With the regulatory environment constantly changing, it is more important than ever that not-for-profit organizations stay on top of trends and federal law updates. The Inflation Reduction Act of 2022 (IRA) is an excellent example of the expanding opportunities available to exempt organizations looking for energy sustainability options, including updating their facilities, energy-efficient power, or electric vehicles.

Opportunities and Incentives Through the IRA

As part of the IRA bill, many provisions extend to not-for-profits that were previously only available to for-profit entities and individuals. For instance, direct pay options (similar to a refundable credit) are now allowed for not-for-profits investing in certain renewable or clean energy, alternative fuels, clean/electric vehicles, and other environmental opportunities. Also, IRC section 179D deduction for energy-efficient commercial buildings is now available for exempt organizations and tribal governments; previously, it was only available to government-owned facilities. Section 179D allows the designer (the for-profit entity) to deduct up to $5 per square foot for certain energy-efficient improvements and buildings. The good news is that, as part of the process, the not-for-profit may negotiate the project's costs with the designer for a discount.   In addition to direct pay options and deductions being extended to not-for-profits, the IRA creates grant funding for organizations providing training and education to installers of certain home energy-efficient projects. Moreover, through the Urban and Community Forestry Program, there will be $1.5B of additional funding to plant trees. If not-for-profits are doing these types of activities, they may be able to access the available funding. 

Taking Advantage of the Provisions

Please note the rules are vast and complex and should be done with care. Some of the energy credits that allow for a direct pay option usually start at 6% of a refundable credit (direct pay) on the costs. However, there is a multitude of provisions that will enhance the credits up to 50% or even 70% of the costs. The most notable enhancements are for projects that pay contractors prevailing wages or use qualified apprentices. There is also an optimal timing for the projects to obtain the most incentive for the organization, and phase-outs will occur over time. Therefore, if your not-for-profit is looking to take advantage of these incentives, now is the time to investigate the new provisions.

Partnering with KBKG to Serve You

Clark Nuber partners with KBKG to help determine how much credit you can get back for implementing section 179D in your organization’s structure. While Clark Nuber can assist you in completing general tax and auditing services, our colleagues at KBKG offer educational resources and in-depth reviews of your investments into green efficiency. Check out the KBKG infographic here for more information on 179D Tax Deduction Benefits for Tax Exempt Entities. 

Next Steps

Now that not-for-profit entities have more deduction opportunities relating to sustainability options, it is an ideal time to speak with your advisors to maximize your credits and deductions. Clark Nuber and KBKG partner together to provide you with comprehensive evaluations on sustainability implementation in regard to your taxes. For more information, contact us and KBKG to assist your not-for-profit organization.   

With housing prices softening and interest rates at all-time highs, now is a good time to consider creative strategies for diversifying your real estate portfolio. Like-kind exchanges present one such opportunity.

What is a Like-Kind Exchange?

IRC Section 1031 outlines the requirements and restrictions for a like-kind exchange. When the rules outlined in Section 1031 are properly applied, you can exchange one investment property for another without triggering a taxable event. Thus, you can defer payment of taxes on the sale of existing property by investing the equity into a new property. Keep in mind, this option is only available for “real property” (variably defined by each state) within the United States. Many different types of investments can qualify as real property, and while their use must be similar, their quality may vary. Some properties to consider under a like-kind exchange can include apartment buildings, single-family rental properties, vacation rental homes, restaurant rental spaces, or commercial office rental space. Since these options are all considered rental investments, they may be considered as similar assets in a like-kind exchange.

What Steps Should I Take in a Like-Kind Exchange?

The like-kind exchange process has a fairly quick turnaround. Within 45 days of the sale of your property you must identify, in writing, replacement property to be acquired. You can identity up to three replacement properties without regard to value. If you identify more than three properties, you must follow the “200% Rule.” The 200% Rule outlines that you may identify as many properties as you wish if the total fair market value does not exceed 200% of that of the original property. You will have total of 180 days to complete a like-kind exchange once you have relinquished your original property. To process the property transaction, we highly recommend working with a Qualified Intermediary (QI). A like-kind exchange is more of a trade, rather than a sale, as you should not access any sales proceeds in the process. Any proceeds to you (the taxpayer) from a relinquished property will be immediately taxable. However, a QI can process the transactions so that you do not hold onto any proceeds.

What Are the Benefits of a Like-Kind Exchange?

Like-kind exchanges are most ideal for taxpayers in a high tax bracket, as federal income taxes would be deferred on the exchanged properties. However, any real estate investor can benefit from a like-kind exchange. Below are some of the valuable benefits of conducting a like-kind exchange.

• There is no limit to the number of like-kind exchanges you can perform. Thus, you have the opportunity to continually exchange properties over time.
• Even with the softening of the real estate market, many taxpayers find that they have significant equity in their property. Selling your current real estate investment and buying new properties in different markets can diversify your real estate holdings.
• Tax rates can change annually, so, with a proper like-kind exchange, 100% of these taxes are deferred.
• With the Washington State capital gains tax being collected in 2023, you can defer the gain and potential state tax by entering a like-kind exchange.
• With the flexibility of real property, you have an increased likelihood of exchanging one property for another.

What Can a Like-Kind Exchange Look Like?

I’ll outline an example of a like-kind exchange for you: Imagine you currently have a commercial office rental space, but there is a trend of companies transitioning to a work-from-home model. Leasing out your office space has become less reliable, but you are seeing an increase in tourism in your area. Your office space has a market value of $500,000 and you’ve found two amazing residential properties that you could rent out: one vacation home for $350,000 and one single-family home for $150,000. First, you will want to identify a Qualified Intermediary to facilitate an exchange so that you’re not holding any sale proceeds. Next, you’ll relinquish your office rental space to the QI. Within the first 45 days of this relinquishment, your QI will identify the new vacation home and single-family home as the properties to exchange. You’ll use the next 135 days to close on both new properties, totaling a combined value of $500,000, equaling the fair market value of your relinquished office rental space. Finally, the QI will pass these two properties to you to complete the exchange, which you would file in that year’s tax return.

