By Mark B. Rubin, senior managing director, FTI Consulting
2014 was an odd year to understand the impact of taxes on businesses, in particular for those connected to the real estate industry.
There have not only been a number of tax laws enacted over the past couple of years, there have been multiple changes to the current tax regime.
Last but not least, a tax bill was signed in December which saved multiple valuable tax breaks, but for only one more year.
On December 16, 2014, Congress saved many tax breaks that had expired at the end of 2013, and it was uncertain whether they would be extended for 2014.
After House and Senate approval, President Obama signed the “Tax Increase Prevention Act of 2014” into law.
Yes, you are reading this correctly — these tax provisions can impact transactions that were entered into earlier this year. Here are some of the more notable extensions:
• 50 percent Bonus Depreciation on qualified property placed in service in 2014 remains available, as well as accelerated depreciation of qualified leasehold improvements, allowing taxpayers to deduct 50 percent of the basis of the property.
• Qualified leasehold improvements also will continue to be eligible for a 15 year depreciable life instead of a 39 year life. The same eligibility applies to qualified retail and restaurant property.
• The reduction of the recognition period from 10 years to 5 years for built-in gains of S corporations which had converted from a C corporation will be continued through 2014.
Section 179 limit increases were extended through 2014. Under the extension, a taxpayer may deduct up to $500,000 of qualifying business property provided total investment during the year did not exceed $2 million. Eligible taxpayers may also deduct $250,000 of qualified leasehold improvements.
• Distributions from an Individual Retirement Account (IRA) directly to a charity are still favorably treated as exempt from taxation under certain circumstances.
• Two credits have been extended into 2014: the low income housing tax credit for new non-Federally subsidized projects and the residential energy efficiency improvements credit. The tax deduction for commercial energy efficiency improvements has also been extended.
In terms of getting used to understanding recently enacted tax laws, 2013 was the first year that the Net Investment Income (NII) Tax was assessed, so the impact was not obvious until 2014.
The Net Investment Income Tax is a 3.8 percent tax on interest, dividends, capital gains, rental and royalty income, passive income, and some non-qualified dividends, after expenses. One of the nuances of the tax is that certain expenses which do not benefit taxpayers subject to Alternative Minimum Tax (AMT) are still available to reduce the NII Tax.
Perhaps of most significance is that taxpayers who meet the stringent requirements of being Real Estate Professionals are not subject to the NII Tax on their earnings from their Rental Real Estate activities.
Careful planning and making appropriate elections need to be considered to qualify under this potentially valuable exception to the NII Tax.
Other changes occurred in 2014 to keep in mind. One is the newly-resuscitated “Pease” provision which limits itemized deductions taken by taxpayers with an adjusted gross income above a certain threshold (over $254,200 for individuals, $305,050 for joint filers).
Further, for anyone with adjusted gross income over a threshold amount ($254,200 for individuals, $305,050 if filing jointly), personal exemptions are reduced and phase out completely at $376,700 for individuals and $427,550 for taxpayers filing jointly.
Significant changes have also been enacted to the New York State estate tax that residents should be aware of.
First, the permitted exemption amount from estate tax in New York increased from just over $1,000,000 to $2,062,500 for the estates of decedents dying on or after April 1, 2014 and will be increased each year to match the Federal Estate Tax exemption by 2019 (currently $5,340,000).
Although this sounds like a benefit for NY decedents, there are numerous “devils in the details” which, under certain circumstances could cause significant tax increases at certain levels.
Complicating estate planning further, New York will also begin to include certain gifts made between April 1, 2014 and January 1, 2019 as part of the base for the calculation of the estate tax. New York does not allow so-called “portability” of the amount exempt from estate tax between spouses, either.
The lack of portability in New York means that whatever amount of the exemption does not get used by the predeceased spouse’s estate is simply gone. Ultimately, the best advice is to review wills and other estate planning documents with these changes in mind.
All of these tax law changes can dramatically affect your short and long term economics. Make sure to connect with your tax advisor and plan ahead – 2015 will no doubt be another wild ride.