Recent US Stimulus and CRE

IN SHORT: The 880-page CARES Act stimulus bill, H.R. 748, offers a number of concessions for borrowers whose loans are federally guaranteed or insured. While the bulk of these measures apply to single-family and multi-family units, banks are being encouraged to modify all loans, which would include loans to commercial borrowers. Additionally, there are a number of provisions that will enable certain real estate operators to harvest tax losses without regard to property type.

Away from the federal legislation, note that a number of states have passed additional laws that largely delay residential eviction proceedings (or defer payment of property insurance premia); only California  and New York have bills in committee that would prevent commercial tenant evictions. Similarly, at the state and municipal level, non-essential construction bans have been implemented in New York, Pennsylvania, Washington (p.11), as well as Boston and Cambridge, MA; Austin, TX (and Travis County); and San Francisco (commercial construction).

Federal Bill Provisions (with links to the relevant sections)

A fix (finally!) allowing QIP to be depreciated over 15 years and receive bonus depreciation

Sec. 2307. Technical amendments regarding qualified improvement property and this discussion of bonus depreciation, p. 211.

In a much delayed fix, the CARES Act legislation reinstates the shortened depreciation time (15 years) associated with qualified improvement property (QIP). As a reminder, QIP is any interior improvement to nonresidential property, excluding any building enlargement, any elevator or escalator, or any internal structural framework of the building but including roofs, HVAC, fire protection systems, alarm systems and security systems. As a result, QIP placed in service after 2017 is now eligible for bonus depreciation (100% of eligible costs). Note that prior tax returns may need to be amended.

Banks can work with borrowers on debt of all types with limited (punitive) accounting implications

Sec. 4013 Temporary relief from troubled debt restructurings, p. 539

Sec. 4014. Optional temporary relief from current expected credit losses, p. 542 

These provisions do not exclusively relate to real estate but cover loans made to residential and commercial property borrowers, among others. The law grants “temporary relief” to banks and other financial institutions from March 1, 2020 through year-end (or 60 days after the national state of emergency is over—whichever comes first) from accounting charges that relate to “troubled debt restructurings” which would encompass any loan modifications -- including a forbearance arrangement, an interest rate modification, a repayment plan, or any other similar arrangement that defers or delays the payment of principal or interest (provided that the loan was not more than 30 days past due as of year-end.)

The goal of the legislation is to allow banks to work with borrowers of all types in temporarily restructuring loans without the negative impact on bank balance sheets and income statements from accounting charges associated with any restructuring. Similarly, financial institutions do not have to comply with FASB ASU No. 2016–13 (‘‘Measurement of Credit Losses on Financial Instruments’’), including the methodology for estimating allowances for credit losses, from last Friday’s enactment through the earlier of the end of the national emergency or year-end.

Small business deferred non-recourse loans that may be used toward rent and mortgage interest; i.e., the loans need not be used toward payroll at all (even as the program is named ‘Paycheck Protection Program.’)

Sec. 1102 Paycheck protection program, p.9

Sec. 1106 Loan forgiveness, p. 41 

The Paycheck Protection Program, an extension of the Small Business Administration’s existing loan programs, grants loans (up to a total of $349B) to small businesses, with the size of the loan based on past payroll costs. Loans under this program may be made from 2/15/20 – 6/30/20. The eligible loan size for each small business is roughly equal to 2.5 times monthly payroll costs (up to a maximum of $10M) to any business concern (including nonprofit organizations) as well as to individuals who operate businesses as a sole proprietorship, or who are independent contractors or who are self-employed. 

Small businesses are generally those that do not employ more than 500 employees (or not more than 500 employees per physical location if the business is an “accommodation or food service” business or franchise.) Certain businesses are considered “small” even with more than 500 employees; here’s a list. 

Payroll costs include:

• Total employee compensation (salary, wages, tips, commissions, paid leave, separation allowances, group health care premia, retirement benefits, state/local taxes on compensation) and sole proprietor/ independent contractor/self-employment wages or income.
• Wages in excess of $100,000 (prorated) are excluded, as are withholding taxes and qualified sick leave and family leave wages already credited under HR 6201. 
• Employees’ primary place of residence must be the US in order to have their payroll costs included.

