Leveraging REITs Post-OBBA: Tax-Smart Strategies for Private Lenders

Kevin Kim:

Alright, good morning, good afternoon, or good evening for those of you on the East Coast or international. Thank you for joining us on this webinar with Fortra Law. Today we are going to talk about some very, very interesting topics. I know it might be a little boring, but we're talking about taxes today. We're going to wait a little bit to make sure that the attendees can fill in. Before we get started, I do want to do a little bit of housekeeping before we get started. Housekeeping is going to be about q and a. So if you have questions, there is a button in the Zoom application that says q and a. Click that button and type your questions in and you'll be able to answer our questions. We'll get to those as we move through the webinar. On top of that, this webinar will be recorded and available on our YouTube page, so please check that out.

The slides will be part of that. So I get a lot of questions. Other slides available for download. They are going to be on the YouTube page, so just wait for that to come out and so that you can enjoy it at your own leisure if you want to get refreshed on this heady topic that is tax. Let's see here. Looks like we've got some people coming in here. I think we're getting pretty close to critical mass. So let's get started. Good morning, my name is Kevin Kim, partner here at Fortra Law. I lead the firm's corporate and securities division. I am also the host of Lender Lounge with Kevin Kim. Today we have some of my favorite CPAs in the industry with our friends at Arm know. So guys, welcome to the webinar. I think everyone on the call probably knows you guys, but let's just do some intros real quick and give us some information about Armino and we'll get started. Who wants to go first?

Ryan Barragar:

Hey guys. Ryan, er here, tax partner at armino. Been working with our private lenders over the course of the past five or six years, especially when it comes to implementing REITs into their structures to take advantage of some of the tax efficiencies that we're going to be talking about over the next hour or so. So excited to be here, Kevin. Thanks for having us. And kick it over to David.

David Erard:

Yeah, hi everyone. David Erard. I am the leader of our real estate tax practice here at Armanino. I work with Ryan and Jason and Kevin and a number of folks on a lot of these REIT implementations. I know there's some other topics that we might want to cover as far as interesting things in the Big Beautiful Bill, which I still have trouble getting that phrase out of my mouth, but excited to be here. Hopefully we can answer some tax questions and give everybody a little bit of guidance. Certainly not intending to try to make anybody an expert throughout this, but more to maybe give you some prompts and some ideas and an understanding of how the Big Beautiful Bill might be impactful to you and your clients.

Kevin Kim:

Alright, so as you guys know who are listening in, the point of today's webinar is to go over the one Big Beautiful Bill act and it was enacted on July 4th signed by the president. It passed by hair, but both houses. And we are currently now making sure that we understand the implications of this both for private lenders but also in general, right? But this is not the big chunk of this bill that's really meaningful for us. Industry people is actually not new. A lot of this stuff isn't new. So anyone want to set the stage for us? I guess the, I guess you can call it the historical aspect of the tax implications for this bill and how it all got started and where we are today with it.

Ryan Barragar:

You want to take this one, David?

David Erard:

Sure. So I think the way I think about the Big Beautiful Bill is a lot of it has to do with extending things that were added on a temporary basis during the first Trump administration. One of the big items that came into the code that's affected a lot of our private lenders was this section 199 A deduction. And just without going into the weeds on exactly what that is, it works out that to be a reduction in your tax rate effectively via a deduction of 20% of the income that it relates to. And for private lenders, some of the requirements for that 199 A deduction look to the amount of W2 wages and the amount of basis and depreciable property. So absent adding a REIT to the structures, the lenders were not able to qualify for this benefit under the way it was set up.

So one of the benefits of the 2017 bill that has now been extended is that the 20% deduction applies to REIT dividends without regard to the depreciable asset basis standard or the W2 wage standard. So the REITs became a fairly clear path to being able to get the deduction that you otherwise would not have been able to. So we saw a huge uptick along with Kevin and his team of folks in this space really looking hard at whether adding a REIT to their structure or converting their structure into would work out in favor of your investors. I don't know the numbers off the top of my head, but I'm going to guess We've worked on 40 to 50 of these REIT implementations together, and I think we've found that for folks that are lending against real estate, the REITs can be a very good option.

The process that we go through is we'll have one-on-one conversations with folks that are considering this just to help you understand exactly what a REIT is, how does that change things? What should your investors expect? So there's a little bit of an education process on what state of play today versus with the REIT and the structure, but we found that most of the clients that we've spoken with after we run through the pros and the cons or have chosen to add these REITs into these private lending structures. So from a headliner perspective, Kevin, I think that's the big change from before that remains relevant to our lending clients. The Big Beautiful Bill did extend or make permanent the 199 A deduction. Just for a little bit of background, the corporate income tax rate was also reduced from 35 to 21% as part of that 2017 bill. I think of the 199 A deduction as a parallel reduction to the individual tax rates, but only for certain types of income. So that's probably the headliner. There's other things that are being discussed, but again, I think of the Big Beautiful Bill largely as being extension of things that were already there. If you think it'd be helpful or interesting, we can talk about maybe some of the more heavily negotiated provisions and what people were thinking about Kevin, but I'll defer to you on where we go from here.

