CARES Act: Capital improvements can amplify a tax refund

By CREJ October 19, 2020

Roof coatings, which the IRS classifies as a maintenance expense, can be deducted in the current year as well. Courtesy Rocky Mountain Photography

Kelly Stitzer
Director of operations and
vice president, CIG Construction
and Roofing

The Coronavirus Aid, Relief, and Economic Security Act was passed in late March, shortly after the scope of the COVID-19 pandemic first became clear. The law’s primary focus was on helping businesses to preserve liquidity through the course of the shutdowns that had recently begun. While most people are familiar with the law’s flagship Paycheck Protection Program, the CARES Act contains a number of other measures that can help businesses save money and improve cash flow.

Certain capital expenditures, in effect, can be funded partially through some of the lesser-known provisions of the CARES Act. With some smart tax planning and fast action, businesses potentially can reap significant financial benefits from the law. To take advantage of those opportunities, though, you need to start planning now because the window of opportunity is closing fast.

What is an NOL? Section 2303 of the new law expands the availability of net operating loss carrybacks, which allow certain taxpayers to reduce their tax liability from prior years by “carrying back” losses incurred in more recent years. This reduces taxable income in those prior years, resulting in an i m m e d i a t e tax refund.

Let’s say, for example, that your b u s i n e s s paid taxes on $200,000 of income in 2017. If you had a loss of $50,000 in 2018, you can retroactively apply that loss as an offset to your prior year’s taxable income. This would reduce your taxable income for 2017 to $150,000. Your 2017 tax bill would be reduced retroactively, and the IRS would refund the difference to you.

Under the Tax Cuts and Jobs Act of 2017, NOL carrybacks were to be eliminated for most taxpayers. Under the new law they’re back, at least temporarily. The CARES Act provides for a five-year carryback of losses incurred in 2018, 2019 or 2020. The new law also removes the previous ceiling on NOL carrybacks, which was limited to 80% of taxable income. This increases the amount of loss that can be retroactively applied to reduce prior years’ taxable income. Finally, provisions in the new law expand the amount that can be deducted by pass-through business owners to offset nonbusiness income.

How does this benefit businesses? If you showed a loss in 2018 or 2019 but paid taxes on income in any of the previous five years, you may be eligible to apply for an immediate refund. If you show a loss in 2020, likewise, you can carry that loss back to prior years, also resulting in a tax refund – providing your business with additional liquidity.

This is where things start to get interesting. By accelerating certain capital expenditures, you may be able to generate a tax loss for 2020; even if your business is otherwise profitable. If you paid taxes in any of the past five years, this could result in a refund of taxes you already paid to the IRS. Unfortunately, however, there is an expiration date on this opportunity. Most businesses only have until the end of 2020. Businesses with a noncalendar fiscal year have until the end of their 2021 fiscal year.

How does this benefit building owners? Bonus depreciation is a key opportunity, especially for building owners investing in certain types of improvements. Investments in roofing or roof coatings, for example, were reclassified several years ago by the IRS, rendering such investments eligible for deduction under new IRS bonus depreciation rules. Businesses that invest in roofing for nonresidential real estate may be eligible to expense 100% of those costs in the year the work was performed, which can result in a net loss for the year. Roof coatings, which the IRS classifies as a maintenance expense, can be deducted in the current year as well.

By moving those kinds of investments forward – that is, by making those investments now instead of in a future year – businesses can establish a net loss in 2020 for tax purposes. That loss can be applied retroactively to offset prior years’ taxable income, resulting in a refund. For most businesses, that opportunity will go away at the end of 2020, as the NOL provisions of the CARES Act will expire for fiscal years beginning on Jan. 1, 2021, or later.

For building owners who employ cost segregation as a tax planning strategy, there are potentially huge benefits to be realized from the CARES Act’s NOL carryback provisions. Cost segregation is the process of identifying specific components of real property to be treated as “personal property” or “land improvements” that may benefit from shorter depreciation periods under the federal tax code. By accelerating depreciation to recognize expense in the current year, building owners can generate tax losses and apply them retroactively to previous years.

What to do? If you are considering certain types of capital improvements, you should act now to find out if these provisions could work to your benefit. Every business is different, and IRS regulations are complex; so you should consult your tax adviser to find out if the NOL carryback provisions of the CARES Act could work for you. If you are eligible, your business could save tens of thousands of dollars in the process.

Featured in CREJ’s Oct. 22-Nov. 3, 2020, issue