Real Estate advisor. ATRA: Digging into the new tax law. May June Ask the Advisor. Ward off really big problems

Transcription

1 Real Estate advisor May June 2013 ATRA: Digging into the new tax law Ward off really big problems Regularly perform preventive maintenance Court accepts reductions in value to reflect carrying costs and lack of control Ask the Advisor Is wrap-up insurance right for my project? Mount Arlington Office Newton Office

2 ATRA: Digging into the new tax law When Congress avoided the so-called fiscal cliff with the passage of the American Taxpayer Relief Act of 2012 (ATRA) in early January, much of the attention focused on the effect on individual tax rates. But ATRA also contains several provisions that can have a significant effect on the bottom lines of real estate developers and investors. Bonus depreciation ATRA generally extends 50% first-year bonus depreciation on qualified property through 2013 (through 2014 for certain longer-lived and transportation property). Qualified property includes new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), as well as qualified leasehold improvement property. You can write off 50% of the cost basis of qualified property in the year the property is placed in service, depreciating the remaining basis over the applicable recovery period. Note that bonus depreciation applies automatically unless you elect not to apply it. The law also extends the provision allowing corporate taxpayers to accelerate certain credits instead of claiming bonus depreciation. Section 179 expensing Internal Revenue Code Sec. 179 allows you to write off the full expense of qualifying property purchases in the year they re made rather than depreciating the purchases over several years. The deduction is reduced by $1 for every $1 of expenses in excess of a phaseout threshold and can be claimed only to offset net income it can t be used to reduce net income below zero. ATRA extends the 2011 expensing limit of $500,000 (with a phaseout threshold of $2 million) through Although Sec. 179 expensing is generally limited to tangible personal property, ATRA allows you to expense up to $250,000 (of your $500,000 maximum) for qualified real property, which includes leasehold improvements, restaurant property and retail improvement property. The amounts had been scheduled to fall to $25,000 and $200,000 for Absent further legislation, they will drop to those levels in Sec. 179 expensing may provide you a greater tax benefit than bonus depreciation because it allows you to deduct 100% of a new asset s cost and, unlike bonus depreciation, is available for used property. But bonus depreciation might apply to more taxpayers because it isn t subject to a purchase limit or net income requirement. Accelerated depreciation The new law extends through 2013 your ability to depreciate qualified leasehold improvement, restaurant and retail improvement property over a shortened recovery period of 15 years, as opposed to the normal 39-year period. This accelerated depreciation had expired at the end of

3 Energy-related incentives ATRA also includes several energy-related provisions. For example, it makes it easier to qualify for a production tax credit (PTC) or investment tax credit (ITC) on certain renewable energy facilities, including wind, geothermal that generates electricity, biomass, landfill gas, municipal solid waste, hydroelectric, and marine and hydrokinetic energy. Previously, such facilities generally were eligible for the credits only if they were placed in service in Under ATRA, the availability of the credits hinges on when the facility begins construction. As long as construction begins in 2013, the facility will be eligible for the applicable PTC or 30% ITC even if it isn t ultimately placed in service until after ATRA also extends the energy-efficient home credit (Sec. 45L) to 2012 and Qualified taxpayers can earn a tax credit of $1,000 or $2,000 for each new dwelling unit, depending on whether the unit achieves 30% or 50% savings in the annual level of heating and cooling energy consumption. Finally, the act extends the credit for alternative fuel vehicle refueling property (Sec. 30c). The 30% credit had expired on Dec. 31, 2011, but now runs through Dec. 31, The credit for Could you earn tax credits for hiring? The American Taxpayer Relief Act of 2012 (ATRA) extends the Work Opportunity tax credit. The credit, which originally expired Dec. 31, 2011 (Dec. 31, 2012, for qualified veterans), is intended to encourage hiring from certain target groups that have faced significant barriers to employment. Under ATRA, the credit is extended for most target groups through In addition to certain veterans, target groups include food stamp recipients, ex-felons and certain individuals with disabilities who ve been unemployed for four weeks or more but less than six months. Employers can earn a tax credit equal to 25% or 40% of a new employee s first-year wages, up to the maximum for the target group to which the employee belongs; the maximums generally range from $2,400 to $9,600. The credit is 25% if the employee works at least 120 hours and 40% if the employee works at least 400 hours. There s no limit on the number of qualified individuals an employer can hire. refueling property brought into service before then may not exceed $30,000. What s next? In addition to the passage of ATRA, tax reform remains on Congress s agenda for 2013 and could bring major changes for future years. Consult with your financial advisor to chart the best course toward minimizing your business and personal taxes. n Ward off really big problems Regularly perform preventive maintenance If just one of your properties is poorly maintained, you could face myriad headaches and possible lawsuits. That s why you must stay on top of repairs and maintenance on all your buildings, whether they be residential or commercial. Scheduling tasks Some maintenance items must be checked weekly, while others may be inspected less often. The property manager, along with the maintenance supervisor, should develop a realistic 3

