As a residential developer who spent twenty years as a CPA Partner in a large local accounting firm, I rarely post much on the various real estate websites. But, in light of the acts that the GO-Zone tax benefits will be sunsetting at the end of 2009 and I constantly see so much misinformation on such sites relative to the GO-Zone Act, I felt compelled to make this post. I have been contacted by an ever increasing number of “GO-Zone†investors as the end of the GO-Zone Act approaches and most know only enough about the bonus depreciation to get themselves into trouble. I hope that this post is taken as the friendly information intended and not as a sermon of some kind.
DISCLAIMER: While all the information contained below is factually correct, I do not represent any readers of this post concerning their personal income tax situations. Accordingly, this should not be construed as tax advice being provided to anyone. Any reader who seeks to take advantage of the GZA should consult his own tax adviser.
First, the GZA tax provisions are the most beneficial tax incentives for “professional†real estate investors since the real estate world was crushed by TEFRA 1986 when the passive activity rules came in to existence. The principal GZA tax benefit is the investor’s ability to depreciate (write off) 50% of the property’s depreciable basis in the year of the acquisition. This bonus is permissible for all taxpayers, but this is also where many non-tax professionals take a wrong turn. The next paragraph is the most important thing that many investors will ever learn about GZ investing.
Rental real estate is specifically identified in the Tax Code as a “passive activityâ€. The only exception to this rule is if the investor qualifies as a “Real Estate Professional†under the Code. VERY IMPORTANT: What are the qualifications necessary to be deemed a R/E Pro?
• More than half of the taxpayer’s time spent performing personal services during the year MUST be in real estate related activities (including development, construction, acquisition, conversion, rental, management, and brokerage), and:
• At least 750 hours per year must have been spent performing such services.
If a taxpayer meets these conditions, his real estate rental activity is not a passive activity, but instead is defined as a “trade or businessâ€. This is hugely important in the context of the GZA…for two reasons:
• R/E pros are entitled to the full 50% bonus depreciation deduction in the first year without any limitation.
• Unlike passive activities, a trade or business loss creates a Net Operating Loss (“NOL) for tax purposes. This is tremendously significant because for the R/E pro, enough current year bonus depreciation to create a “negative taxable income†(subject to some very minor conditions) will usually result in an NOL. The NOL generated can then be carried back five years or forward indefinitely. An straightforward, simple example of the effects of generating an NOL:
o In 2009, taxpayer acquires $500,000 of GZ property and deducts $250,000 in bonus depreciation. Taxpayer’s taxable income before the GZ bonus is only $150,000, resulting in a current year NOL of $100,000. Accordingly taxpayer has a zero federal income tax liability for 2009.
o Taxpayer elects to “carry back†his $100,000 NOL to tax year 2004 where he had originally reported taxable income of $100,000. Taxpayer files and amended return for 2004. When the NOL is carried back to 2004, his amended 1004 taxable income is zero, so he claims a refund for ALL taxes originally paid for 2004.
There is yet another technicality in the GZA that is rarely ever understood fully by lay persons, but to your CPA, it is hugely beneficial. Unlike most areas of the code where “accelerated depreciation†is involved, the GZ bonus depreciation is NOT subject to Alternative Minimum Tax. Your tax professional can explain the benefits of this treatment to you.
Lastly, the bonus depreciation provisions of the GZA expired at the end of 2008 for most of the Katrina ravaged Gulf Coast. However, it was extended through December 31. 2009 for the three coastal counties in Mississippi and 13 selected parishes in Louisiana. These are counties in which the DHS study indicated that more than 60% of all buildings were either destroyed or substantially damaged by the storm.
In conclusion, the GO-Zone Act affords real estate professionals with previously unheard of tax advantages and the Act is about to expire. While tax benefits will never make a bad deal good, they should always be considered in connection with anyone’s investment decisions. If you decide to invest in GZ property, understand the law, but more importantly, understand your own tax situation and whether or not you will qualify for all of the tax benefits.
