The $100,000 Real Estate Employee Retention Credit Windfall

I want to talk about something a little awkward.

Partly awkward because the thing we’re going to discuss doesn’t present tax legislation in a very favorable light.

Partly awkward because the thing we’re going to discuss is a little foggy.

And then, quite honestly, awkward because it took a couple of tax practitioners I respect a lot, Dan Chodan and Ed Zollars, quite a bit of effort to convince some of us that what I’m about to describe probably works. Or maybe works. Even though it shouldn’t, probably, as a policy thing.

But let’s go though the details quickly. And then–if you’re interested–the next step for you is to talk with your tax accountant. And get more detailed information from them.

The Original Business Employee Retention Credit

To put everybody on the same page, let me quickly describe the original employee retention credit and then a special flavor of the credit.

The original employee retention credit gives employers up to $7,000 per employee per quarter in 2021 if their business got beat up bad by the COVID-19 pandemic.

Note: This blog post goes into more detail: Three Tips for Bigger Employee Retention Credits. But so you know the general contours… A firm qualifies for employee retention credits if it suffered a substantial decline in gross receipts. And it qualifies if government orders closed or partially closed the business.

The precise credit formula, by the way, works like this for 2021: You get seventy percent of the wages you pay nonowner employees during a quarter but no more than $7,000 per employee per quarter.

A firm with ten employees making $10,000 or more a quarter, for example, might get $70,000 in tax savings for the quarter. And then again for the next quarter if they continue to qualify.

An important practical point: The employer can get the money nearly immediately. Often by taking the funds out of the very next payroll tax deposit they would otherwise make.

And that’s the original employee retention credit formula

The $100,000 Recovery Startup Business Employee Retention Credit

For the last two quarters of 2021, a new special flavor of the employee retention credit exists. The recovery startup business credit.

The recovery startup business credit gives an employer employee retention credits if she, he or they start a new trade or business.

A firm doesn’t use this flavor of employee retention credit if it can qualify using the original employee retention credit. The original flavors of the employee retention credit will almost always deliver bigger refunds.

But as long as a firm started the new trade or business after February 15, 2020 and as long as its average annual receipts for the three previous tax years don’t exceed $1,000,000? Yeah, that firm is good to go.

Two other wrinkles to note:

1. A firm can’t get more than $50,000 for a quarter in recovery startup business employee retention credits. A firm also can’t receive the credit except in the third and fourth quarter of 2021. Thus, the maximum refund for the recovery startup business credit equals $100,000.
2. All the trades or businesses an employer owns get aggregated for purposes of calculating the eligibility, totalling the wages that plug into the formula, and determining the credit limits. This last bit is important, as you’ll see in a minute.

Real Estate Rentals Count as a Trade or Business

Here’s the next thing you need to understand. And you can probably see where this is going. But say you buy a rental. Sometime after February 15 202o. And ideally sometime before the third quarter of 2021 ends. Let’s say you get a tenant into the property and everything totally setup and running.

Your rental probably qualifies as a trade or business. You need to be motivated by profit. You will need to display regularity and continuity in your activity. You’ll need to have separate or separable books and records. But the tax accountants who think a lot about this, all agree you should be able to fairly easily meet these requirements.

And if this is the case? The new rental property means you may qualify for a recovery startup business employee retention credit.

But you want to understand how the aggregation rules for employee retention credits work.

Employee Retention Credit Aggregation

The employee retention credit rules make employers aggregate the trades or businesses they own. An entrepreneur who, say, runs a sole proprietor, owns an S corporation, and then holds a majority interest in a partnership? She doesn’t do three separate employee retention credit calculations. She aggregates these three businesses together into a single employer. And then she does a single set of calculations.

For example, you recall I mentioned a few paragraphs ago that an employer’s average annual gross receipts for the previous three years can’t exceed $1,000,000 if the employer wants to claim a recovery startup business credit. The average number used in that determination? The average after aggregating the annual gross receipts for all the trades or businesses.

For example, if an aggregated employer combined three businesses and that aggregated average equals $700,000? That employer qualifies for a recovery startup business credit if it starts a new trade or business after February 15, 2020.

The $100,000 Real Estate Employee Retention Credit

And here’s why things get weird…

The same aggregation of course applies–at least under current IRS guidance–for wages that plug into the employee retention credit formula.

Say, for example, an employer averages less than $1,000,000 a year in gross receipts in its existing trade or business. That would be true of the overwhelming number of small businesses.

Say that existing trade or business pays ten employees $10,000 a quarter, but doesn’t qualify for the original employee retention credits.

If the business owner starts a new rental property trade or business before the end of September, bingo, the business gets employee retention credits on the wages paid during the third and fourth quarter in the existing business.

Note: If the business owner starts a new rental property trade or business after September but before the end of December, the business gets employee retention credits on the wages paid during just the fourth quarter.

But you see the windfall. The aggregated employer’s wages means she, he or they get that credit equal to seventy percent of the first $10,000 paid during the quarter to each employee by the existing business.

With ten employees, the $50,000 per quarter limit kicks in. The employer doesn’t get $7,000 for ten employees. She, he or they get $7,000 for the first seven employees. and than a little bit for the eighth employee.

But that’s the way the math works.

And let me make sure readers understand: Another way to describe the above accounting? The IRS will provide $100,000 of cash to you if you buy a rental before the end of September. Well, as long as you understand the rules, that is. And as long as they don’t change the rules.

A Quick Digression for Tax Accountants

The odd result described here stems from the IRS using the small eligible employer rules for the recovery startup business credit. The IRS did this as a workaround because Congress didn’t provide rules for recovery startup business employers. If a tax practitioner has questions about the mechanics, probably she or he wants to refer IRS Notices 2021-20 and IRS Notice 2021-49.

Last Words and a Caveat

I don’t want to put words into anyone’s mouth. But I think it’s fair to say some tax accountants see the accounting described above, nod their heads and think, “Wow,  real estate employee retention credit? Interesting…”

Others see the accounting above, shake their heads and think, “Oh my gosh, the IRS needs to change their guidance. And quickly.”

Probably most knowledgeable tax practitioners will agree that owners of existing businesses want to consider this tax planning opportunity.