THE GO ZONE ACT
GREAT TAX BENEFITS FOR SOME PEOPLE
Written by Kelly Hayes, CPA & Attorney
Hello and welcome to my world. I'm Kelly Hayes and I'm an attorney and CPA with the law firm of Siegel, Greenfield, Hayes & Gross P.L.C.
When Hurricane Katrina hit on August 29, 2005, it created a wide path of destruction from New Orleans all the way to Mobile, Alabama. The destruction and loss of life and property was so great that it prompted President Bush and Congress to enact the Gulf Opportunity Zone Act of 2005 (the GO Zone Act). The GO Zone Act was meant to spur investment and business development in the areas hit hardest by Hurricane Katrina. One of those areas is the Biloxi/Gulfport/Ocean Springs area of Mississippi. Prior to Hurricane Katrina, Biloxi was a sleepy little town of about 50,000 that had 8 casinos located on barges connected to either hotels or some type of permanent establishment on land. I have visited the area several times, since I have property in Gulf Shores, Alabama, and several pre-construction projects in Biloxi, Mississippi. Hurricane Katrina basically destroyed the entire town of Biloxi, including all of the casinos. Most of the casinos were picked up by the storm surge and placed on land. The State of Mississippi quickly enacted legislation to allow casinos to build up to 800 feet in from the water line and, as a result of that legislation, there are now going to be approximately 22 casinos in Biloxi. Given that bit of background, the first question to ask is, "What is this "GO Zone Act?" The GO Zone Act was, again, enacted by Congress and signed by the President late in 2005. There are many features of the GO Zone Act, but the one that is of most interest to real estate investors is the 50% bonus depreciation deduction. As you probably know, whenever you buy a piece of property and hold it out for rent, you're allowed to depreciate that property. Residential rental properties are depreciated over 27 1/2 years using a straight-line method. This means that if you paid $300,000 for a condo (ignoring the land cost), you would depreciate that over 27 1/2 years, which would generate $10,909 of a depreciation deduction every year. The GO Zone act allows you to take an additional 50% first-year bonus depreciation deduction. This means your $10,000 depreciation deduction now suddenly becomes a $155,454 depreciation deduction. That's not all. Congress recognized that by allowing this large depreciation deduction, many properties would generate a huge loss. It therefore amended the net operating loss rules to allow you to carry back this loss generated by this big depreciation deduction five years as opposed to the normal two years. You can also carry the loss forward 20 years. I will get into the details in a moment. Finally, when you carry that loss back, it is not an add back for alternative minimum tax purposes. This can be a huge benefit for certain people who have a lot of deductions and generate alternative minimum tax. A discussion of the alternative minimum tax is beyond the depth and scope of this article, but those of you who are paying alternative minimum tax are probably familiar with it and understand that this net operating loss (NOL) carry back is quite a benefit.
Let's talk a little bit more in depth now about this big depreciation deduction and, more importantly, who can use this depreciation deduction. There is a two-step process in calculating the benefits and opportunities of the GO Zone Act. The first step is the easy part, that's calculating the actual deduction, which, as you can see below, I have done with Example 1. The harder part is determining step 2, who can actually utilize these deductions. As an added note, the bonus depreciation only applies if you place your residential rental property in service before December 31, 2008. There is some discussion in Congress about extending this date, but it hasn't happened yet. Let's look at Example 1:
STEP 1
EXAMPLE 1: SINGLE MEMBER LLC
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Close on purchase of $600,000 condo on January 15, 2007
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Allocate 10% of purchase price to land (estimated)
The LLC's Tax Return:
Rental Income 30,000
Expenses:
Association Dues 3,600
Insurance 5,000
Interest 33,600
Management Fee 6,000
Miscellaneous Repairs 2,000
Depreciation (1/2 of $540 + $270,000÷27.5) 279,819
Net Loss -$300,019
(Note: If this were a multiple member LLC, each member would share this loss based on their ownership percentage)
The Member would show a $300,019 loss on his or her personal 1040 tax return. The question then becomes, "How much of this loss can you use?" The general rule is that if you are actively participating in a trade or business (which is a fairly low threshold of time spent in order to achieve this), then this loss can offset current year rental income, other passive income (except interest and dividends) and, if the Member's adjusted gross income is below $100,000 (assuming the Member is married), then the Member can deduct up to $25,000 of this loss against his other non-passive income, i.e. W-2 income, interest and dividends, etc. If the Member's adjusted gross income is more than $150,000, then the Member cannot deduct any of these losses. Finally, if the Member is deemed to be a real estate professional (my other article talks about real estate professionals), the Member can deduct the entire amount of this loss against other non-passive income. If the real estate professional deducts the entire amount of this loss and still has loss remaining, he or she can carry the loss back five years and deduct it against his or her income in the fifth year, and then carry any forward if he or she has deducted everything in the fifth year to the fourth year, etc. Carrying back a loss to prior years is a fairly routine task and your CPA should be able to do that for you.
As you can see from the above example, the potential tax benefits can be substantial. You need to discuss these tax benefits with a tax professional prior to purchasing property, as these rules are complex, and you need to determine how much tax benefit you actually get before you buy. The Go Zone is one of the best tax incentives our country has ever seen.