Kevin Kim:

Yeah, let's set the stage a little bit because I think the bulk of our conversation will be around the READ strategy because that is a meaningful deduction for investors in the sector, but there are other aspects to this bill that are remarkably influential to both our audience as lenders, but also their audience, so their borrowers and such. How will this influence the real estate investor community as well? Because ultimately if they win, we win, right? I would like to just give a high level touch of the different features that this bill has that are outside of the 199 A extension or made permanent part. For example, there's things about, I can call it the depreciation rules. There's this discussion on salt. There's a lot of things that were really important to people who are lending and also people who are investing. So any other meaningful discussion points to bring up? Let's talk about,

David Erard:

Yeah, maybe let me cover the state and local deduction or salt and then Ryan, I'll ask you to cover the depreciation part of it, the state and local tax deduction. So just to give everybody some context and background. Prior to 2017, state taxes were deductible by individuals. There were some limitations for alternative minimum tax and some other things where maybe you didn't get full benefit, but the general rule was that state taxes were fully deductible. So that basket included things like property tax as well as state income taxes. And not to make this a political conversation, but blue states tend to have higher state income tax rates than red states do. And so I think as part of the 2017 bill, they added in a $10,000 annual cap on people being able to deduct their state income taxes on personal returns. And that had the most impact on places like California and New York where state income tax rates are fairly high and also property tax rates were fairly high.

So even your middle income earners were running up against this $10,000 salt cap. And that was probably one of when they passed the bill in 2017, that was certainly one of the pay fors, meaning when they'd go through and they do these bills, they have to look at the budgetary impact of the tax breaks that they're giving and then the tax, the ways that they're generating revenue through new streams of tax. So reducing the benefit of state income taxes was what I think of as one of the big pay fours of the 2017 bill. It also, not surprisingly, has not been all that popular with people because there are a lot of even middle income earners like I was saying, that that run up against these limitations. So a big part of the horse trading and a lot of the headlines prior to the passage of the Big Beautiful Bill had to do with, should we expand the salt cap?

Should it increase from 10,000 to a larger number? And that did happen, it went up to 40,000, but it also phased back down to $10,000 fairly quickly for people in the higher income brackets. I think it starts to phase back down after 500,000 of income. So long story short, the assault cap is still in place. It was increased to 40,000, but I would expect that most people who would really benefit from it are still going to be capped at that $10,000 amount because of the political sensitivity on it and really which states were suffering or where citizens were likely to run up against the cap. It was one of the, I would say kind of the headline conversations, at least as a tax guy on one of the very interesting points that they were negotiating. But like I said, they did keep the salt cap, they did keep a salt cap in place.

It was increased that increased phases out. And then on a secondary issue, for those of you that have a lot of income that you're receiving on K ones from partnerships, there was a lot of conversation around whether they would change the rules to prevent some workarounds that were put into the code where a partnership would pay state income tax on behalf of a partner and the partner would be able to deduct that without being subject to the $10,000 annual cap. So a lot of noise around the salt cap, and I think it got a lot of attention because it is a sensitive item and who it was impacting, but there's not really, I would say as I'm looking at it now, I don't think things on the salt rules are a whole lot different for people in 2025 than they were in 20.

Kevin Kim:

Very good. Ryan, you want to touch on the, we're going to go a little deeper later, but you want to touch on the other aspects that you know about?

Ryan Barragar:

Yeah, I would say the other big component of the bill that a lot of our real estate clients were keeping a keen eye on where the bonus depreciation, so bonus depreciation, as many know the benefit was being reduced by 20% every year until there was going to be a complete phase out in 2027. This new bill stated that bonus depreciation is restated and not only is it restated it, it's at a hundred percent. So all your short lived property is eligible to be basically expensed in the first year for any asset that's been placed in service after January 19th, 2025. So that's a big win for our real estate owners and something that's going to generate a lot of deductions upfront that's going to help with their tax strategy.

David Erard:

And Kevin, that's a huge financial impact for people that own real estate. And it's certainly one of the themes of the Big Beautiful Bill is the intention of incentivizing people to build things and do things within the us, which is part of the reason the bonus depreciation came back. I don't know that it's going to be directly impactful to those that are lending, but I think from a business standpoint, probably helpful to understand the issues and the benefits that some of your borrowers might stand to get through these bonus depreciation and additional expensing provisions.

Kevin Kim:

And many of our listeners are also ancillary involved in real estate investing as well. So it's important to know all that it's a meaningful thing for all of 'em. And also those of you listening who want to buy a heavy ass car, that's

Jason Gilbert:

Appreciation there. So Ryan, you touched on something that I want to make sure that we call out because the bill is effective January 19th. So there's a 19 day funky window at the beginning of the year that if you place something in service as of January 1st, it doesn't become effective until the 19th, right?

David Erard:

I think it's a little bit more nuanced than that, Jason. I think it applies to tax years ending after January 19, and it's kind of fascinating as to why they would pick that date. But for the gist of it would be for most people, that means these provisions kick in 2025 because your year ends on December 31st, 2025, but there's got to be some fiscal year thing, or sometimes when they're proposing a bill, they'll pick a cutoff date based on when something was initially proposed. So I don't know off the top of my head, which the reason why they picked January 19, it could be something as petty as there's a fiscal year company out there that has a January 20 year end or January 18 year end. It could also be something that they built into or put into the bill based on when things started being proposed.

