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Construction Industry Update | Q1 2019

There’s a cold winter chill in the air, but don’t let that dampen your spirits as we roll into 2019.  With the first two months of the year in the books, contractors are likely beginning to mobilize for a busy spring season.  Thanks for taking a few minutes to join us for YHB’s first quarter construction industry update.

In this edition, we’ll take a look at a high-level overview of the economy and also dive into some recently issued regulations regarding rental real estate as it relates to the new 20% pass-through deduction.

Economic Update

As we talk with our clients and referral sources, the number one question we get asked is with regards to our outlook on the economy, specifically as it relates to those in the construction and real estate industry.  The general feel from many publicized economic reports and talk in the media is that we are bound to be headed for a recession.  Whether it’s the up-and-down stock market that was evident near the end of 2018, narrowing yield curves, or uncertainty surrounding interest rates, trade wars, and inflation, there’s no doubt that the negative warning signs steal the headlines in the news.

This is not to diminish these items, as some of the signals that have preceded previous recessions are undoubtedly showing up in our economy today.  Nevertheless, the vibe, at least to the naked eye, is that the economy in most markets appears to be running strong.  Unemployment is relatively low, fuel prices are modest, and most restaurants you visit or drive by appear to be packed to the brim.  Most contractors we speak to have a healthy back-log headed into 2019.

So who’s right and who’s wrong?  That’s the trillion dollar question.  It would certainly be prudent to be cautiously optimistic.  Contractors would be well-served not to over-extend themselves and their resources, even when times are good.  The old adage of “cash is king” has never been more true.  Contractors who build up adequate cash reserves and remain fiscally conservative through profitable times will be the ones feeling the least impact if things take a turn for the worse.  In the current interest rate environment, a properly designed treasury management plan can still earn a modest return on cash and equivalents with no risk.

Make sure you are pricing in anticipated material and wage increases into your longer-term project estimates.  Continue to monitor economic trends.  Make hay while the sun shines, but don’t bite off more than you can chew.

New Rental Real Estate Rules

Tax season is well underway for those of us in the CPA profession.  Many of you are likely in the process of assembling your information in anticipation of filing and hopefully taking advantage of the many new provisions of the Tax Cuts and Jobs Act.  One of the most generous, yet complex provisions of the act relates to the new 20% deduction for qualified pass-through income.

This new deduction, often referred to as the 199A deduction, provides a potential 20% reduction in the taxable income of a pass-through entity, which could be a partnership, S corporation, or trust.  While service based businesses potentially lose the benefit of this deduction at higher income levels, construction trades or businesses that pay adequate wages are likely to qualify for the full deduction.

It is not uncommon for a contractor to be involved in real estate outside of their normal construction activities.  This could be through personal investment properties, partnerships or LLC’s, or the renting of real property back to your construction trade or business.  The proposed regulations surrounding the 199A deduction issued last August led most professionals to believe that any rental real estate activity would rise to the level of a trade or business that would qualify for the 20% deduction.  Nevertheless, the recently issued final regulations apply some additional hurdles that could disqualify some taxpayers from taking the deduction on their rental income.

Fortunately, the IRS has written into the regulations a safe-harbor where if met, allows a rental activity to qualify in most cases.  Generally speaking, if you or anyone else you hire or contract with to perform services related to a rental activity, spend 250 hours or more working on the property, then the safe harbor will be met.  Beginning in 2019, a written contemporaneous log must be maintained to satisfy the requirement.  In addition, the regulations have specifically excluded properties subject to a triple net lease from qualifying for the safe-harbor.

Additional rules apply to rentals between related parties.  To say the rules are confusing would be an understatement.  Don’t automatically assume that your rental does or doesn’t qualify.  Consult with your tax advisor to ensure that you are not claiming an untitled deduction or leaving money on the table.

We hope you’ve enjoyed this edition of YHB’s construction industry quarterly update.  Keep striking while the iron’s hot.  We look forward to speaking with you soon.