New Economic Stimulus Incentives

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by Elliot Pisem, Lary S. Wolf

Published: March 20, 2002

Source: R & H Letter to Clients and Friends

On March 9, 2002, President Bush signed the Job Creation and Worker Assistance Act of 2002 (the "Act"). In addition to providing new tax benefits for capital investment applicable throughout the nation, the Act contains significant incentives for investment in the area of New York City damaged in the terrorist attacks of September 11, 2001. New York State and City have also announced their own sets of incentives to encourage businesses to invest in Lower Manhattan and to induce commercial and residential tenants to remain in (and even to relocate to) that area.

The rules governing qualification for the various incentives are very complicated, and the results of very similar investments may be different depending on where the property is located, when it is placed in service, and certain other conditions. Some of the benefits of the new incentives can be claimed on tax returns for 2001, which are currently under preparation, or can even be used to claim refunds for prior years. This memorandum describes the basic qualifications for the Federal, State, and City incentive programs (including the major Federal tax benefits now available on a nationwide basis), but a thorough analysis will be required to ensure that a transaction qualifies for the special benefits.

FEDERAL TAX PROVISIONS

One of the primary tax benefits under the Act is substantially liberalized depreciation allowances, the details of which are described below. The following chart provides a framework for identifying the new benefits:

	Outside the New York Liberty Zone⁽¹⁾	Within the New York Liberty Zone
Personal Property	30% Expensing	30% Expensing
Tenant Improvements	30% Expensing	5-Year Write-Off
Other Real Property	No Special Benefits	30% Expensing

Property Located Outside the "New York Liberty Zone"
30% Expensing

The main tax incentive in the Act for investment outside of the "New York Liberty Zone" (or "NYLZ") is the ability to take a deduction equal to 30% of the cost of certain capital expenditures for the acquisition of depreciable property in the year in which the property is first placed in service. This deduction reduces the taxpayer's basis in the property; moreover, the taxpayer is still entitled, in addition to this 30% deduction, to its regular depreciation deduction, computed by reference to the remaining 70% of the property's cost, for the year in which the property is first placed in service. The 30% deduction is allowable for alternative minimum tax purposes, as well as for purposes of the regular tax.

Generally, in the case of real property located outside of the NYLZ, only "qualified leasehold improvement property" will qualify for 30% expensing, while the cost of "base building" and common areas will not qualify.⁽²⁾

In order to qualify for 30% expensing outside the NYLZ the following four requirements must be met:

1. The property must be one of the following:

depreciable property to which the so-called "Modified Accelerated Cost Recovery System" of Internal Revenue Code section 168 applies and which has a recovery period of 20 years or less under that System,
otherwise depreciable computer software,
water utility property, or
"qualified leasehold improvement property."

To qualify as "qualified leasehold improvement property" all of the following conditions must be met:

a) the property must be an improvement to an interior portion of a property which is nonresidential real property,

b) the improvement must be made under or pursuant to a lease (or other grant of a right to use property) between unrelated parties, by the lessor, the lessee, or any sublessee of that portion,

c) that portion must be occupied exclusively by the lessee or any sublessee,

d) the improvement must be placed in service more than three years after the date the building was first placed in service, and

e) the expenditure for the improvement must not be attributable to the enlargement of the building, an elevator or escalator, any structural component benefiting a common area, or the internal structural framework of the building.

2. The original use of the property must commence with the taxpayer after September 10, 2001 (with a special rule for sale-leasebacks).

3. Either:

the property must be acquired by the taxpayer after September 10, 2001, and before September 11, 2004 (or after September 10, 2004, if pursuant to a binding written contract executed after September 10, 2001, and before September 11, 2004), and no written binding contract for the acquisition of the property may have been in effect before September 11, 2001, or
the taxpayer must begin manufacturing, constructing, or producing the property for its own use after September 10, 2001, and before September 11, 2004.

4. The property must be placed in service by the taxpayer after September 11, 2001, and on or before December 31, 2004 (or, in the case of certain long-lived property, including many improvements to real property, December 31, 2005)⁽³⁾⁽⁴⁾

Net Operating Losses

The Act liberalizes the treatment of net operating loss carrybacks and carryovers in two important ways.