Kevin Kim:

Also, just because they're lazy in publishing the federal registers, it's hard to do.

David Erard:

It could be, it could also have to do with January 20 being the day that the administrations change. So pick a reason. But yeah, Jason, your point is well noted that for most people, these provisions are effective in 2025. If you happen to have a fiscal year that ends sometime in the first 18 days of January and in 26 years of practicing, I've seen that zero times. But it's possible somebody does.

Kevin Kim:

Alright, so let's get deeper into this 20% deduction because this is the big mover and shaker for all of us. We've been watching this like a hawk, I know I have everyone was for the past year and a half now, people on the fun side have been reticent to go in the direction of the reed strategy because they were of the mind that it might get killed at the end of this year. Now that we know that it's made permanent. Let's get into the deduction itself and then let's kind of get into the REIT aspect of things. So give us the details of the deduction because it's nuanced. You guys gave some color earlier. It's not as necessarily eligible for everybody. Any kind of businesses, certain kinds of businesses qualify, certain kinds don't. Correct.

David Erard:

Correct. So high level, most businesses would qualify for this if you're just manufacturing and distributing, doing just running a prototypical business. And then they carved out a few businesses for consultants, accountants, lawyers,

Fund managers, so people that were on whatever, however, we got onto the naughty list I guess we got there. So there's some businesses that were carved out from it. And then they have standards that you have to meet in order to get the deduction. And so maybe I'll back up and just talk about the mechanics of it. So it's not something your fund or if you have a REIT that the REIT would claim as a deduction on your own tax return. It's something that is passed through in a sense. So you give, in a fund setting, you would have a K one going to investors that would have information that they would use to calculate the deduction on their individual tax returns. So one of the, in my view well negotiated provisions from the last time around was that REIT dividends. And so there are two types of REIT dividends.

There's ordinary dividends, which I think of as a distribution of rental income or interest income. There's capital gain dividends which get taxed at capital gain rates. So from a REIT dividend standpoint, the 20% deduction applies to those ordinary dividends and the vast majority of what our clients in the lending space would be passing out to investors will be ordinary REIT dividends. So those qualify without regard to a couple of thresholds that were put in relating to how many, part of the incentive was we want you to buy property in the US and we want you to hire us people. So you'll get this 20% deduction as long as you have the rules would think of as an appropriate amount of wages in the business or an appropriate amount of depreciable property used in the business. So again, kind of the incentive back in 17 was we want you to hire people and we want you to buy stuff. Fortunately for those that have REITs, there is a real synergy from a private lending standpoint in the sense that the REIT dividend and adding a REIT to the structure is really the most likely and probably only way that the type of income that you're getting from private lending is going to qualify for this deduction. So Kevin, I don't know if it'd be helpful to go any more in the weeds than that. We could probably spend a couple hours talking about it, but that's kind of the gist of it,

Kevin Kim:

And I think it's important for the folks to know. The truth behind the deduction is technically for your funds, your investors who are below a certain threshold of income or depreciable assets, if you're just a regular fund, you don't have a subsidiary read or you're not a you, investors can technically qualify on their own if they individually as the investor can meet the necessary threshold requirements. If they're capped out, they're capped out because of their income or their net worth, but if they're not they, they're eligible to claim it for regular funds. For our audience members who do not have their REIT yet for their fund, but want to understand the eligibility for their investors, it is available to them provided they are under the certain bracket. Now my understanding is the bracket phase out is a little bit higher now.

David Erard:

Yeah, I think they changed that a little bit, but the gist is you weren't subject to the wage or depreciable property limitation if a given person's income was less than 350,000 a year, and I think that might've been increased to 400 under the Big Beautiful Bill. So yeah, some investors, Kevin would qualify for that deduction without a reit, but I don't know offhand how many folks are getting investment of a meaningful size from folks that would be below those thresholds.

Kevin Kim:

Right. And from a strategy standpoint, this is the reason, probably the reason why this became such a popular trend was the vast majority are running accredited investor only targeting family office, high net worth, ultra high net worth type investor. They're going to be well above the bracket, so they're going to be phasing out. So that's an important consideration as to why to think about this as a meaningful deduction for your investors and it is on them. It's not necessarily us that we should be educating our investors as to you should be taking your K one to your own tax people and claiming this deduction. And to be clear for our audience, I get this question all the time, this only applies to taxable investors. If the investors investing is a non-taxable plan, it does not apply to them. If you've got an offshore feeder fund, that complicates a lot of things as well.

So we're not going to get in the weeds of that. We could spend hours on that one as well. Okay, so let's talk about, we know now that going into a REIT will ensure that anybody who's taxable can get that deduction, which is the big reason why I know Jason and I were doing a lot of roadshows together with clients from at 17 all the way to 1920 ish and explaining this to clients from a strategy standpoint. Now, because this has become so prevalent, you guys, we've done so many together and collectively the industry has done so many, and so this has become kind of standardized amongst fund managers. It's become quite common to see as an add-on component early stage, and I think our groups both advocate for the read strategy to be a subsidiary reed strategy as a means to maximize efficiency. Ryan, Jason, you guys want to talk about that? I know Jason, you and I have presented that to clients many times, but I know Ryan, you're running on that side now. So anything you guys want to talk about as it pertains to the structural component as to why clients are going in that direction?

