasehold improvement property.
ATRA also revives the rule treating qualified leasehold improvements as 15-year property, thus making such property eligible for bonus depreciation. Consult with a certified public accountant or other tax professional for questions regarding what property falls within the Internal Revenue Service’s definition of qualified leasehold improvements.Qualified Leasehold Improvements
Qualified leasehold improvements are depreciated over a 15-year life and are eligible for 50 percent bonus depreciation. Qualified leasehold improvements are defined as any improvement to an interior portion of a building that is nonresidential real property if the improvement is made pursuant to a lease (generally) by the lessee (or any sublessee), and the improvement is placed in service more than three years after the date the building was first placed in service. Certain improvements are not included, such as any improvement that enlarges the building, adds an elevator or escalator, or adds any structural component benefiting a common area or the internal structural framework of the building. This can be a significant benefit to landlords making improvements under long-term leases.
Section 179 Expensing
ATRA also retroactively increases IRC Section 179 maximum expensing amounts for 2012 from $139,000 to $500,000. Effective for 2013, ATRA increases the Section 179 maximum expensing amount from $25,000 to $500,000. After 2013, the maximum expensing amount is again scheduled to drop to $25,000. This opens a window of opportunity for substantial write-offs during 2013 for certain equipment associated with the development of real estate.
The expansion of benefits under Section 179 is good news for businesses and individuals who invest in personal property. However, Section 179 applies only to personal property and qualified real property, such as qualified leasehold improvements, qualified restaurant property, and qualified retail improvement properties. Additionally, Section 179 is limited in the case of luxury autos and some SUVs. Another limitation of Section 179 is that it is not allowed on leased property except in very limited instances.
AMT Amounts Permanent
Perhaps the most significant effect ATRA has in regard to the 2012 tax year is that ATRA increases the Alternative Minimum Tax exemptions for all taxpayers on a permanent basis. Previously, Congress would “patch” the AMT problem every year by increasing the AMT exemption for that tax year only. This permanent change will prevent many taxpayers from owing additional tax with their 2012 income tax returns. For 2012, the AMT exemption amount increases from $33,750 to $50,600 for single taxpayers, $45,000 to $78,750 for taxpayers married filing joint returns, and $22,500 to $39,375 for married taxpayers filing separate returns. Going forward, the AMT exemption amounts will be adjusted annually for inflation.
Medicare Contribution Tax
The new 3.8 percent tax imposed by the Affordable Care Act took effect Jan. 1, 2013. This tax applies to taxpayers with AGIs greater than $200,000 if single and $250,000 if married. The tax is imposed on the lesser of the net investment income or the amount of AGI over the threshold limit. Net investment income includes interest income, dividends, rental income, and capital gains on the sale of property, among other types of passive income.
However, the gain on sale of trade or business assets does not qualify as net investment income. Thus, if a taxpayer is actively involved in a trade or business that is sold, the gain on the sale of the business (even if some of the gain is capital) is not subject to the 3.8 percent on investment income. As such, rental income is not considered net investment income if the rents are earned as part of a trade or business activity, and if the taxpayer actively participates in the activity.
Remember that most of these changes affect the 2013 tax year and will not be reflected in this year’s return for 2012. However, some of the “permanent” changes enacted by ATRA are not necessarily permanent if Congress decides to overhaul the entire tax code this year. Given the ongoing fiscal discussions, more changes affecting taxpayers could materialize later this year.
Shelly B. LaGroue, CPA, is a member of the certified public accounting firm Forwood & LaGroue in Mobile, Ala.
This article is designed to provide information in regard to the subject matter and should not be considered accounting, tax, or legal advice.
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