First, although net operating losses may normally be carried back for only two years, a net operating loss incurred in a taxable year ending during 2001 or 2002 may be carried back for five years, for purposes of both the regular tax and the alternative minimum tax. Since many taxpayers may already have filed returns for fiscal years that ended early in 2001, it is now necessary to focus on whether those returns reflected net operating losses that can now be carried back to pre-1999 years, in order for refunds to be claimed.

Second, the Act eliminates on a temporary basis the rule that net operating loss carryovers or carrybacks to a taxable year may be used to shelter only 90% of the alternative minimum taxable income for that year. For example, if, for alternative minimum tax purposes, a taxpayer incurred a net operating loss of $2,000,000 in 1999 and earned $500,000 of taxable income in 2000, only $450,000 of the net operating loss carryover from 1999 could be used in 2000 and the taxpayer would be required to pay alternative minimum tax on the remaining $50,000 of income. Under the Act, this 90% limitation will not apply to (1) net operating losses carried back from 2001 or 2002 to a prior year (during the new five-year carryback period) or (2) carryovers to 2001 or 2002 of net operating losses from any prior year. Again, there is a need to focus on whether prior returns need to be amended or claims for refund need to be filed in order to take advantage of this new provision.

Property Located in the "New York Liberty Zone"

Generally, the incentives available within the NYLZ are even more generous than those otherwise available under the Act.

30% Expensing

The time requirements for qualifying for 30% expensing are more liberal in the NYLZ than elsewhere. Also, in some cases, "base building" and similar expenditures may qualify.

The Act sets out six requirements that must be met in order for property within the NYLZ to qualify for 30% expensing:

1. The property must be:

depreciable property to which the so-called "Modified Accelerated Cost Recovery System" of Internal Revenue Code section 168 applies and which has a recovery period of 20 years or less under that System,
otherwise depreciable computer software,
water utility property, or
nonresidential real property or residential rental property, but only to the extent that it rehabilitates real property damaged, or replaces real property destroyed or condemned, as a result of the September 11, 2001, terrorist attacks.

2. Substantially all of the use of the property must be in the NYLZ and in the active conduct of a trade or business in the NYLZ.

3. The original use of the property in the NYLZ must commence with the taxpayer after September 10, 2001 (with a special rule for sale-leasebacks), so that only new construction, and not the purchase of an existing occupied building, will qualify.

4. Either:

the property must be acquired by the taxpayer by "purchase" (which will generally exclude acquisitions of property from a related person) after September 10, 2001, and no written binding contract for the acquisition of the property may have been in effect before September 11, 2001; or
the taxpayer must begin manufacturing, constructing, or producing the property for its own use after September 10, 2001.

5. The property must be placed in service by the taxpayer after September 11, 2001, and on or before December 31, 2006 (or, in the case of nonresidential real property or residential rental property, December 31, 2009).

6. The property must not be "qualified New York Liberty Zone leasehold improvement property" (discussed below).

Five-Year Write-Off for Leasehold Improvements

In the case of "qualified New York Liberty Zone leasehold improvement property" ("Q-ZLIP"), the 30% expensing does not apply, but another benefit is made available -- the cost of such property may be written off over a five-year period, on the straight-line method (nine years for alternative minimum tax purposes), in lieu of the 39-year period that would generally be applicable. Q-ZLIP must meet the following requirements:

1. The property must be an improvement to an interior portion of a property which is nonresidential real property,

2. The improvement must be made under or pursuant to a lease (or other grant of a right to use property) between unrelated parties, by the lessor, the lessee, or any sublessee of that portion,

3. That portion must be occupied exclusively by the lessee or any sublessee,

4. The improvement must be placed in service more than three years after the date the building was first placed in service,

5. The expenditure for the improvement must not be attributable to the enlargement of the building, an elevator or escalator, any structural component benefiting a common area, or the internal structural framework of the building,

6. The building must be located in the NYLZ,

7. The improvement must be placed in service after September 10, 2001, and before January 1, 2007, and

8. No written binding contract for the improvement may have been in effect on September 11, 2001.

Property that does not satisfy all of these requirements may still be eligible for 30% expensing, if it meets the requirements for that benefit.