Ryan Barragar:

Yeah, so I think it can be a little bit scary when you say at aee to your structure. So just from a high level, what you're doing is you're creating a new entity that sits below the fund and the fund is a hundred percent owner of the reit. So you're adding a new entity and that entity is a special type of entity for taxation purposes. It falls under the corporate rules, but where it gets specialized tax treatment is the REIT receives a deduction for all the income that it distributes throughout the year. So that's how you're going to reduce the double layer of tax that a corporate entity generally generates. So it's a hybrid, it's corporation, but it acts like a flow through because there's minimal entity level tax. There are some actual ancillary benefits for the REIT to be taxed as a corporation. So not only does it receive the 20% deduction, but it also by virtue of being a corporation, it blocks UBTI unrelated business taxable income that your tax exempt investors are very sensitive to, and it also blocks the state source income at the fund level.

So working with a lot of fund managers, a lot of the questions that we receive are, how do I block UBT? I have a lot of IRA investors, they just can't have it. How do we get rid of that? And UBTI is generated by either participating in ordinary business activities or investing in a partnership that has some kind of leverage to it. So you you're taking on debt to create income. When we have all the activity being held at the reit, it will block all the debt, anything like that, the investors receiving a REIT dividend, which would not be subject to UBTI and not subject to tax. So that's a really important issue. Second is when you don't have a REIT and you have a fund and you're operating in different states and lending in different states, you have to source the income to where the activities are held.

And different states have different rules that create kind of a tax issue where you're providing K ones to these various states to all your investors, and they may be filing in 15, 20, 25 states complicating their own individual tax return. And there's withholding rules that each state can apply from time to time. So you create this big administrative burden by operating in other states. And when everything is pushed down to the reit, the REIT kind of captures all of that and the investor will pay tax, they'll pay federal tax on their REIT dividend and they'll pay tax in their home state on the REIT dividend because it'll block all the other state source income

Kevin Kim:

Investor that from an operator standpoint, it's a huge burden off of everybody. I mean so many clients that a lot of their investors moved to California lenders who their investors moved to Nevada, Texas, Florida, and they're so upset now because they have to pay for California income tax. This is one of the most interesting components. It reduces the operational burden on the client significantly, it seems like to comment on the UBTI aspect, I've significantly seen, I have a client that said, even if this tax bill died this year, I actually don't care. The UBTI aspect alone has opened so many doors for us because there are certain types of investors when you're going out and raising capital, they can't touch anything that has UBTI. So a lot of these charities and endowments, they can't touch UBTI. And so this is massively beneficial for our clients who have access to those types of investors.

They can now raise the money and there's a lot of interest in those communities because they need an income type investment. So it's a really interesting opportunity for those of you guys who are really now storming those beaches and getting out there and you kind of hit the cap on the accredited investor kind of community. There's a lot of interest both in the RIA community and in the non-taxable quasi institutional investor community that really love the fact that there's no UBTI in this. Jason, you and I spent a lot of time together on the road with clients advocating for a substructure, and there were a lot of reasons why I can get into the tactics of it, but I really want you to share your thoughts on it because you and I sat in many rooms together with clients and walked them through it many phone calls, and I think it's really valuable for all us just to understand why are we doing this as a subrate? I give this all the time. Oh, I can do it in my fund right now. I've got a hundred plus investors. I got this, I got that. Give us your perspective on it because I really liked the way you explained it last time we were in a room together, so

Jason Gilbert:

Well, let's be honest, back in 17 and 18, we weren't sure how long this was going to last.

Kevin Kim:

Oh, for sure. Right?

Jason Gilbert:

Yeah. We were all hedging on the fact that it was going to be good while it was here, and then if it disappeared, how do you get out of it?

Kevin Kim:

Because

Jason Gilbert:

Ryan and David will attest once you make the reelection, so if you do the reelection at the fund level, you're not going back. You're baked, it's set. You can't unwind it. You'd have to close the fund and start launch a new one to get out from underneath the reelection. So by doing the sub read, it gave us all the flexibility. If this thing's actually sunset some point in the future, we just close it up, wind down the reit, it's a sub of the fund, move all the loans back up into the fund, the REIT goes away and you just go back to being your standard fund structure. What we found along the way while we were hedging for the tax bill changes was the sub gives a large amount of flexibility in the way that you handle the assets, the way you deal with performing and non-performing. You start having foreclosure proceedings and you take back the assets. It's not easy functioning with those assets in a reit. There's nuances and Ryan and David could jump into the heavy details of those nuances, but it's nuanced as soon as you start taking back the property and where you house it in the REIT and if you keep it in the reit, so by having the sub reit, you had the flexibility to park those assets back up in the fund

Kevin Kim:

Or a PRS, right in a taxable REIT sub, right?

