A Q&A with tax law pros
by Alicia Hoisington
Major tax law changes took place at the end of 2017 when the Tax Cuts and Jobs Act was introduced, but hoteliers are still navigating the waters as the Internal Revenue Service continues to clarify guidelines.
Because last year was the first filing season under the new changes, some hotel owners and operators haven’t had the time to completely assess the situation in order to take full advantage. That’s why experts say now is a perfect time for a checkup. Today’s Hotelier connected with three such experts to get the 411 on the changes affecting hoteliers on the federal level.
Going into this tax season, what should hoteliers keep top of mind in order to take advantage of tax law changes?
Lillian Chen, tax partner at Moss Adams: One might want to consider Opportunity Zone investments. If a hotel owner has capital gains in 2019 and is looking to invest in another hotel or other real estate, it might be worth checking whether the target investment is sitting in a designated Opportunity Zone. There are more than 8,000 census tracts in the U.S. designated as Qualified Opportunity Zones, so it is quite possible that an investment one is otherwise going to make is in a QOZ. There are strict requirements to deal with, but with proper planning and structuring, investing in an Opportunity Zone will not only provide for deferral of tax on capital gains realized in 2019, but it can also result in permanent exclusion of gain on sale of the QOZ investment in the future if the investment is held for at least 10 years. The QOZ rules are complicated but worth reviewing if the right conditions exist: capital gains to reinvest, an otherwise attractive investment located in a QOZ, and a desire to hold for the long term.
Mark Flinchum, partner at Katz, Sapper & Miller: Most hotels are structured as pass-through entities for tax purposes, such as S-corporations, partnerships, and LLCs. For these types of entities, the new tax law created the Qualified Business Income deduction, which allows an operator of a hotel to potentially get a deduction of 20 percent of their taxable income. However, if the QBI deduction is not limited, it basically lowers the hotel owner’s federal tax rate from 37 percent to 29.6 percent. There is a limitation on the QBI deduction, however. For example, if taxable income is $1 million, the QBI deduction is going to be the lesser of 20 percent of that taxable income, which would be $200,000, or 50 percent of the qualified wages. There is an alternative calculation that allows the taxpayer to take 25 percent of the eligible wages and 2.5 percent of the Unadjusted Basis Immediately after Acquisition to determine the QBI deduction limitation. The regulations provide more on how to determine UBIA.
Stefi George, tax partner at Akerman: The highest profile changes were those that affect corporations and choice of entity. A lot of hotels do not operate as C-corporations and typically have not because of the double tax. With the substantial reduction of the corporate tax rate from 35 to 21 percent and a number of other changes that were made available only to corporations, such as eliminating the alternative minimum tax, it makes it at least worth considering whether a corporate structure might be beneficial for your ownership. If your structure allows you to take advantage of the new pass-through deduction available for non-corporate entities – partnerships, LLCs, S-corporations – you should plan ahead to maximize that deduction to the fullest extent possible. The qualified business income deduction provides an up-to-20-percent deduction, drastically reducing the tax rate applicable to non-corporate entities, but it may require careful planning and some changes to your structure to take full advantage of the benefit.
What were some of the biggest changes that affected hoteliers for the positive?
George: A major change that affects hoteliers is the increase in bonus depreciation. It’s now 100 percent for qualifying properties, increased from the previous 50 percent. That has provided an immediate benefit and huge boon to the industry. The upshot is there is an incentive to immediately invest in property because this is a short-term benefit that will decline. It’s 100 percent now, then will decrease over time and phase out in 10 years, so the highest benefit to invest in a property is now. But, there are some issues still being sorted out with respect to qualified improvement property, which covers the enhancements to the interior of the hotel. Because of what people believe is a drafting error, these interior enhancements are not eligible for the bonus depreciation. There is a conflict between wanting to maximize the benefit but not wanting to make certain interior enhancements until Congress issues a fix. Generally, though, it’s been a positive impact for the hotel industry and a welcome change to the code.
Chen: The change in bonus depreciation from 50 percent to 100 percent was one of the most positive changes for all taxpayers, including hoteliers. Hotel owners tend to spend a significant amount on property of the type that would qualify for bonus depreciation. Aside from the obvious furniture, fixtures, and equipment in a hotel and current qualified improvement property issue, a cost segregation professional can typically identify items that are not as obvious that also can be written off over a much shorter recovery period. The tax savings from accelerated deductions potentially increases cash flow to owners immediately. Cost segregation is a great tax deferral strategy, and owners can use the excess cash to reinvest in the property or make other investments.
How about changes for the not-so positive?
Flinchum: One of the tax reform changes that could be problematic for hotel owners is the changes to section 163(j). Depending on leverage, the applicability of section 163(j) could subject the hotel owner to interest expense limitations. The interest expense limitation comes into play if your interest expense exceeds 30 percent of your modified taxable income. Modified taxable income is calculated as the taxpayer’s earnings before interest, taxes, depreciation, and amortization (EBITDA) times 30 percent. However, starting after 2021, the modification becomes 30 percent of your earnings before interest and taxes without the depreciation and amortization add-back. We’re projecting there could be some significant limitations in 2022. Section 163(j) doesn’t apply if your gross receipts are below $25 million, but a number of hoteliers have several properties, and there are aggregation rules requiring combination of revenues of all the properties to determine if a taxpayer is subject to 163(j).
George: There were a couple of changes that weren’t so positive depending on your position. One of the changes was that net operating losses can no longer be carried back; they can only be carried forward. And they can offset only 80 percent of your income in a given year. You’re going to need to pay some income tax. And, there’s also a limitation on excess business losses from active businesses. So, if a new hotel is expecting to generate losses in its first two years, this would have a negative impact because it wouldn’t be able to fully offset its income with those losses.
Keeping in mind that tax law is always subject to change, experts say it’s best to plan with what is known today. While sunsets are on the horizon for many regulations, hoteliers should take advantage now to see the best gains.