Landmark Legislative Victory Makes Tax Extenders Permanent
By: Thomas J. Bisacquino, president and CEO, NAIOP
NAIOP’s efforts helped lead to the passage of the PATH Act of 2015, which makes permanent several critical CRE-related tax provisions, providing increased predictability for investment decisions.
IN DECEMBER 2015, NAIOP’s government affairs efforts resulted in a landmark legislative victory that was more than 10 years in the making. With the passage of the Protecting Americans from Tax Hikes (PATH) Act of 2015, several critical commercial real estate-related provisions that had previously been temporary were made a permanent part of the U.S. tax code.
For over a decade, provisions such as the 15-year recovery period for qualified leasehold improvements, the Section 179 small business expensing of qualified leasehold improvements, and bonus depreciation came under the heading of “tax extenders.” This meant that they, and many other provisions, were at risk of expiring unless Congress extended them — which it often did for only one year at a time. Year after year, our government affairs team worked successfully to ensure that these CRE-related elements of the tax code, all of which benefit the CRE industry, remained front and center among House and Senate legislators.
The 39-year recovery period was especially out of sync with industry realities. Until 2004, the Internal Revenue Code required that depreciation for qualified leasehold improvements occur over the economic life of the building structure itself — 39 years — rather than over the economic life of the improvements. More than a decade ago, in 2004, tax legislation was enacted that temporarily reduced this 39-year depreciation period to 15 years, a period more reflective of the true economic life of leasehold improvements in the modern commercial real estate market.
Our government affairs team fought to ensure that this provision and others were not forgotten or negotiated away as members of Congress wrote and rewrote reauthorization legislation each year, debated these stipulations in committees, and set and canceled official votes on the floor of the House and the Senate. During these legislative fights, the NAIOP team also successfully protected the industry from those trying to eliminate capital gains treatment for real estate partnership carried interest, eliminate the ability to defer taxes on real estate like-kind exchanges and other proposals harmful to commercial real estate.
Legislative Focus in 2016
NAIOP’s legislative victories on the tax front in 2015 by no means reduce the challenges that lie ahead for the industry. Now that so many once-temporary tax provisions have been made permanent, the next step for tax legislation is comprehensive tax reform. Leaders of both parties have already signaled that they are laying the groundwork this year for a major rewrite of the tax code to be accomplished in the first year of the next presidential term. This year, those discussions and negotiations will be taking place, and we will be active participants in the talks.
In broad terms, the future direction of tax policy and its treatment of real estate will be at stake. Specific issues and provisions such as Section 1031 like-kind exchanges, capital gains treatment for carried interest and the proper valuation of inherited property for tax purposes are being quietly discussed during the heated rhetoric of the presidential campaigns. Be assured that NAIOP is at the table so that our members don’t end up on the menu.
Key Outcomes of the PATH Act of 2015
The PATH legislation resulted in a number of key outcomes that affect the CRE industry. All of these provisions were once temporary, subject to renewal every one or two years. The PATH Act has either made them permanent or extended them for longer periods, providing vastly increased predictability for investment decisions.
The 15-year Qualified Leasehold Improvement Depreciation. This provision permanently reduces the recovery period for depreciation from 39 years to 15 years. The length of time over which assets may be depreciated is important for real estate development and investment. Longer depreciation periods result in higher capital costs to building owners, creating disincentives for them to upgrade and modernize space for their tenants.
The owner of a building making qualified leasehold improvements valued at $100,000 as part of a lease agreement, for example, would recover that investment over 15 years by expensing nearly $6,700 annually (1/15th of $100,000). However, if that depreciation has to be spread out over 39 years, then the owner can only recover approximately $2,600 annually (1/39th of $100,000), a cash flow decrease of $4,100 in one year. In other words, an owner recovers a $100,000 investment in qualified leasehold improvements at a rate 2.5 times faster under the 15-year depreciation rule than with a 39-year depreciation schedule.
Section 179 Small Business Expensing. The PATH Act permanently extends small business expensing limitations and phase-out amounts, and makes permanent the rules allowing certain qualified leasehold improvements to be eligible for expensing. It increases the expensing limit to $500,000 (with a phase-out at $2 million) and is indexed for inflation, beginning in 2016.
Bonus Depreciation. The Act extends for five years bonus depreciation for property acquired and placed in service during 2015 through 2019. The bonus depreciation is 50 percent for property placed in service during 2015, 2016 and 2017. It is reduced to 40 percent in 2018 and 30 percent in 2019. This bonus depreciation applies to qualified property with a recovery period of 20 years or less.
New Markets Tax Credits. The Act extends these for five years. It authorizes the allocation of $3.5 billion of New Markets Tax Credits for each year from 2015 through 2019.
Energy-efficient Commercial Buildings Deduction. The Act extends the deduction for energy efficiency improvements for two years, through 2016. A separate provision updates the standards used to the ASHRAE 2007 code.
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A like-kind exchange or “1031 exchange” refers to section 1031 of the U.S. Internal Revenue Code. This section of the U.S. Internal Revenue Code provides that capital gains taxes can be deferred in cases of exchanges of property held for productive use in a trade or business or for investment, provided the properties exchanged are comparable (“of like kind”). When the taxpayer ultimately sells the asset, the tax is paid. In commercial real estate, the provision encourages transactions because it enables investors to overcome the “lock-in” effect of tax rules, allowing them to remain invested in real estate while shifting resources to more productive properties or changing geographic locations.