Jason Gilbert:

Or you can go to a taxable subsidiary, but it didn't force you to automatically create a taxable REIT subsidiary. You didn't have to, you could just park 'em back up in the fund. You can move them out of the reit and you had some flexibility to move assets or make some moves. If you had bad REIT income or you had an opportunity to generate income that was going to be bad REIT income, you still had the fund sitting there as a standalone entity, you could just make those investments up at the fund. If you made the re-election as your main entity, you lose lost a lot of flexibility.

Kevin Kim:

And from a tactic standpoint, whenever we're designing a fund strategy, most of these are open-ended. Flexibility seems to be the priority for a lot of sponsors because you're going to be operating this thing for the longest one we've seen in operation is 20 years. You're going to be running this thing for a long time and you need flexibility in the business plan and in operations. And that's to me, the shining beacon of why a subgroup makes the most sense. I've also found that tactically speaking, I really like, for me it's, it's almost like an insurance policy, right? Because God forbid you were to screw up on the compliance and we're not going to get into the compliance today. I've done a bunch of webinars on that. We'll link to those in the below because we have a bunch of webinars we've done on that. But God forbid you were to mess up on the compliance, you can go back, you can live the fight another day with your open-ended fund and you can stand up a new one.

I've also had, it was remarkably simple. We had a very complex org chart with different feeders and masters and all this stuff that, well, that makes my life a lot easier. I don't have to worry about one fund just becoming a read. I can have everything feed into this thing, and that gives my client a lot more flexibility for their investors. So I find that the sub strategy is immensely flexible, both just in those operational aspects alone, but as they scale now, they have so many different options to the degree where now clients are now exploring securitization, they're exploring JVs and they're integrating their REITs in one way or another with those strategies as well. And it's immensely useful because of the tax deduction. Beyond all of that, my thoughts have been, the only con that I can really think of is the read itself needs to have the a hundred or more investors, and this is the one thing that I want everyone to, I don't want to get too deep on this, but everyone ask this question, I've got a hundred investors in my fund.

I'm good, right? No, no, no. The subsidiary REIT needs to meet the test. You guys want to learn more about testing? We have a whole video on that. We can get through that with you guys through that video. I do want to touch on the new developments. Now where we are in this kind of REIT world, I mentioned taxable REIT subsidiaries. First of all, explain what those are. Who wants to, Dave, you want? Because I don't think everyone really understands what they are because there's a unique strategy to use them, particularly when it comes to things you shouldn't do in a REIT like loan sales and foreclosure properties and selling REO. So the idea, give us the stage when it comes to what A TRS is, and then we'll kind of get into the new changes.

David Erard:

So a taxable REIT subsidiary is simply a corporation that is owned wholly or in part by a reit. And what it's used for is to manage some of the REIT testing when you have assets or activities that are not good for REITs. So one of the REITs, if you're comparing a REIT to a traditional fund, REITs have a little bit more administrative stuff that you have to deal with. You have to make sure that the type of income and the type of assets that are generating income comply with the REIT standards. Most real estate backed loans will. But then you get into some nuances where, for example, let's just say you've made a loan to a hotel and you have to foreclose on that, or you've made a loan to a condominium development and have to foreclose on that. Hotels and condominiums are two types or two examples of things that would create income that wouldn't be good for a reit.

Hotels, you can use a special purpose structure that's a lot of brain damage, but doable for a REIT condominiums, there's really no way around. So a lot of times taxable REIT subsidiaries are used for holding assets that would create the type of income that would be problems for a reit. So in, I think it was back in 2018 or so, or maybe earlier than that, you're limited on the size, relatively speaking of how big can a taxable REIT subsidiary be? So 20% was the standard for a long time it went up to 25% temporarily, I think as a way to help people get through the 2008, 2009 crisis and then decreased back down to 20%. The Big Beautiful Bill allows it to be up to 25% of the value of the REITs assets. So it's helpful in the sense that you have a little bit more room if say you have one of your larger loans that converts to REO and that REO needs to be held in a reit. This is a tool that allows you to do that without compromising your REIT status.

Kevin Kim:

And for those listeners, where this becomes very useful is either loan sales, right? Loan sales is a big issue for REITs, not the end of the world, but it complicates some of the compliance I've used TRSs significantly. For clients who'd like to do loan sales, this added 5% is very useful In the foreclosure world, I would see, I think it's the primary driver. It really makes the tax bill a lot easier on the client to do it this way instead of going, moving the asset to the parent fund. Now, if you exceed 25%, you're going to have to use the parent fund. But what's interesting is this coincides with another kind of quasi recession that we're seeing in real estate, namely office. And so there's a significant amount of REO in office, and then also you're seeing it now in industrial real estate too. So I think it's very useful for our clients who are doing commercial bridge and commercial construction loans to think about. Now, the Reid is a very important topic, and I don't want to just overshadow the Reid strategy for our listeners. One thing that was kind of a point of confusion, this goes to a question we got from Rob over at Boomerang, the deduction, there was some talk for a while that the deduction was actually higher. I think it was like 23%. I want to confirm because I'm pretty sure that it's not law. It does not pass through. It did not actually end up being 23% we're confirmed on that, right?

