A version of this article appeared in Multi-Housing News on March 27, 2024.
The real estate industry tends to be dynamic, but a spate of recent pivotal regulatory changes is making 2024 particularly important for real estate leaders charged with setting their firms’ goals and strategies.
Many of these changes are associated with legislation that impacts tax credits, depreciation amounts, and reporting requirements, that can affect companies’ cash flow, tax obligations, and compliance activities. They’re worth watching as 2024 proceeds.
Monitoring regulatory and industry changes can help real estate leaders plan appropriately. Below are impactful shifts we’re seeing in real estate this year.
Decreased returns jeopardize leader retention
Carried interest, also known as a promoted interest or a promote, is a commonly used real estate compensation strategy that gives financial interest in the long-term capital gain of a development to the recipient, typically a partner or C-suite executive. As performance-based fees, promotes align executive compensation with the real estate fund’s returns.
As values in commercial real estate assets decline, investments, and income from promotes are declining as well. This drop in promote value will drive compensation-related decision making in 2024 as C-suite leaders, stakeholders, and partners work to retain senior executives or attract executives looking for new opportunities.
Stakeholders with junior and limited partner roles whose key compensation is tied to the promote structure are also seeing material declines, if not total losses.
General partners and C-suite leaders who want to retain key colleagues are reviewing incentive programs to counteract current market trends and position their firm for the future.
Bonus depreciation changes
The slow phase out of bonus deprecation, a core tax-management tool, has reached a turning point for many taxpayers. Bonus depreciation declined to 80% in 2023 and 60% in 2024. However, the U.S. House of Representatives passed the Tax Relief for American Families and Workers Act of 2024 — known as HR 702 — which includes provisions for extending 100% bonus depreciation. It’s uncertain if the bill will be passed by the Senate and signed into law by President Joe Biden.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
If HR 702 isn’t enacted, commercial real estate investors and developers may find value in cost recovery planning opportunities from the Tangible Property Regulations (TPR) and taking advantage of Qualified improvement property (QIP).
TPR applies to anyone who makes expenditures to acquire, develop, improve, repair, or maintain property. It ultimately provides more opportunities to expense eligible capital repair costs, especially for stabilized properties that have been held for a while, rather than having to capitalize and ratably depreciate such costs as improvements. Under IRC Section 162, taxpayers are permitted to deduct amounts paid for repairs and maintenance to tangible real or personal property, if the amounts wouldn’t otherwise be required to be capitalized under IRC Section 263A. While these regulations aren’t new, they’re worth revisiting as cost recovery methods available for tax planning.
QIP encompasses many improvements made to existing commercial buildings, is currently depreciated over 15 years, and is eligible for bonus depreciation. These favorable QIP depreciation provisions can give eligible real estate firms the opportunity to increase depreciation and defer current federal tax liabilities, providing immediate cash flow relief.
New SEC rules impact RIA reporting
Investments in private-fund vehicles have boomed in recent years, including real estate, causing significant changes to the SEC’s Registered Investment Advisor (RIA) guidelines and regulations.
Changes impacting investment advisers registered with the SEC under the Investment Advisers Act of 1940 were released Aug. 23, 2023. They were designed to increase transparency and protect investors in private funds, including real estate funds.
Private funds have become important to financial markets, increasing exposure for direct and indirect investors participating in pension plans, retirement plans, endowments, and foundations. As a result, the SEC is tailoring their rules to address risk and harm to investors and restrict adviser activity contrary to the public interest and protection of investors.
The new rules require private fund advisers registered with the SEC to:
Provide investors with quarterly statements detailing information regarding private fund performance, fees, and expenses
Obtain an annual audit for each private fund
Obtain a fairness opinion or valuation opinion in connection with an adviser-led secondary transaction
The new rules require that all private fund advisers:
Refrain from activities and practices that are contrary to the public interest and the protection of investors, although some activities may be permitted if the advisor provides disclosures to investors, and in some cases, the advisor must also obtain investor consent
Refrain from certain types of preferential treatment that have a material negative effect on other investors and prohibit other types of preferential treatment to investors unless new certain terms are disclosed in advance of an investor’s investment in the private fund and all terms are disclosed after the investor’s investment
Increased tax incentives for energy efficient buildings
As part of the Inflation Reduction Act’s modifications to IRC Section 179D, there’s significant additional value available for real estate owners prioritizing energy efficiency. Beginning in tax year 2023, the maximum IRC Section 179D deduction increased from $1.88 per square foot to up to $5.36 per square foot with inflation adjustments applied annually.
Newly constructed or substantially renovated commercial buildings and multifamily residential buildings that are four stories or higher are eligible for the deduction based on the energy efficiency associated with three building systems:
Interior lighting
Heating ventilation and air conditioning (HVAC) and hot water
Building envelope
Owners and tenants of commercial properties and residential rental buildings of four stories or higher that made improvements after Jan. 1, 2006, are eligible for the deduction.
Under the new rules, a project must achieve a 25% energy cost savings threshold to qualify for any IRC Section 179D deduction. The deduction increases on a sliding scale for each percentage point of energy cost reduction above 25%.
To qualify for IRC Section 179D’s higher deduction tier, additional prevailing wage and apprenticeship requirements must be met. However, for projects beginning construction prior to Jan. 30, 2023, the additional labor requirements for the higher deduction tier are waived.
The Inflation Reduction Act also increased the IRC Section 45L tax credit starting in 2023 and extending through 2032. This credit can be particularly beneficial to residential multifamily developers and single-family home builders who reduce energy consumption in newly constructed residences.
The credit offers a per dwelling unit tax credit up to:
$2,000 per unit completed through Dec. 31, 2022
$500–$5,000 per unit for multifamily properties completed Jan. 30, 2023, through Dec. 31, 2032, or potentially up to $2,500 per unit if construction began prior to Jan. 29, 2023
$2,500–$5,000 per unit for single-family properties completed Jan. 1, 2023, through Dec. 31, 2032
A dwelling unit is generally considered eligible for the IRC Section 45L tax credit if the unit is in a newly constructed or substantially renovated residential building, meets certain energy reduction standards, and is certified by a qualified third party. The IRC Section 45L credit can be claimed on a lookback basis by amending open prior-year tax returns.
Through the end of 2022, single-family home and multifamily developers constructing new residences of three stories or less, not including below-grade parking, could claim the credit. Starting in 2023, IRC Section 45L applies to residential developments and multifamily buildings of any story height.
Qualifying properties include:
Multifamily properties, such as apartments, townhomes, and duplexes
Senior housing facilities
Student housing
Single-family homes
Manufactured and mobile home parks
Changes on the horizon
Real estate leaders are advised to continue monitoring regulatory activity throughout 2024 and beyond as many industry changes will stem from this area.
For example, the Biden Administration has proposed key changes to legislation behind IRC Section 1031 exchanges allowing investors to re-allocate funds from sales of real estate assets into new like-kind properties, delaying taxation on that sale. While like-kind exchanges were not affected in 2023, new legislation may be proposed in Congress.
Also look for further changes and amendments from the SEC. The SEC proposed a new rule addressing how registered investment advisers safeguard client assets. As part of this proposal, the SEC intends to amend certain provisions of the current custody rule for enhanced investor protections.
The SEC also proposed corresponding amendments to the recordkeeping rule under the Investment Advisers Act of 1940 and to Form ADV for investment adviser registration under the act.