Of note: these loans are eligible for up to 100% forgiveness based on the total amount spent in the 8 weeks after the loan is originated on all of the following items:

-Payroll costs

-Interest on mortgage debt

-Rent obligation payments

-Utility payments

NB: Mortgage debt and rents under lease obligations must be in effect prior to 2/15/20 in order to be eligible.

The amount of loan forgiveness is reduced if the average number of employees in the 8-week period following the loan is lower than the average number of employees between 1/1/20 and 2/29/20 or the period from 2/15/19 through 6/30/19 (the borrower may choose). Similarly, wage reductions in excess of 25% for employees who earned less than $100,000 in 2019 will also reduce the total amount of the loan forgiven. 

The loans are intended to maintain workers’ employee status and keep their compensation close to their pre-coronavirus levels; however, an employer who reduces worker count or wages between 2/15/20 and 4/27/20 but then reinstates worker counts and compensation by 6/30/20 to prior levels will still be eligible for loan forgiveness.

In order to have a loan forgiven, small businesses will be required to provide documentation (payroll tax filings, state income, payroll, and unemployment insurance filings; cancelled checks, etc.) Forgiveness cannot exceed the principal amount of the loan. 

Borrowers of these loans will have “complete payment deferment relief” including payment of principal, interest, and fees for a period of not less than 6 months and not more than 1 year.  There are no prepayment penalties and loans that are forgiven will be excluded from gross income.

Loans that are not forgiven after the 8-week period will have a maximum maturity of 10 years, with an interest rate no higher than 4 percent. Paycheck protection loans have no prepayment penalty. Banks will be encouraged to lend as each of these loans will carry a risk weight of zero percent; additionally, the SBA will reimburse lenders according to a set schedule based on the face amount of outstanding loans extended under the program.

Applications to the program are made to any lending institution that is approved to participate in the program through the existing U.S. Small Business Administration (SBA) 7(a) lending program, as well as additional lenders approved by the Department of Treasury and numerous community banks. 

Landlords who own multifamily properties (5 or more units) that have federal guarantees may request loan payment forbearance

Sec. 4023. Forbearance of residential mortgage loan payments for multifamily properties with federally-backed loans, p. 570 

Between 3/27/20 and the earlier of the end of the national emergency or 12/31/20, borrowers of federally-backed loans on multifamily properties (properties with 5 or more units) may request forbearance for up to 30 days (which may be extended to two additional 30-day periods at the borrower’s request).

Forbearance will only apply to permanent financing (temporary financing, such as a construction loan, is excluded). 

Federally-backed loans include those purchased or securitized by Fannie or Freddie or have any type of guarantee or assistance from HUD, the Federal Housing Administration, the U.S. Department of Agriculture or the Department of Veterans Affairs.

During the period of forbearance, multifamily borrowers 1) cannot evict or initiate the eviction of a tenant from the applicable property solely for nonpayment of rent or other fees/ charges, and cannot charge any late fees or penalties because of a late payment of rent, and 2) may not issue a notice to vacate under until after the expiration of the forbearance, and then must provide at least 30 days from the notice to vacate before requiring the tenant to vacate.

Multifamily borrowers have the option to discontinue the forbearance at any time.

Landlords with dwellings backed by federal guarantees may not evict residential tenants for 120 days due to non-payment.

Sec. 4024. Temporary moratorium on eviction filings, p. 574

For 120 days following 3/27/20, lessors to residential tenants in dwellings with federally-backed mortgage loans and federally-backed multifamily mortgage loans may not make, or cause to be made, any filing with to initiate a legal action to recover possession of the dwelling from the tenant for nonpayment of rent or other fees/charges or charge fees/penalties relating to nonpayment of rent, and may not issue a notice to vacate for 120 days (and must then provide at least 30 days from the notice to vacate before requiring the tenant to vacate.)

Note: Multifamily REITs may be hit particularly hard by these provisions, depending on the financing for their properties. Even so, some landlords are announcing their own eviction moratoria voluntarily; for example, Essex Property Trust  has announced that it will be halting all evictions for 90 days for residents who have been financially impacted by the COVID-19 pandemic, and will avoid rent increases for 90 days by offering a lease renewal with no rent increase to help residents weather the crisis.  Additionally, they will be waiving late fees and creating a payment plan for residents who are unable to pay their rent. Essex Property Trust is down over 25% for March as of this writing—more than 50% more than the decline in the S&P 500 over the same period. 