Ryan Barragar:

Stated 20% correct.

Kevin Kim:

Right. I think what happened was the media kind of confused everybody. So it was in one of the proposed proposed edits and actually never made it through to the final bill. So it is,

David Erard:

I think it might, Kevin have been part of the Senate bill. It was, but I don't think when they reconciled and passed it in the final version, they did not increase it

Kevin Kim:

And the Senate wanted to up it to 23 in the proposed amendments. So just confirming for our audience, it's still 20%, but that's really, really meaningful in my opinion, because this is a ordinary income tax situation. It's always been the big downside of these funds is that ordinary income is the harsh of these funds, but this is the only way to really get it down. I do want to touch into now some of the other aspects because this bill has so many other aspects to it. Now we're not going to get into deeper on salt. We're not going to get into tax on tips and social security. We're not going to get into that because honestly, that's, you can listen to a bunch of stuff that's outside of our industry for that. We want to concentrate on what's germane to real estate and what's germane to lending that bonus appreciation aspect. Ryan, you talked on it earlier. Let's get a little clarity. I've had many conversations around this with my real estate clients, but also lenders and they don't really quite understand how it works. And my philosophy has always been the best lenders out there are constantly educating their borrowers. There are a lot of new market entries into the real estate investor community. So help us understand this so we can educate our counterparties when it comes to this change.

Ryan Barragar:

So when you buy property, you can kind of think of the property in three different categories. You have the land component, you've got the building component, and you've got the shorter live asset component, let's say tables, desks, items like that that aren't structural. So what bonus depreciation does is it says, okay, of whatever you purchase, you can immediately expense a hundred percent of whatever is non-structural or non land and take as a deduction in the first year, which is huge, right? You get a deduction without spending money and investor returns go up because you have more cash available to return.

Kevin Kim:

So for our listeners, that means improvements to the property that are not structural. So if you're doing a rehab, if you're doing a, I mean ground construction, probably not all of it, but a good chunk of the improvements to the non-structural improvements are all now deductible, but it is a depreciation component. So the way it works is it can get recaptured, correct. I think we're having some audio issues up,

David Erard:

Correct? Yeah, the depreciation deductions can be recaptured. So I guess one planning point for people to think about, whether it's for your deals or deals you may even be involved with as a lender, the purchase price allocation really does have some impact both to the seller because of that depreciation recapture you mentioned. So the more value that you allocate to things like tables and chairs and washing machines, the more ordinary income the sellers like to have or are likely to have. And then on the flip side, the more of the purchase price a buyer allocates to those kinds of things, the more they stand to deduct immediately. So purchase price allocations can be really important, especially if you're talking about larger transactions. I had also note on the bonus depreciation that there are, again, one of the big themes of the Big Beautiful Bill is to incentivize production and investment into the us.

There are even some kind of structural things that can be written off for certain industries now. And so I'd say a deep dive on that should probably be a session of its own. But the theme here is there are a lot of favorable depreciation rules that got extended and expanded going back to 2017. And the phase out that Ryan was referring to, adding bonus depreciation at a hundred percent over 10 years was too expensive for the bill to pass under reconciliation in 2017. So it phased down. It's now back, and I think you'll see if I'm handicapping it right, you may see a change in demand for certain types of properties. You may see the tax benefits for some of the buyers are going to be very compelling. So it might create some artificial demand for things that people are going to use manufacturing and distribution and things like that.

So you might see a big change in demand on commercial or industrial real estate, but I can't say that I've seen that yet, but it's good to Kevin. I think your point, and I totally agree with it, is that it's good to be aware of these changes because your borrowers and people you're transacting with, these are going to be very meaningful potential impacts to them if they're looking at how the bottom line on how do all of these things really affect me economically and after tax. So there's a lot of incentives that property owners now have or that have an expanded version of that I think are going to change the demand for certain types of real estate. And I'm actually really excited about that, excited and very much excited that there are incentives to bring those types of things back into the us and I think the bill does a good job of incentivizing that. But for this group, I would say just be aware that some of those incentives are out there. Depreciation is a really powerful tax deduction. The faster you can write things off, the better your deal will pencil out over the course of a lot of time. The time value element of these deductions is very compelling.

Kevin Kim:

And on the appreciation, I was talking to a developer client of mine and I was asking him, do you think that this is going to lead to a resurgence in STR? He's like, you forget about the local rules that are now in place all over the country. And so that's what's actually stopping us. We're not really that interested in the tax deductions. Were always going to be a cherry on top. The cities are stopping us from doing it. So if you're thinking that this is going to make a big shut in the arm for the STR community, which is one of the groups that really benefits from this, it's tricky. Like cities like Palm Springs and Anaheim, these big tourist cities, the STR community is struggling because of local municipalities and their regulations. One thing that's not on the slide deck that I'd like to bring up also is that the one Big Beautiful Bill act also give us clarity as to the future of kill qualified opportunity zones.