4 painting. Other focal points are carpet replacement, mechanical system repair, and plumbing and electrical repair. Create a formal schedule for fixed asset repair and maintenance, and assign someone to update this schedule (usually the property manager). Describe each item fully, including the manufacturer, operating procedures (if applicable), location within the property, and any details of purchase and existing warranties. The inventory should also state where to obtain needed parts and service. This schedule can help management quickly assess the condition of fixed assets and helps transition the task if a new person is put in charge of repairs and maintenance. schedule for each task. Moreover, it s critical to create checklists that facilitate daily, weekly, monthly or even seasonal reports. Make sure you have a system for issuing work orders and monitoring task completion. Accounting for all systems To cover all the bases, regularly take stock of every piece of equipment on each property, including elevators, HVAC systems, pumps and motors. Be sure to include structural components, such as roofs and supports. For the exterior of a building check the: n Foundation walls and waterproofing, n Fascia and soffits, n Grading and drainage, n Exterior painting, and n Window seal repair and replacement. And don t forget the interior. Some hotspots that deserve attention are moisture control systems, drywall installation and repair, and interior Handling inspections and preventive maintenance Another task: Determine the types of inspections and preventive maintenance that should be performed on each piece of equipment and structural component. Note how frequently these tasks should be done. Often the property manager programs routine maintenance reminders into his or her smart phone calendar or writes it in his or her day planner to stay atop the schedule. Determine the types of inspections and preventive maintenance that should be performed on each piece of equipment and structural component. For equipment items, develop a schedule that outlines when each item needs to be cleaned, lubricated, serviced or overhauled. Also list spare parts that should be kept readily on hand. For structural items, add a to-do list for periodic inspections related to painting, patching or similar maintenance issues. Estimating labor requirements The property manager should estimate how much time, labor and money the preventive maintenance program will require and develop cost estimates that are realistic for both the budget and level of 4

5 work involved. In some cases, it may be cheaper to replace an outdated asset, rather than maintain it. For example, many older buildings use old air conditioning systems which might be expensive to maintain. Reduce monthly utility bills by replacing the entire system. Moreover, equipment will likely last longer, deferring replacement costs, and major equipment breakdowns will be less frequent. The building owner could also benefit from a tax credit for energy-saving equipment, together with Section 179 expensing or other increased depreciation writeoffs, in the event of an equipment upgrade. (See ATRA: Digging into the new tax law on page 2 for more information.) But before you start upgrading at random, make sure you evaluate whether the financial benefits of the renovations, over the long term, outweigh the costs. Recording all activities will pay off eventually Maintaining accurate records will help you determine whether time, money or both can be saved by simply performing certain maintenance activities less frequently, or whether certain items should be inspected more often. Keeping good records can also help verify whether your maintenance personnel are performing needed tasks to your satisfaction. Plan ahead Maintaining your buildings equipment and infrastructure shouldn t be just an occasional occurrence. To ensure your properties are always in tip top shape, performing regular inspections and maintenance is critical. n Court accepts reductions in value to reflect carrying costs and lack of control When real-estate-related assets undergo valuation, their value may be reduced for lack of marketability. But, as the wife in a divorce case recently learned the hard way, the value of ownership interests in companies holding such real estate assets may be further reduced to reflect carrying costs and lack of control. Experts weigh in In Barth v. Barth, a married couple owned minority interests in numerous real estate development companies that owned land held primarily for the purpose of residential subdivision development. In the two years leading up to their divorce trial, the companies suffered substantial losses in a poor real estate market. At trial, a neutral expert, charged with valuing the real estate owned by the companies, testified that he assumed a six- to 12-month timeframe for selling the residential lots in a bulk sale. Therefore, he applied a 50% bulk, or marketability, discount to the value of the real estate. 5

