How New Tax Laws May Impact the Hospitality Market: Are You Ready?

While all industries were adversely affected during the pandemic, perhaps none has had devastation inflicted like the hospitality market. Now, widespread vaccine rollouts have contributed to a sense of optimism (tinged with caution), and yet, even as occupancy rates begin to inch up, the hospitality industry’s resurgence faces other threats. A number of proposed tax laws could diminish the market’s expected rebound, curbing profits and growth.

However, not everyone is aware of how these taxes will impact their businesses, finds Ken Bernice, managing director at global consulting firm FTI. As a leader in the space, FTI team members are helping make educated decisions for those likely to be affected by assessing each unique situation. In some cases, that entails providing guidance and confidence in decision-making for clients whose portfolios are at risk of either being acquired or completely dissolved. In other scenarios, FTI has supported hospitality clients who have been able to merge with other companies for expanded results.

Whatever your current situation, here is what you need to know about the implications of tax laws for the hospitality market.

 Bright spots helped the industry cope

As the hospitality business plummeted, including in the highly lucrative convention business, some tax relief was at hand. First, the hotel room occupancy tax rate was eliminated during the important summer months as tourists once again flocked to the Big Apple. 

In addition, the dip in net operating income has given the industry the ability to push back, appeal or reassess property taxes. And COVID-related tax deductions added another layer of relief. “Specifically, the employee retention credits and payroll tax deferrals have provided a much-needed jolt,” says Steve Bertonaschi, senior managing director in FTI’s real estate solutions practice. He adds that the retention credits are likely to be extended further based upon the latest proposals. 

New taxes could inflict financial damage

While that relief was welcome, the reprieve could be short-lived, given proposed tax increases on the horizon. As is the case with most industries, these could either have a direct impact or an indirect impact on hospitality, points out Bertonaschi. “An increase to corporate-level taxes would certainly be that direct hit, but at least in the latest discussions, that increase seems to be going by the wayside,” he says. “And while an increase on taxes to the wealthy can always be concerning, at this juncture it doesn’t appear that it would have a significant impact.”

But for real estate professionals, there are a number of items in the tax laws proposed by the current administration that could be concerning, says Bernice, citing the following:

  • An increase in the long-term net capital gains rate from 20% to 25%.
  • An imposition of tax on book income of certain large corporations
  • An amendment to the business interest limitation rules to apply Internal Revenue Code (“IRC”) Section 163(j) at the partner level and the allowance carryforwards of disallowed business interest expense to expire after five years. “This provision could change the interest disallowance from a timing difference to a permanent difference, thus increasing taxable income for real estate companies,” Bernice cautions.
  • Proposal for carried interest which would replace the existing mechanism under IRC Section 1061(a) for calculating the long-term-to-short-term recharacterization amount. As Bernice explains, under the current proposal, a partner’s “net applicable partnership gain” with respect to an applicable partnership interest could be recast as short-term capital gain unless an exception is applied. “Among other provisions, the proposal would extend the long-term capital gain holding period for gain attributable to an applicable partnership interest from three to five years, and those who hold a carried interest would face higher taxes on their interest,” he says.

Bernice adds that on a positive note, real estate professionals had feared that the Biden administration would eliminate the IRC Section 1031 Like Kind Tax Deferred Exchange, which allows a property owner to sell investment property and defer the taxes that would normally be due upon that sale. According to Bernice, members of the House Ways and Means committee recently distributed letters to their constituents letting them know that IRC Section 1031 was safe.

The time is now to mitigate the impact                      

As with any proposed tax changes, the best way to prepare is to talk with professionals who have proven expertise in this area, says Bernice, noting FTI’s widespread footprint with offices in New York City, California, Chicago and the United Kingdom.

Bertonaschi says that FTI’s advice and guidance has led to client success using the strategies most applicable to each, whether through expansions, mergers, acquisitions or dissolvements.

“Mergers and acquisitions have hit the industry hard, with the larger hotel companies, including hotel REITs, making strategic acquisitions in an environment that is ripe with opportunity to consolidate activities, centralize management and build greater economies of scale,” he says. While acquisitions further provide an ability to gain immediate tax deductions through depreciation write-offs of a sizable amount of assets, it’s vital to ensure that the deals are being created to capitalize on greater tax efficiencies—an area where FTI has considerable experience.

Bernice adds that they have seen a number of hospitality acquisitions where opportunistic private equity funds acquire distressed hotel portfolios. “The pandemic has caused immense value decline and challenges, which is forcing hospitality companies to reassess and or reposition their portfolios,” he says.

In addition, some portfolios of significant size have taken on large capital expenditure projects within their hotels during the pandemic to better reposition themselves positively for the recovery. These projects have another benefit in that they could lead to powerful tax savings through depreciation deductions.

Bertonaschi has also advised numerous clients who are taking this chance to amend their leases to more attractive terms, specifically in a Real Estate Investment Trust (“REIT”) operating company/property company lease structure. “The goal is not only to help improve cash flow, but get a better handle on taxes, including use of tax attributes down the road.”

While there are numerous opportunities available in the market today, hospitality companies need to rely on seasoned professionals who can help assess options and weigh the risks and advantages to create the best potential benefits.

Would you like more information on how these new taxes could potentially impact your business? Connect with team members in your region who can help you identify and mitigate risks by contacting FTI today. Click here to connect today.

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FTI Consulting is an independent global business advisory firm dedicated to helping organizations manage change, mitigate risk and resolve disputes: financial, legal, operational, political & regulatory, reputational and transactional. FTI Consulting professionals, located in all major business centers throughout the world, work closely with clients to anticipate, illuminate and overcome complex business challenges and opportunities. The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, Inc., its management, its subsidiaries, its affiliates, or its other professionals. FTI Consulting, Inc., including its subsidiaries and affiliates, is a consulting firm and is not a certified public accounting firm or a law firm. ©2021 FTI Consulting, Inc. All rights reserved.

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