Now, I know we don't spend a lot of time on this. Jason, you and I used to do 'em back in the day, but just want to touch on this real quick. It's basically made the program permanent. There's going to be renewals every five years it sounds like, which is really great for hopefully building more infill into rural communities and low-income communities for building affordable housing and also adding more industrial real estate. I think those are the two industries that really, really benefited a lot from QOZ and of course small business as well. So for those of you who are doing commercial real estate, those of you who have experience in the QOZ industry, I would take a look at that as well because it's a really nice alternative to 10 31 tax deferrals, and sometimes it's just the only saving grace for those kinds of investors. I do want Kevin, yeah, go ahead. Go ahead.

David Erard:

There's kind of two ways to think about those. And on the one hand, for those of you that have high amounts of capital gain, the QOZ stuff can be really compelling in the tax outcome where you don't have to pay tax on a good chunk of the gain that you have today, and you never have to pay tax on the gain when you exit whatever you're going into in an opportunity zone. So as an investor, it can be fairly compelling. We've also seen the emergence of QOZ funds. So some of our clients who have sponsored other types of vehicles have also started QOZ platforms. So I'd say there's opportunity there both as an investor and for whatever it's worth, I would kind of tell people, don't do this just because you get the tax spiff. Make sure you believe in the deal that you're investing into. But also as a fund sponsor, if you set these things up and you get into some compelling assets, there's a lot of incentive for people to invest in those kinds of things.

Jason Gilbert:

One other thing that there's been a pile on effect to the qualified opportunity zones, not actually being in a QOZ fund but not actually investing in it, but the assets and the properties adjacent to a qualified opportunity zone. So they're doing the development across the street. The properties around and surrounding that opportunity zone that's actually been redeveloped have all seen a bump in valuations.

David Erard:

So

Jason Gilbert:

It's been a good pile on effect of maybe that particular asset isn't a qualified, a qualified opportunity zone, but the surrounding across the street is, and that value immediately takes a step forward.

Kevin Kim:

That happened in Los Angeles, right? There was a pocket of West Mid Wilshire downtown that was considered to be a QOZ, but the surrounding area all of a sudden saw a huge bump in valuation and we'll see the same thing. I think people are excited to see that, and especially in Texas because they've been having valuation challenges. And same with Florida. And the nice part is now they have a set methodology and designating the zones so we don't have to worry about people rushing to the finish line and make a big mistake like they did in Imperial County. And so I think this is a very, very useful thing for our people who are thinking about real estate investing. But from a lender standpoint, I think you'll see a resurgence of interest in the commercial real estate side because that was a big, big driver for QOZ real estate investors, and I think continue, it'll resurge particularly in areas that are kind of low income or rural.

That seems to be the concentration of the bill. And also because rates are so high and so volatile, this is a very interesting alternative to DST strategies, which were all the rage when rates were low. And so I think this is a very good part of the bill. I'm excited that it's back. I'm excited that we don't have to worry about it going away. And our listeners right now, we will probably see a resurgence of that industry come back, and there's maybe events and promotions and all that kind of stuff for that as well. So I encourage everyone to look into that as well for their real estate investing.

David Erard:

Kevin, sorry if I could really quickly, I just want to highlight something Jason said with those. Initially, I would say some of the properties that were within the QOZ got a little bit of an artificial bump because there was a demand for those so people could qualify for the incentives. We also had a lot of conversations about buying the property across the street, knowing it wasn't in the zone, but if the QOZ program works as it was intended to, meaning it creates development, it enhances the values there, it should also enhance the value of property across the street if these things work. So initially, people were happy when they owned property within the zones because they got the bump. And then as time's gone on, we've seen a lot of our clients kicking around the idea of should we buy some stuff across the street knowing it's not in a zone today?

Kevin Kim:

And to be clear on the ozone program, it applies both to real estate and to businesses. So many of our clients are interested in interesting startup strategies that work. They actually do work. So there's a lot of ways to look at that. This is not an ozone webinar, but if you're interested in all that, let's have a conversation. Now. Let's talk about the last component that we wanted to touch on as the ancillary have pieces of the bill. We were worried about this. There was a lot of conversation of getting rid of the carried interest loophole, and there was a lot of discussion about raising the tax brackets, basically the tax rate on the individual side. Can we comment on that really quick? I think it's important, and we don't have a lot of carried interest concerns in our space. It's all near income, interest income, but for real estate investors and also our clients who have holdings in real estate, this is a very meaningful, meaningful thing

Ryan Barragar:

On the real estate holding, the concern was carried interest. Typically outside of a real estate asset, if you want the long-term capital gain treatment, you've got to hold the asset for longer than three years. There's a special carve out for if the property is real estate, you can qualify for the carried interest if only being held a year. The concern was they were going to get rid of that year holding and move it to three years, similar to non-real estate assets. Good news is that went away. It's still just a one year hold where you get the long-term capital gain treatment super favorable there, as well as the top rate for individual taxpayers and every level really is reduced. So that was set to go back to the top rate of 39.6%. However, the bill extends the top rate to 37% permanently.

Kevin Kim:

Alright, I think that's all the topics we have on the slide deck. If our listeners have any questions about this bill, their tax strategy for their business REITs, how can they reach you guys?

David Erard:

Best way? It would probably be through our website initially, or we're happy to share our direct contact information with anybody who's interested. Kevin, if they have a way to ping you, we're happy to do that. Or we can put it up on screen now if anybody's interested.