Overview

A like-kind exchange is an ideal process if you are looking to diversify your real estate portfolio. By using a Qualified Intermediary and following the like-kind exchange rules, you can defer 100% of the federal income taxes associated with property sale. If you need a QI or have questions about processing a like-kind exchange, Clark Nuber can help. Send me an email and I would be happy to talk more about saving money in real estate. Want to learn more accounting solutions for real estate investors? Check out my article Real Estate Investors: What to Ask Your CPA. © Clark Nuber PS, 2023. All Rights Reserved.

Originally published 10/6/2023 and updated 2/17/2023 to include a current example of risk-free rate.  Your discount rate, which impacts both lease liability and lease classification, is a key item to understand and determine as you begin implementation of Accounting Standards Update No. 2016-02 and subsequent updates (Topic 842).

Why is the Discount Rate Important?

In determining the lease liability, the discount rate is applied to all future lease payments to calculate the present value of those lease payments. Since the right-of-use asset is based on the lease liability, the discount rate will, in turn, also impact the initial value of the right-of-use asset. In determining the appropriate classification of a lease, as either a finance lease or an operating lease, one factor to consider is whether the present value (calculated using the discount rate) of lease payments is equal to substantially all of the fair value of the asset. Therefore, the discount rate can impact the balance sheet and the income statement, based on determination of lease classification as either an operating or finance lease. We’ll discuss calculating the lease liability and lease classification further in future articles.

Determining Your Discount Rate

For lessees, the discount rate for the lease is the rate implicit in the lease unless that rate cannot be readily determined, in which case the incremental borrowing rate or risk-free rate is used. The discount rate is established at the later of: a) the beginning of the earliest period the lease is presented in the financial statements, or b) the lease commencement date. In the case where subsequent remeasurement of the lease is required, a new discount rate would be established at remeasurement. The implicit rate and incremental borrowing rate are as follows:

Implicit Rate

The rate implicit in the lease is the rate of interest that, at a given date, causes the aggregate present value of (a) the lease payments, and (b) the amount that a lessor expects to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the lessor, and (2) any deferred initial direct costs of the lessor. Essentially, this is the rate of return provided to the lessor under the lease. While this information is readily available to the lessor, the lessee may not have sufficient information to determine the rate implicit in the lease. If the rate is provided, the lessee must use this rate as the discount rate. While the majority of leases will not include a readily determinable rate, using the rate implicit in the lease will likely result in a lower lease liability as the lessor’s rate of return will likely exceed the company’s borrowing rate.

Incremental Borrowing Rate (IBR)

Under Topic 842, the incremental borrowing rate is defined as, “the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.” The incremental borrowing rate will vary depending on factors such as the size of the loan, loan term, and economic environment at that time of lease commencement. Determining the appropriate IBR to use as a discount rate may be difficult to determine, depending on the size and expertise of your organization, as well as borrowing history, and will require organizations to develop a process to estimate this rate. For this reason, a practical expedient policy election has been provided under the new standard to ease implementation.

Policy Election – Risk-free Rate

Through various updates to ease the burden of implementation for private companies and not-for-profit organizations, entities that are not public business entities can make an accounting policy election to utilize a risk-free discount rate as their discount rate in place of their incremental borrowing rate. The risk-free rate applied should be determined using a comparable term to the lease term, determined as of the later of the beginning of the earliest period the lease is presented in the financial statements, or the lease commencement date. The election is made by class of underlying assets, with disclosure required to inform users of the financial statements of the rate applied to each class of assets. This rate can only be used when the rate implicit in the lease is not readily determinable. If the rate implicit in the lease is readily determinable, that rate must be used as it best reflects the economics of the transaction and can be easily determined. In cases where this accounting policy has been elected for a class of assets, but one lease within the asset class includes a readily determinable implicit rate, the rate implicit in the lease must be utilized for that specific lease, while the risk-free rate can be applied to the remaining leases within the asset class. Using the risk-free rate in place of the incremental borrowing rate will likely result in a higher lease liability, based on discounting the lease payments at a lower rate. For this reason, companies may elect the accounting policy election for one class of assets (higher volume and/or lower dollar value leases – e.g., equipment leases) while applying the incremental borrowing rate to another class of assets (less frequent transactions and/or higher dollar value leases – e.g., real estate leases). Risk-free rates can be found online on the Treasury website. To demonstrate an example, ABC Company entered into an agreement to lease equipment for a five-year term, commencing July 1, 2019. The Company adopted ASC 842 on January 1, 2022, and elected to use the risk-free rate as the discount rate for the lease liability. The risk-free rate is determined the latest of the lease commencement dates or the date the Company adopted the new lease standard (January 1, 2022). The risk-free rate should be determined using a period comparable with the lease term. The guidance does not specify whether, at adoption of ASC 842, that calls for the initial term of the lease or the term remaining on the lease at adoption. While the initial lease term is five years, as of January 1, 2022, the Company has two and a half years remaining on the lease at adoption. Based on the treasury rates on January 3, 2022 (closest to date of adoption), the Company could elect a rate between the two and three-year term (.78% - 1.04%) or the five-year term (1.37%). The Company’s policy should be applied consistently and disclosed in the financial statements. Daily Treasury Par Yield Curve Rates from Treasury Website:

Need Help?

If you have questions regarding the new lease standard, or you need assistance implementing it for your organization, reach out to your Clark Nuber representative or send us an email. © Clark Nuber PS, 2023. All Rights Reserved.