5 Differences Between Income Tax Basis and GAAP for Real Estate Investors– April 12, 2022 by Maria Revello

How an entity’s financial statements are presented is often governed by bank documents or investor agreements, leaving owners of real estate firms without much of a choice in the matter. However, in some instances, you may have a choice between using income tax basis or GAAP to present your financials. In this situation, it’s important to know which factors are the most relevant so you choose the method best suited for your organization.

The most significant difference between generally accepted accounting principles (GAAP) and the income tax basis of accounting is that income tax basis allows entities to focus on the actual flow of funds and operations and their impact on eventual tax dollars. Generally, this is crucial information for investors as they consider potential capital contributions, the longevity of investments and returns on their investments.

Outlined below are five of the most common accounting differences affecting the timing of recognition of income/loss when comparing income tax basis and GAAP.

1. Accounts Receivable

GAAP financial statements require a policy for identifying any accounts whose collections are doubtful and for establishing an allowance against these identified accounts until final determination is received.  The income tax basis allows such doubtful amounts to be recorded as a bad debt expense immediately upon identification.

2. Depreciation

Under the income tax basis, real estate assets are depreciated over periods specified in the Internal Revenue Code, while GAAP uses estimated useful lives. The income tax basis allows for accelerated depreciation methods, while GAAP traditionally depreciates over the applicable lives on a straight line basis.   

3. Rental Income and Lease Expense

Under the income tax basis, rental revenues are generally recorded in accordance with the contractual terms of the lease. Under GAAP, rental income is recognized on a straight-line basis over the term of the lease. In addition, GAAP requires lease expense for the lessee to be recognized on a straight-line basis over the term of the lease, and, with the implementation of ASC 842, requires right-of-use assets and liabilities to be captured on the balance sheet.

>> Download our lease accounting guide for private companies to better understand the overall adoption and impact of ASC 842

4. Organization and Start-Up Costs

Organization and start-up costs are generally capitalized and amortized in tax basis financials rather than being expensed as incurred under GAAP.

5. Real Estate Acquisitions

Real estate acquisitions under GAAP require the consideration of tangible and intangible assets in the purchase price allocation. Common examples of intangible assets would include in place leases and above/below fair market value leases. Under the income tax basis, those considerations are not generally required.  

In addition to the five commons items above, there are also items that exist in GAAP financial statement presentation that are not income tax basis concepts:

  • Impairment analysis. Under GAAP, long-lived assets are reviewed for impairment if a triggering event occurs indicating that the carrying value may no longer be a reasonable representation of value.
  • Derivative instruments. GAAP requires derivative instruments, such as interest rate swaps, to be recorded on the balance sheet at their settlement value (asset or liability) — with changes in each period recorded as other comprehensive income/loss. 

While income tax basis could be a streamlined way for your firm to present its financial statements, the ultimate decision and impact will depend on your financial situation, entity structure and operations.

Contact Lisa Metzinger at lmetzinger@cohencpa.com, Maria Revello at mrevello@cohencpa.com or a member of your service team to discuss this topic further.

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Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.