6 To value the spouses interests in the companies, the husband s expert discounted the values by a 30-month carrying cost for real estate taxes and mortgage interest payments the company owners would pay out of their own pockets. She assumed they would carry the lots for 30 months until the market improved enough that the entities could sustain themselves by selling individual lots. She also applied a 45% minority interest discount to reflect the lack of control the couple, as minority owners, had over the entities decision making. The trial court adopted the husband s expert s opinions about the carrying costs and their effect on the value of the parties ownership interests in the companies. The wife appealed, arguing that the court shouldn t have discounted the value of the ownership interests by carrying costs because those costs had already been accounted for when the neutral appraiser valued the real estate. The wife also argued that a 45% minority interest was excessive, but she didn t provide any rebuttal evidence supporting a lower amount. The appeals court weighs in The appeals court began its analysis by pointing out the difference between valuing the real estate owned at the company level and valuing the husband and wife s ownership interest in each of the companies. It conceded, though, that the appraised value of a company s assets generally serves as the rough starting point for valuing an ownership interest in the company. The wife was correct, therefore, in asserting that specific discounts applied to the value of the companies assets shouldn t be applied again when valuing ownership interests in the companies. But, the court said, the marketability discount that had been applied to the value of the real estate was distinguishable from the discount applied to the value of the ownership interests in the companies to reflect the carrying costs. The appeals court conceded that the appraised value of a company s assets generally serves as the rough starting point for valuing an ownership interest in the company. The court explained that the 50% bulk or marketability discount reflects the time, money and risk required to sell all 15 lots at once. The carrying cost discount measures how much interest and real estate taxes must be paid to carry the property while awaiting sales of the individual lots in the ordinary course of business. The court concluded, therefore, that the trial court didn t erroneously double-count the carrying costs discount. The court also upheld the 45% minority interest discount. All three adjustments the marketability, carrying cost and minority interest discounts combined reflected a 91% reduction from the initial equity value of the interests at the asset level. But the court found that the size of the collective discounts was not enough to indicate that the trial court abused its discretion. Plan accordingly The potential application of significant discounts isn t limited to the divorce arena. Interests in realestate-related entities could be subject to sizable discounts in a variety of contexts including bankruptcy, taxes, and mergers and acquisitions to varying effect. Your financial advisor can help you determine how they could affect you. n 6

