Your taxes have changed and you need to be on top of your situation. The change will have its most severe impact on people who are buying SNFs. If your tax advisor hasn’t called you yet to discuss this, then you need to make sure someone is looking at this for you.
The 2017 Tax Act made several very significant changes. One of the strangest is that a taxpayer can deduct no more than $500,000 of losses from partnerships and s-corporations. If a taxpayer has losses greater than that, the losses are suspended and carried forward to the next year. In the next year, the carry forward losses can only offset 80% of the income in the next year.
For example: a person has several partnerships from which he receives K-1s. Some of the K-1s report income and some report losses. When all the K-1s are added together the net number is a $2 million loss. The person can only deduct $500,000 of losses. The other $1.5 million carries forward to the next year. The person can only use the $1.5 million carryforward to offset up to 80% of the next year’s losses.
For people with significant other income such as wages, stock gains or pension income, the $500,000 limitation means that they will end up paying tax on their other income in excess of $500,000.
This turns into a problem very fast. A simple example is a person who has $10 million of losses this year and nothing else on his return. He can use $500,000 this year but has nothing to deduct it against. The $500,000 plus the $9.5 million carry to next year. In the next year, the $10 million loss reverses and turns into $10 million of income. The taxpayer has the $10 million carryforward. Because of the 80% limitation, the person can only deduct $8 million of the loss carryforward. Even though the person had zero income and zero cash distributions across two years, he pays approximately $800,000 of federal tax on $2 million of income.
Any time you have a loss year followed up by income years, you will pay tax on 20% of the income in the income years no matter how large your loss carry forward.
For people purchasing skilled care facilities, typically the losses from depreciation and first year operations created large losses which could be carried forward and offset taxable income for a year or two or three. Because of the 80% limitation on the loss carryforward, this could lead to big problems. Now, the trick to taxes is to assertively plan your income to avoid big losses and big income years. You want your income to be flat from year to year.
The easiest way to do this would be to have a cost segregation study prepared and wait until the rest of your returns are finished to see if you want to use the depreciation benefit this year or to delay taking the added depreciation write off till a later year. If you delay the deduction to the later year, you are better off than creating a loss carry forward which would be limited to 80%.
Also, people should consider whether they want to deduct large losses from money-losing locations which will be shut down or sold in the next couple years. When a shut down or sale occurs, all the prior losses flip into income. The big losses in the early year will carry forward and offset only 80% of the shutdown income. In this case, carefully consider whether you can take advantage of the tax rules which often prevent you from taking a loss. For instance accounting methods, passive loss rules, or basis limitation rules.
There are many ways to finesse this if someone is on top of the situation. If you aren’t on top of it, you are could end paying some big, unexpected, and unfair tax bills.
Kuno S. Bell, CPA, J.D.
Pease & Associates, LLC
(216) 978 9090