Reinvestment of Proceeds of Involuntary Conversions

Many owners of property located within the NYLZ will be receiving insurance proceeds to compensate them for damage to their property as a result of the September 11, 2001, terrorist attacks. If the amount of these proceeds exceeds the basis of the property, the owner will realize a gain. Section 1033 of the Internal Revenue Code permits the owner to defer recognition of that gain if the insurance proceeds are reinvested in property similar or related in service or use to the damaged property or in any other tangible property held for productive use in a trade or business. In many cases, the reinvestment must be accomplished within a period of two to three years after the date on which insurance proceeds are first received, unless an extension of the "replacement period" is granted by the Internal Revenue Service. In the case of property in the NYLZ damaged in the September 11 attacks, the Act extends the replacement period to five years after the close of the first year in which the amount of insurance proceeds exceeds the taxpayer's basis, so long as the replacement property ultimately acquired is located in the City of New York (whether or not within the NYLZ). Additional extensions can still be granted by the Service.

In the case of a taxpayer taking advantage of section 1033, the taxpayer's basis in the replacement property is reduced to reflect the deferred gain. However, if the replacement property would otherwise be eligible for 30% expensing or the five-year write-off, it appears that those benefits will be available with respect to the reduced basis.

Work Opportunity Credit

In order to provide an incentive for increased employment within the NYLZ, the Act extends the benefits of the work opportunity credit to employers who pay wages during 2002 and 2003 to individuals who perform substantially all of their services within the NYLZ on behalf of businesses located in the NYLZ. Additionally, if a business relocates from the NYLZ to another part of New York City due to significant physical damage resulting from the September 11 attacks, wages paid to employees who perform substantially all of their services within the City, even though outside the NYLZ, may also qualify.

The credit is limited to 40% of the first $6,000 of wages paid to an employee for each of the years during which the credit is available. In the case of employers outside the NYLZ who qualify for the credit, the number of employees taken into account cannot exceed the number of individuals employed in the NYLZ immediately before the attacks. In general, large businesses (those which, together with other businesses "under common control," employ more than 200 employees on a worldwide basis) will not be eligible for any credit.

The credit can be applied against the regular tax and the alternative minimum tax.

Tax-Exempt Bonds

The Act also permits the issuance of $8,000,000,000 of tax-exempt bonds to fund construction and development primarily within the NYLZ. The authority to issue these bonds is divided equally between New York City and New York State. Various sublimits apply to the amount of bonds that can be issued to fund projects within New York City, but outside the NYLZ, and to fund construction of residential rental property.

NEW YORK STATE AND CITY INCENTIVES

The Empire State Development Corporation of the State of New York ("ESDC"), in cooperation with the Economic Development Corporation of the City of New York ("EDC"), has developed assistance plans that offer financial incentives to attract and retain individuals and businesses within designated areas of Lower Manhattan. To facilitate the implementation of these plans Governor Pataki has established the Lower Manhattan Development Corporation ("LMDC") and the federal government has authorized the disbursement of a $2 billion Community Development Block Grant to the LMDC, which supplements $700 million of funds previously disbursed to the State to aid in the rebuilding of Lower Manhattan.

The LMDC plans on disbursing grants to eligible individuals through its Individual Housing Assistance Program (the "Housing Program"), in accordance with its Draft Assistance Plan For Individuals (the "Housing Plan"). The LMDC is currently seeking comments on this Housing Plan. Thus, the information provided below is subject to change. The primary goal of the proposed Housing Plan is to create financial incentives to encourage individuals to relocate to a lower Manhattan location and to remain in that area if they currently reside there. An individual can receive assistance for either rental housing or owner occupied units. Rental units and owner occupied housing within the "Immediate Impact Zone," which is the area south of Chambers Street and west of Broadway, and the entirety of Battery Park City, will be eligible for a grant of 30% of the monthly rent or mortgage payments, plus maintenance costs and taxes for purchased units, up to $12,000 over two years. Units located outside the Immediate Impact Zone but south of Canal Street and Rutgers Street in Manhattan are also eligible for the 30% grant, but limited to $6,000 over two years. To qualify for the incentive, new tenants must sign at least a two-year lease after the beginning date of the Housing Program and the lease term must begin prior to August 31, 2003. New owners must purchase their housing between September 11, 2001, and August 31, 2003, and agree to remain for at least two years. Only one grant per unit is available and the recipient must occupy the unit for which the grant is being provided.

