United States

State tax matters for the real estate industry during COVID-19

INSIGHT ARTICLE  | 

The real estate industry has been directly impacted by the current COVID-19 pandemic. Across all sectors of the industry, investors, owners and lessors are expected to experience financial stress in an overall declining economy as cash-strapped tenants struggle to pay their rents. Lessors and landlords in particular that are highly leveraged will likely see distress as debt obligations come due. Additionally, state and local governments throughout the country will likely put in place policies that significantly affect the ability to collect rents through eviction moratoriums.  The hospitality, non-essential retail and senior living sectors in particularly will be significantly affected. However, there may be certain niche sectors such as data centers and logistics centers that will likely remain in relatively good financial condition given the sudden rise in remote working.

Until the cases of COVID-19 reach a plateau, it will be difficult to fully assess the impact of the virus on the real estate industry. While there is some uncertainty as to how the federal stimulus packages will impact the economy generally, and the real estate industry specifically, some items have been addressed such as the recovery period for qualified improvement property (QIP) as later discussed. At the same time, state and some local governments are contemplating economic relief measure for certain industries, including real estate.

Credits and incentives

Many state and local governments are and will be offering various tax credits and incentives to businesses directly affected by the COVID-19 crisis. In addition, there are many credit and incentive programs currently available. Depending on the jurisdiction these programs may offer tax incentives or grants to retain employees and loans.  This may be particularly beneficial to hospitality as well as property managers, both of which tend to have a more significant payroll component to their operations. 

The CARES Act, the primary federal economic stimulus package enacted in response to COVID-19, provides relief for businesses including U.S. Small Business Administration Economic Injury Disaster Loan Assistance, Paycheck Protection Programs, or loans for midsized businesses. These loans hope to incentivize businesses in retaining and paying employees. In addition to loans, the Employee Retention Credit further provides relief for businesses in this downturn. For more information on potential relief provided by the CARES Act and the states, please read our articles, Loans for small and midsize business and Coronavirus Credits and Incentives Relief for small businesses.

Income and franchise tax

As the economy enters a downturn, businesses that are contracting may be generating net operating losses (NOLs) that they will not be able to use for some time. Until business starts to expand, there may be ways to monetize NOLs through various planning techniques. Identifying refunds for taxes paid in prior periods could create some additional cash flow, and identifying which states conform to the federal extended NOL carryback provisions is another factor to consider with regard to the overall impact of the CARES Act on your cash flows. Additionally, under the CARES Act, QIP is now allowed to be depreciated over 15 years and is eligible for bonus depreciation. From a state and local tax perspective, similar federal conformity considerations will need to be monitored because it is anticipated that state legislative action will occur in the coming months in response to these new federal provisions.

Sales and use tax

While many of the services performed throughout the real estate industry are exempt from the sales and use tax as nontaxable professional services, property managers may still have substantial sales and use tax liabilities. For example, sales tax is often overpaid on construction services which are exempt in almost every state. Construction contracts can be highly nuanced resulting in incorrectly calculated and charged taxes. Identifying sales and use tax overpayments on construction services and other purchases could lead to short-term cash refunds and long-term tax savings as companies are better positioned to identify sales and use tax exemptions and exclusions after a thorough review.

Employment tax

While many businesses will be laying off employees, certain sectors of the real estate industry may see a sharp increase in employment to deal with COVID-19. Consideration should be given to employment tax impact from additional hiring. Certain data and logistics centers, among others, are considered essential businesses that may benefit from state incentives on projected hiring. Alternatively, for those businesses reducing workforce, minimizing the state unemployment tax impact of workforce reductions and analyzing independent contractor approaches from a tax perspective are key considerations for businesses struggling in the economic environment caused by the COVID-19 pandemic.

Outsourcing

For most real estate industry companies, many accounting and finance personnel are working remotely. Most companies are ill equipped to conduct business remotely for long periods of time. Outsourcing some compliance functions, either temporarily or permanently, could reduce internal costs and ease operational burdens for these functions to real estate funds and fund managers. 

Takeaways

The COVID-19 crisis is having differing effects on the various sectors of the real estate industry. Those effects depend on the sector; they also depend on the location of the operations. All real estate industry firms should consider the potential tax risks and opportunities that arise from the current economic crisis. Addressing state and local tax matters during this period can prevent the proliferation of state tax exposures and can even result in substantial tax and cash savings for firms that plan appropriately. RSM’s state and local tax team has the industry experience required to provide comprehensive services to all sectors of the real estate industry at this time.

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