RSM US LLP real estate professionals Troy Merkel and Brad Collins discuss the future of tax and technology automation, and how it can help real estate firms scenario plan for numerous consequences such as divestitures or the tax implications of the proposed American Families Plan. Merkel is a senior real estate analyst and audit partner with firm’s national real estate practice and Collins is principal and leader of the firm’s partnership technology services team.
How have tax-focused financial reporting needs of investors and managers changed in recent years?
Merkel: Real estate has always been a tax-advantaged investment class, especially in the United States where rules allow you to shelter income or cash flow through depreciable losses and other mechanisms. Therefore, tax reporting has always been one of the top priorities for any investor, and many real estate investors are very tax-motivated. This is particularly true of some of the equity we have recently seen enter the asset class—from family offices and high net worth individuals.
Investors want deeper insights into all aspects of their investments, including tax. Getting a high-level report on the cash return or internal rate of return is no longer enough. In the last couple of years, we have seen increased demand for transparency that comes with real-time reporting and online dash boarding to provide comprehensive views of an investor’s tax exposure. A greater proportion of investment decision-makers are millennials, and they want the same technology available in their working life that they use in their personal life. They expect to be able to instantly access and analyze data with a simple touch on their mobile device.
How can technology aid tax reporting?
Collins: We focus on their tax reporting pain points when we talk to our clients. I recently spoke to the manager of a multibillion-dollar real estate fund with thousands of investors. They shared how incredibly difficult it was to harness real-time data on the tax performance of their investments. They often field questions from investors about fund performance; requests for estimates of what they should pay in federal, state and local taxes; and what it means for those tax obligations if they make a large investment or divestiture.
Real-time data is important for leadership’s scenario planning. A tax technology platform that provides tax directors and chief financial officers with information needed for their tax compliance is table stakes. The differentiating factor is having tax information at their fingertips when they need it so their business and investors can make better decisions.
When someone from the investment team comes in and asks what buying an asset means for investors from a tax perspective, they can provide an answer. Investors want to know their tax liabilities as quickly as possible to understand the tax effectiveness of their investments.
What does President Biden’s American Families Plan mean for the taxation of real estate investment?
Merkel: Biden’s recently released tax proposal calls for changing the long-term capital gains rate, which is taxed at 20% for investments held for over a year. That could potentially change to mirror the ordinary income tax rate, which for top-end individuals is around 37%. To compound that change, the proposal suggests an increase in that rate to 39.6%. That could have very serious ramifications for the after-tax IRR of long-term investments, and real estate is almost exclusively a long-term investment. Another key aspect of the proposal includes the elimination of 1031 exchanges when the gain realized exceeds $500,000.
Real estate investors want to be able to see long-term projections of how these types of legislative changes might produce potential tax liabilities or benefits. Our technology provides the flexibility to do this by carrying out a technology-enabled multiple scenario analysis. Even as the presidential candidates were on the campaign trail, we had clients calling us to ask: “I heard this announcement from one of the candidates. What does that tax law change mean for me?” And often they are snippets rather than fully-fleshed proposals, so you have to run a lot of different scenarios.
What factors should firms consider when selecting a tax reporting technology platform?
Merkel: When we are advising clients on digital transformation, the biggest problem is often that they went into it without a plan. At various times, they have had pain points and have found individual solutions without a holistic approach. They end up with a digital Frankenstein’s monster with systems that do not integrate. They start Band-Aiding things, using robotic process automation to connect systems that were never intended to work together. The solution is to sit down with an advisor who can look holistically at the business, rather than myopically solving a specific problem.
Collins: Real estate firms must ask themselves whether they want to have all their data in one place with a single-service provider that can give them an end-to-end platform experience. Some advisors use multiple technologies, some off-the-shelf and some home-grown, in order to serve clients. In my view, that approach is antiquated. When sponsors are evaluating a service provider, they need to question how that provider is going to serve them from data ingestion to delivery, and whether they can loop back to access their data afterward to analyze it. Is the provider not only satisfying their technical tax needs, but also bringing in the tech savvy needed to truly drive value?
What will the future of financial reporting look like?
Merkel: In many cases, crisis is the crucible of innovation, and that is certainly true for COVID-19. The ability to do real-time reporting and access data quickly so you can make very fast business decisions is not going to revert back. Investing in technology is mandatory, and it brings so many added benefits. Some of the more sophisticated investment shops are investing in fractional assets or single family residential and they are dealing with multiple data points. They need to be able to scale up and not only use the data, but also to analyze it in real time. Firms that fall behind will also struggle to attract talent. Millennials and Generation Zers expect access to data and data analytics.
Collins: Service providers will continue to become more and more integrated with clients, creating a single ecosystem, much like Apple and Google do in the personal sphere by delivering all of the services in your life. Leveraging technology lays the groundwork for advisors to become not just tax consultants, but true holistic advisors.