In order to help attract and retain businesses and their employees within Lower Manhattan, the LMDC will oversee the World Trade Center Small Firm Attraction and Retention Grant Program. The Guidelines for this Program were adopted as of March 6, 2002. This Program has preliminarily allocated $80,000,000 of grants to small firms (10-200 employees) that sign or renew leases for at least five years, or purchase new facilities, and commit to remain for at least five years in the area of Manhattan south of Canal Street. In addition, the Program provides grants to small firms that were located in or near the World Trade Center that sign or renew leases for at least five years, or purchase new facilities, and commit to remain for at least five years anywhere in New York. The amount set aside for this Program will be disbursed to eligible businesses in two installments. The amount of each grant will vary depending upon the initial location of the business prior to September 11, 2001, and its location in the City thereafter, and the number of full time permanent employees on the business's Application Date and on the 18-month anniversary of such Date. In general, the amounts of the grants will be either $2,500 per employee, if located within a "Restricted Zone" prior to and after September 11, 2001, or $1,750 per employee, if located elsewhere.

Businesses that have more than 200 employees may be eligible for benefits under the World Trade Center Job Retention and Creation Program. The Program is generally described in the New York State World Trade Center Disaster Action Plan for New York Business Recovery and Economic Revitalization (the "Action Plan"), dated January 30, 2002, promulgated by ESDC in cooperation with EDC. Although guidelines have not yet been adopted, the Action Plan proposes to allocate $170,000,000 for benefits under this Program to businesses located in Lower Manhattan at the time of the World Trade Center Disaster, as well as to businesses seeking to locate new operations and employment in Lower Manhattan. The Program offers a combination of grants, loan guarantees, and low cost loans, the amounts of which will be evaluated on an individual basis based upon an assessment of the economic value of the project to the City, risk, location, and size of the workforce. In general, to qualify for this type of assistance, the business must make a commitment no later than December 31, 2004, to maintain jobs in New York City for a minimum of seven years. As a part of this Program, the State plans to identify certain industries (e.g., high technology, new media, and bio-technology) that it believes offer the downtown area significant potential job creation opportunities.

Finally, the New York City Commercial Revitalization Program will provide incentives to businesses that relocate to Lower Manhattan. These incentives include real property tax abatements and commercial rent tax reductions for tenants moving into commercial, retail, or office space in Lower Manhattan.

* * *

These major changes will require further study and analysis. Meanwhile, if you have any questions or would like to discuss the impact of any of the changes or programs on your business, please contact Elliot Pisem at (212) 903-8777, Lary S. Wolf at (212) 903-8719, or any of our other attorneys.

FOOTNOTES_________________

1. The "New York Liberty Zone" is the area in the Borough of Manhattan located on or south of Canal Street, East Broadway (east of its intersection with Canal Street), and Grand Street (east of its intersection with East Broadway).

2. By way of example, take the case of a $1,000 leasehold improvement constituting nonresidential real property that is placed in service by a calendar year taxpayer during January 2002. Under the ordinary depreciation rules, the taxpayer's depreciation deduction for 2002 (based on a 39-year life) would be $24.57 (an amount equal to $25.64 (i.e., 1/39 of the $1,000 cost), minus a small reduction to reflect the application of the "mid-month convention") and the deduction for each subsequent year would be $25.64. Under the Act, the deduction for 2002 would be $317.20 (30% of $1,000, plus 1/39 of $700, again with a small adjustment for the mid-month convention) and the deduction for each subsequent year would be $17.95.

3. A taxpayer, whether within or without the NYLZ, may elect to decline the benefit of 30% expensing. Also, 30% expensing may not be available for property financed with tax-exempt bonds or otherwise subject to the "alternative depreciation system" of Code section 168(g).

Real Estate Taxation