7 Ask the Advisor Is wrap-up insurance right for my project? The expense of construction litigation and insurance has prompted developers to seek cost-efficient ways to limit their liability. One option, known as wrap-up insurance, can provide comprehensive coverage while cutting costs. It s worth considering for multimillion-dollar, labor-intensive projects and when permitted under state law. How it works With wrap-up insurance, a developer provides a single source for project-specific liability insurance. The policy covers the developer, general contractor, subcontractors, construction managers and possibly design professionals. The developer is designated as the named insured, and the other parties become additional insureds. The insurance typically comprises workers compensation, general, excess, pollution and construction defects liability. It also may include builder s risk and errors and omissions coverage. The defects liability coverage usually runs for an extended period after the project s completion, corresponding to the relevant state s statute of limitations or repose. Advantages for developers Wrap-up insurance can reduce problems associated with obtaining adequate liability coverage for a construction project. Many trade contractors, for example, rely on insurance policies that carry exclusions for new residential attached housing construction. Wrap-up insurance provides coverage they might be unable to purchase on an individual basis, allowing you to hire contractors and subcontractors based on their qualifications, not their insurance coverage. You can use wrap-up insurance to secure consistent coverage and speedy, coordinated claims handling. Because you ll deal with a single insurer, there won t be coverage gaps and disputes between multiple insurers. And litigation between the parties is less likely, since the policies provide ways of resolving disputes. In exchange for wrap-up insurance, you should receive bid credits from contractors, thereby cutting construction costs. You also can reduce insurance costs by instituting requisite on-site job safety programs and avoiding the need for tail coverage. If a case goes to trial, the parties can forge a unified defense. Further, wrap-up insurance carries a smaller risk of depleting liability limits. The defense costs usually come out of the deductible or self-insurance retention, so you have policy limit amounts available to cover judgments or settlements. Coverage also imposes fewer administrative burdens. For example, you ll no longer need to collect certificates of insurance and endorsements from contractors. But wrap-up insurance does shift the burden of insurance policy and job safety administration from the individual contractors to the developer. Worth considering Wrap-up insurance programs are attractive in today s litigious environment. Your financial advisor can help you determine the best insurance option based on your specific costs and benefits. n This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use REAmj13 7

8 Mount Arlington Office Business Interruption Claims May Require Newton Financial Office and Legal Assistance Business interruption insurance typically pays for income that is lost while operations are suspended after a natural or man-made disaster. However, these claims can be difficult and even contentious if there are differences of interpretation about the calculations, projections or the meaning of policy provisions. When disasters such as Hurricane Sandy occur, the need for a forensic accountant and an attorney can arise. Although many of the insurance claims that result from such a storm are relatively straightforward, policy claims for business interruption insurance may require detailed proof of the losses. Insurance basics: Most insurance claims involve determining what costs and replacement values of equipment and materials were lost or damaged in the disaster, proving the losses and values, and submitting a claim. Business interruption insurance typically pays for income that is lost and expenses that are incurred while operations are suspended. A business interruption policy typically covers expenses including: n Profits that would have been earned if it were not for the loss (usually limited to 12 months). n Continuing costs Operating expenses and other fixed costs still being incurred by the business (these expenses must be ordinary and necessary such as salaries and related payroll costs during the interruption period). n Replacement of inventory and machinery. n Temporary location The extra expenses for moving to, and operating from, a temporary location may be covered. (The expenses for permanent relocation, if necessary, may also be included). n Other expenses Businesses are reimbursed for reasonable expenses (beyond the continuing costs) that allow the business to continue operating while the damage is being repaired. Important: This type of insurance is arguably one of the most complicated on the market today, and submitting a claim is time consuming and takes careful consideration. Claims can be delayed or denied if there are differences of interpretation about the loss calculations, income projections or the meaning of policy provisions. A business may approach its accountant or attorney for advice on how to approach a claim for business interruption coverage, especially if the business has already filed a claim and is experiencing push back or denial from the insurance company. The business may also need professional help to get the insurer s attention especially after a major disaster when insurance companies can be overwhelmed with claims. A forensic accountant and an attorney can work with the business to determine the losses and prove them in a claim. When it comes to business interruption claims, it is important to properly calculate losses upfront. Forensic accountants, particularly those experienced in business valuation and litigation, have skills that are important in determining losses for business interruption claims such as forecasting, modeling and properly presenting damages and losses. Working with an attorney, who can aid in the legal interpretation of the policy, a forensic accountant can quickly and efficiently assemble the information and calculations needed for a viable business interruption claim. Filing a well-crafted claim can help in a quick and easy resolution with the insurance company. Please contact Marcia Geltman, CPA/Partner or Thomas Dartnell, CPA/Non-for-Profit Partner on (973) to discuss further. Mount Arlington Office Newton Office