Net operating losses may be used in full and can now be carried back five years, but this benefit does NOT apply to REITs (but would apply to non-REIT real estate businesses)

Sec. 2303. Modifications for net operating losses, p. 193

The 2017 Tax Cuts and Jobs Act (“TCJA”) had limited Net Operating Losses (NOLs) to 80% of taxable income and could not be carried back to reduce income in a prior tax year. However, the CARES Act now makes NOLs able to fully offset taxable income (i.e., 100% vs. 80%) and can be carried back five years beginning in 2018, 2019 or 2020 (businesses must use the earliest year applicable) which should result in tax refunds for those making use of this provision (pre-TCJA, the corporate tax rate was 35%, versus 21% presently.) 

However, the above specifically excludes REITs (p. 196), but does allow the carryback for non-REIT real estate companies, many of whom may incur losses in 2020.

Temporary removal of cap on partnership and sole proprietorship excess business losses, which may be applicable to certain taxpayers in real property trades or businesses (469(c)(7)

Sec. 2304. Modification of limitation on losses for taxpayers other than corporations, p. 202

The TCJA contained a provision for tax years in 2018 through 2025 that limited the deductibility of current year business losses for pass-through businesses and sole proprietorships.  (Excess business losses are the amount by which total deductions attributable to a taxpayer's trades or businesses exceed total gross income and gains attributable to those trades or businesses.) The limitation was $250,000 (single filers) and $500,000 (joint returns.) Business losses in excess of these amounts were disallowed in the year incurred but could be carried forward to future years as NOLs.

The Act suspends the above caps though 2020, allowing non-corporate taxpayers to deduct excess business losses arising in 2018, 2019 and 2020 up to 100% of taxable income by filing for refunds or amending prior years’ returns. 

While other provisions that limit losses, such as passive activity rules, continue to apply, note that the passive limitation does not apply to those real estate professionals in real property trades or businesses, for whom 1) more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and who 2) perform more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates. As a result, the ability to deduct unlimited business losses may be material for these real estate operators, particularly in 2020. 

Increased deductions on business interest expense (applicable to a construction/development/brokerage firm that did not designate itself a “real property trade or business.”)

Sec. 2306. Modifications of limitation on business interest, p. 207

The increase in allowable deductions of interest expense will reduce cash taxes for taxpayers subject to the 163(j) limit and allow these businesses increased liquidity—which may be particularly relevant for organizations with significant leverage. 

Under the TCJA, beginning in tax years 2018 onward, the deduction for business interest was limited to the sum of business interest income, floor plan financing interest, and 30% of the “adjusted taxable income” (ATI) of the taxpayer. (Floor plan financing is a revolving line of credit that allows a borrower to obtain financing for goods, such as retail auto inventory; ATI prior to 2022 is essentially EBITDA; in 2022 and beyond, it’s EBIT.) Disallowed amounts could be carried forward indefinitely. 

The CARES Act increases the 30% limit to 50% of ATI for taxable years beginning in 2019 and 2020, thus allowing taxpayers to deduct more of their business interest. In addition, a business can elect to use its 2019 ATI in computing its 2020 limitation if that would produce a greater interest deduction (with losses that can then be carried back under the new NOL provisions.) 

In the case of a partnership, elections are made by the partnership, and the partnership applies the limitation, rather than the partnership’s partners. (For more information on how these interest expense limitations had applied to corporations and partnerships, see question 15 from the IRS here.)

Recall that an electing “real property trade or business” (any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business) is not considered a trade or business for purposes of the business interest limitation. However, once elected, the real property trade or business is required to use the alternative depreciation system (ADS) for depreciation—which equals 40 years on a straight line basis for non-residential real property and 30 years for residential real property. These designations are generally irrevocable.

Special rules apply to partnerships, and the increase is only allowed for the partnership’s taxable year beginning in 2020. In 2019, a partnership does not get to use the 50% limit; instead, excess business interest is allocated to a partner as determined under the 30% adjusted taxable income limitation. In 2020, 50% of this excess is treated as business interest paid or accrued by the partner (and is not subject to the 2020 limitation and will be fully deductible) while the other 50% of the excess business interest is subject to the general excess business interest limitation rules (i.e., only allowed in a future year to the extent of excess taxable income or excess interest income to the partner from the same partnership).