2023 Tax Issues Affecting Multifamily Real Estate Investors

By Thomas L. Bakaitus, Jr., CPA, MST
[email protected]

On March 7, 2023, Tom Bakaitus spoke at the 2nd Annual Pittsburgh Multifamily Symposium at Nova Place and addressed several tax changes or concepts that multifamily real estate investors need to be aware of. These include changes related to energy efficient tax credits and deductions and a new development in the Pennsylvania treatment of like-kind exchanges.

Energy Efficient Tax Credits

When President Biden signed the Inflation Reduction Act of 2022, one of the results was the expansion and modification of the energy efficient home credit as defined in the Internal Revenue Code (IRC) Section 45L.

This is a tax credit designed to provide incentives for residential home builders and multifamily developers for new construction designed and built to reduce energy consumption. The construction must meet the Energy Star Home Program or the Department of Energy (DOE) Zero Energy Ready Home Program requirements.

45L Extension and Expansion

45L was originally set to expire on December 31, 2021, but is now available for tax years 2022-2032.

The 2022 credit can be $2,000 per unit and the building cannot be greater than three floors above surface. For 2023-2032, the credit is $5,000 per unit and the building can be greater than three floors above surface.

Complexities

The significant changes made to IRC 45L through the Inflation Reduction Act of 2022 are great conceptually but are fraught with complex issues including defined terms and certifications.

For example, an “eligible contractor” must obtain certification from an “eligible certifier”. An “eligible contractor” is basically the person who owns and has basis in the building. If a third party hires the contractor, the person who hired the contractor is then the “eligible contractor”.

The credit is computed on IRS Form 8908 which becomes part of the tax return for the year the building is placed in service and the credits reduce the depreciable basis of the property.

Energy Efficient Tax Deductions

The Inflation Reduction Act of 2022 also made significant changes to IRC 179D, an additional deduction for energy efficient commercial buildings.

The deduction in 2023 is $5.36 per square foot for buildings that create certain energy efficiencies and is available to owners of commercial buildings. In 2023, if a tax-exempt entity owns the building, the deduction can be passed to the person “primarily responsible” for the design, which includes architects and engineers.

In IRC 179D, the term “commercial buildings” includes multifamily residential properties with greater than three floors above surface.

Like-Kind Exchanges – IRC Section 1031

IRC Section 1031 is another federal provision that directly impacts multifamily real estate developers. If a taxpayer disposes of a property and has a gain, the gain can be deferred if the property that was disposed of is replaced with a similar (like-kind) property.

The big news here is related to the way that Pennsylvania is now treating like-kind exchanges. On July 8, 2022, House Bill 1342 was signed into law, making significant changes to Pennsylvania’s income tax laws including granting the tax deferral benefit of like-kind exchanges beginning in the 2023 tax year.

Prior to enactment of this legislation, Pennsylvania was the only state in the nation that did not provide a state tax benefit for like-kind exchanges. However, it should be noted that this deferral of gain applies only in the context of income tax. Pennsylvania taxpayers who engage in like-kind exchanges after 2022 may still be required to pay sales and use tax and transfer taxes, as applicable, for each transfer.

Historical Tax Credits – IRC 47

Historical tax credits are available to the owner of any income producing property which meets certain criteria. This is a 20% credit that, following the Tax Cut and Jobs Act (TCJA) of 2017, must be spread over five years.

To qualify, a building must be at least 50 years old, demonstrate an exceptional significance to the community, and must be listed on the National Register of Historic Places. This program is administered by the National Park Services (NPS) and the State Historic Preservation Office (SHPO) and building owners can apply directly to the NPS.

The credit is 20% of the Qualified Rehabilitation Expenditures (QREs) and includes construction costs and other allocated costs incurred during a 24-month period. However, a request can be made to expand to a 60-month period. The depreciable basis of the property must be reduced by the amount of the credit.

The application process for Historical Tax Credits is critical and must be followed exactly. Generally, the architect files the paperwork, which is completed in three steps, referred to as Part I, Part II, and Part III. It’s also very important to note that a building cannot be placed into service before Part I is filed or no Historic Tax Credits will be granted.

Summary

Energy efficient tax credits and deductions, PA’s treatment of like-kind exchanges, and Historical Tax Credits are only a few of the significant tax changes and issues impacting multifamily real estate developers.

For a better understanding of these, and other tax regulations, contact Louis Plung & Company Tax Partner Thomas L. Bakaitus, Jr. at [email protected].