Authored by Mallory Gorman
The Tax Cuts and Jobs Act (the Act) includes significant changes to the Internal Revenue Code (the Code), including some that affect taxpayers engaged in the real estate industry. One of these changes relates directly to the receipt of up-front cash tax increment financing (TIF). Prior to the Act, IRC section 118 allowed a corporate taxpayer to exclude from income a contribution to its capital, including a contribution by a party who was not a shareholder (a municipality awarding up-front cash TIF, for example). Due to a corresponding requirement to reduce basis in the asset acquired by the amount of the proceeds received, this exclusion deferred the ultimate tax liability to a point in time when the asset was ultimately sold. Although the application of IRC section 118 did not permit “tax-free” receipt of the TIF funds, it did defer the tax liability to a later point in time where its receipt could be anticipated and managed.
Additionally, the statute required that the recipient be a corporation to be able to take advantage of the deferral treatment. This required a structural “work-around” given that the developer recipient of TIF funds is typically a partnership or a limited liability company taxed as a partnership. To fulfill this requirement, it was not uncommon to have an S corporation be the recipient of TIF proceeds where the S corporation would either loan over the proceeds to the development entity, or contribute them in exchange for equity in the recipient developer. The form of the transaction would depend on the recipient’s individual circumstances as there were challenges with both of these structures.
The Act has substantially modified IRC section 118 so that a corporation receiving up-front cash TIF can no longer exclude these contributions unless the municipality makes the contribution as a shareholder in its capacity as such.
Real estate developers frequently used this provision to receive up-front cash TIF proceeds on a tax-deferred basis, but now its usefulness is limited. The Act’s modification is effective for contributions received after Dec. 22, 2017, but does not apply to contributions made after such date if the contribution occurs pursuant to a “master development plan” that has been approved by a governmental entity prior to such date. Because the IRS has said that it does not plan to further explain what is meant by this transition language, we are left to interpret the provision based on experience as to the interpretation of the term “master development plan.” Fortunately, some projects that received TIF funds after the effective date may still qualify for the tax deferral if the surrounding circumstances are favorable.
Further complicating matters is state conformity to the federal IRC section 118 modifications. Although some states have adopted the federal provisions in their entirety, others have chosen to forgo some of the provisions. Georgia, for example, has chosen to specifically opt out of the IRC section 118 modifications. Consequently, while up-front cash TIF proceeds received by a corporation may be subject to federal tax, they may escape state taxation if the previous structuring methodologies are used.
To avoid or minimize tax on receipt by the developer, organizations must now consider alternative approaches to designing the TIF incentive. It is also time to review your state’s conformity to the Act and whether there is still time to have some input into the legislative process so that the tax impact of these incentives can still be deferred. We will explore your options in the next newsletter.
For more information on this topic, or to learn how Baker Tilly state and local government specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.