RSM on tech, taxation and representation

This article is sponsored by RSM

RSM serves as an audit, tax and accounting advisor to more than 3,200 real estate and construction companies across the US. The firm recently launched a proprietary allocation and tiering platform that aims to turn the tax compliance function from a cost to value center.

Troy Merkel, senior real estate analyst and audit partner with RSM’s national real estate practice, and Brad Collins, principal and leader of the partnership technology services team, tell PERE about the future of tax and technology automation, and how it can help real estate firms scenario plan for numerous consequences such as divestitures or the tax implications of the US presidential election.

How have investors’ and managers’ tax and financial reporting needs changed in recent years?

Troy Merkel: Real estate has always been a tax-advantaged investment class, especially in the US where rules allow you to shelter income or cashflow through depreciable losses and other mechanisms. Therefore, tax reporting has always been one of the top priorities for any investor, and many real estate investors are very tax-motivated.

That is particularly true of some of the equity we have recently seen enter the asset class from family offices and high-net-worth individuals. In the last couple of years, we have seen increased demand for transparency that comes with real time reporting and dashboarding.

Investors want deeper insights into all aspects of their investments, including tax. Getting a high-level report on the cash return or IRR is no longer enough.

A greater proportion of investment decision-makers now come from the millennial generation and they want the same technology available in their working life that they use in their personal life. They expect to be able to instantly access and analyze data with a simple touch on their mobile.

How can technology aid tax reporting?

Brad Collins: When we talk to our clients we focus on their tax reporting pain points. For example, I was recently talking to the manager of a multi-billion-dollar real estate fund with thousands of investors. They shared how incredibly difficult it was to harness real time data on the tax performance of those investments.

They are fielding questions from investors about fund performance, fielding requests for estimates of what they should pay in federal, state and local taxes, and what it means for those tax obligations if they make a large investment or divestiture. What real estate firm leadership needs for investors is access to tax data in as close to real time as possible so they can carry out scenario planning.

The understanding that a tax technology platform will provide a tax director or chief financial officer with of what they need for tax compliance is table stakes. The differentiating factor and added value is in having tax information at their fingertips when they need it so their business and investors can make better decisions.

When someone from the investment team comes in and asks them what buying an asset means to their investors from a tax perspective, they can provide an answer. That is where having the right technology allows people in those roles to really drive value.

“What real estate firm leadership needs for investors is access to tax data in as close to real time as possible so they can carry out scenario planning”
Brad Collins

For example, in the last several weeks while votes were being counted in the presidential election our clients were asking us to run scenarios based on whether Joe Biden or Donald Trump would get to put their tax plans into action. This is just one way a flexible, cloud-based technology platform also adds value by enabling managers to turn their tax reporting around much faster. Investors want to know what their tax liabilities are as quickly as they possibly can to understand the tax-effectiveness of their investments.

What has been the impact of covid-19?

TM: Covid-19 drove demand for more frequency and detail in reporting. A number of managers we work with were receiving requests for weekly calls with their investors updating them on very specific details about the performance of their assets.

Tax reporting is a component of that, alongside leasing activity and rent collection. By leveraging technology investors can bring all of that data together and examine it in real time.

Another of the impacts of covid, both in the US and Europe, was the introduction of government aid packages. Some of those had very significant tax ramifications and investors needed to assess if they were entitled to participate in those programs.

Having the technology to analyze their data for that purpose really made a difference, because in many instances the resources were allocated so quickly that the fastest to the line most likely won out. Companies that could not assemble and analyze their data in time likely lost out on millions of dollars of financial aid.

What might the US election mean for the taxation of real estate investment?

TM: Both presidential candidates indicated they would make tax changes that would impact real estate. However, the Biden campaign was more specific about measures that will have an impact on taxation not only of real estate but investment in general.

The main proposal is to change the long-term capital gains rate, which is taxed at 20 percent for investments held for over a year. That could potentially change to mirror the ordinary tax rate, which for top-end individuals is around 37 percent.

To compound that change, there have been suggestions that there may be an increase in that rate to 39 percent. That could have very serious ramifications for the after-tax IRR of long-term investments, and real estate is almost exclusively a long-term investment.

“As the presidential candidates were on the campaign trail we had clients calling us to ask: ‘I heard this announcement from one of the candidates. What does that tax law change mean for me?’”

Troy Merkel

After three or four years everyone will be on a level playing field, but in the meantime, some sponsors and investment markets could get burned by the fact that they might not meet their anticipated IRR projections because the tax structure the industry has come to rely on has changed.

A Biden administration could also abolish the 1031 Exchange rule, which currently means if you sell a real estate asset and invest the proceeds in a new real estate asset within 180 days you can effectively roll over the capital gain component of that transaction into the new investment and forego tax payments. That mechanism has been much-used in the past by high net worth and family office investors. If it is changed, investors will need to assess what that means for their tax planning strategies, and for future purchases and divestments.

There may also be changes to depreciation rules under a Biden presidency which would have significant tax implications. Investors want to be able to see long-term projections of how politically-driven changes might produce potential tax liabilities or benefits. We can do that for them by carrying out a technology-enabled multiple scenario analysis.

As the presidential candidates were on the campaign trail, we had clients calling us to ask: “I heard this announcement from one of the candidates. What does that tax law change mean for me?” And often they are snippets rather than fully-fleshed proposals, so you have to run a lot of different scenarios.

BC: That is why one of the features we included when we built our tax allocation and tiering platform was the ability to clone data. All that data is kept within the platform and when a client asks a question, we can clone the data so the client retains the original data while we run multiple scenarios and use that to create visualizations of the results.

By pulling the data into a visualization, sponsors can see what the effect of the Trump or Biden plans would be, and compare that with the status quo. For example, what would be the capital gains impact of selling and asset in 2020 versus 2021 if the 1031 Exchange rule is changed?

What factors must firms consider to choose a tax reporting technology platform?

TM: When we are advising clients on digital transformation the biggest problem is often that they went into it without a plan. At various times, they have had pain points and have found individual solutions without a holistic approach.

They end up with a digital Frankenstein’s monster where the systems do not integrate. They start band-aiding things by using robotic process automation to connect systems that were never intended to work together. The solution is to sit down with an advisor like RSM that can look holistically at the business, not just at solving a specific problem.

BC: Real estate firms must ask themselves whether they want to have all their data in one place with a single service provider that can give them an end-to-end platform experience. Some advisors use multiple technologies, some off-the-shelf and some home grown, in order to serve clients. In my view, that approach is antiquated.

When sponsors are evaluating a service provider, they need to question how that provider is going to be serving them all the way from data ingestion to delivery, and whether they can loop back to access their data afterwards to analyze it. Is the provider not only satisfying their tax-technical needs, but also bringing in the tech savvy needed to truly drive value?

What will the future of financial reporting look like?

TM: In many cases, crisis is the crucible of innovation, and that has happened with covid-19. The ability to do real time reporting and access data quickly so you can make very fast business decisions is not going to revert back.

Investing in technology has just become table stakes. There are so many added benefits to it.

Some of the more sophisticated investment shops are investing in fractional assets or single family residential and they are dealing with more and more data points. They need to be able to scale up and not only use the data, but also be able to analyze it in real time.
Firms that fall behind will also struggle to attract talent. Millennials and Generation Z expect access to data and data analytics.

BC: Service providers will continue to become more and more integrated with clients, creating a single ecosystem, like Apple or Google seek to do in the personal sphere, delivering all of the services in your life.

Leveraging technology lays the groundwork for advisors to become not just tax consultants, but truly holistic advisors.