Kevin Kim:

Alright, and as you guys know, you can find us@forlaw.com. You can email me a k.Kim@forlaw.com. Also, wanted to do one little bit of housekeeping at the end. Any questions from our audience? We've got a little bit of time left. Want to make sure we answer any questions. I know you guys have some burning questions about tax, but if you don't, but if you want to ask, please use the q and a button and ask away and we can get to 'em right away. Right now, nobody, I guess Rob is the only one that's really deeply, deeply passionate about tax. Alright, guys.

David Erard:

Kevin, go ahead. Just one point, a lot of the questions will probably come up as you start to think about how do I do this? Should I do this? We have walked a number of clients and I'd say dozens and dozens of clients through the process of should we do this? And once the conclusion is we want to do it, then how do we do it? So REITs can be a little bit scary for those that are not familiar with them, there's a lot of stuff that you need to take care of with it. So I'd just say for those that just want some education on that and what it looks like, we're happy to have those conversations for those that decide to do it. And you're like, oh boy, I've got to now figure out how to do all this stuff. Kevin and his team as well as our team, were very familiar with the process of implementing these types of structures, can help you with, we've helped with a lot of investor questions when those come up as to why does it make sense, why do you guys want to do this? So we would, I guess just the message is if anybody's out there thinking you want to consider it, we're happy to have conversations with anybody to talk about what it might look like and how to do it if you decide to.

Kevin Kim:

Yeah, I mean, if you're running a debt fund right now in private lending, I would say contact one of us for consult because this is something that you really want to think about. It's a huge boon to your investors. It doesn't matter how big you are, it's worth learning about in detail. And we'll also make sure we share the other webinars we've done on this topic so you guys can learn more. Last point note, I want to make sure,

David Erard:

Kevin, I saw a question from,

Kevin Kim:

Oh, great, yeah, let's see a question here.

David Erard:

I think it had to do with where the management fee would be charged, meaning to the REIT or to the fund. I think that the management fees are initially charged to the fund just based on the way the documents work. But what we've done is we've worked with a number of clients to say that the assets all reside in the reit. The asset management fee largely should be born by the reit. So Jack, I'm trying to answer the question thoroughly, but I'd say the asset management fee is still charged by the fund or charged to the fund I should say. But the expense, I think we push for people to record all of it, or the majority of that asset management fee to the reit, which is where the assets reside.

Kevin Kim:

And this really, from a legal standpoint, just requires an additional line item in the documents disclosing optionality. And there's another question here from Gwendolyn. Can we accept EB five investors in a reit? Okay, so I think I'm the only one that can actually comment on this because I've done a lot of AB five work. EB five does not really work in these contexts because these loans, EB five requires an investment that will create jobs. And so when it comes to a mortgage fund, a debt fund, we are lenders. So a lending fund is not designed to create jobs. They don't create jobs, they make loans. There's no economist out there. I've heard people try to do this. There's no economists out there that's going to do and allow this for a lending fund from an economic study standpoint. Now, there are EB five strategies that are loan based, right?

They make mezzanine loans or first position loans to a construction project that will create jobs. If you have a multi-Strat strategy, meaning that you have multiple loans in your EB five strategy in your NCE, right? Then you might be able to consider this. However, because the rate of return is so low in an EB five NCE offering, you use a fund structure. Say you're doing like five loans or something like that, or 10 loans even because the rate of return is so low, a reach strategy actually may not be that meaningful because the investors are not looking for a deduction. In fact, they're typically not even us people. So that's kind of a problem on that front. So it requires a little bit of nuanced thinking. I have seen it used for EB five companies that will take their EB five investors after they finished and they need to do a redeployment.

They'll stand up some type of debt fund investment fund that is real estate focused and that will be a restructure because that gives tax benefits. And by that point in time, the investors will be considered us tax people so they can get that benefit. But it's a very complicated planning exercise. Gw, if you are in the EB five industry, please contact me. I'm happy to walk you through all this. We've done a lot of EB five projects for CE and regional centers. Alright, last point of note, I want to make sure we let everyone know about our upcoming conference here at Fortra Law. We are hosting Innovate. Again, this is our eighth year in a conference. We will be doing it on August 21st through the 22nd at the VEA Hotel here in beautiful Newport Beach. And you can see the information here on the slide.

The website is fortracon.com. There's the cost to attend this year. We're adding some additional layers of education via our, I'll call them round tables. Day before the conference. The way it's going to work is the 21st is going to be round tables and then welcome reception, which is also really fun because we're going to be right in front of the Bay Hotel courtyard. We're going to be overlooking the ocean. Beautiful, beautiful event. The conference will begin on the 22nd. The main day of the conference will be on the 22nd, so if you're interested in learning more about this conference, please contact us or you can learn more at fortracon.com. I think that's all the time we have today. We have about two minutes left, so that is all. For those of you who are listening, thank you for listening to this webinar, and if you want to find it later, it will be on our YouTube page. Just search Fortra Law on YouTube and it'll be there pretty soon. Thank you for listening. This is Kevin Kim signing off.