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Tax Reform: Interest Deductibility Fact Sheet

Real Property Borrowers Avoid New Interest Deduction Limitations

Last updated: December 4, 2018

Executive Summary

Section 13301 of the Tax Cuts and Jobs Act (H.R. 1), signed into law in December 2017 generally denies a deduction for net business interest expense in excess of 30% of a business’s adjusted taxable income (ATI). 

The 30% restriction does not, however, apply to electing “real property trades or businesses.” Such businesses are defined as “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.”

Real property trades/businesses that elect out of the interest deductibility restriction must use alternative depreciation system (ADS) recovery periods for cost recovery purposes. The ADS periods for residential rental property and nonresidential real property are 30 years and 40 years, respectively. 

The new interest deduction limitation is effective as of January 1, 2018. It is important to note that the new 16 (j) limitation only applies if the taxpayer has gross receipts of $25 million or more.

INTEREST DEDUCTIBILITY QUICK FACTS

  • New 30% ATI limit on business interest deductibility does not apply to electing real property trades and businesses.
  • Businesses electing out of interest deductibility restriction must use 40-year ADS recovery period for nonresidential real property.
  • “Real property trade or business” includes real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.
  • Proposed rules to implement this provision of the TCJA have been released, including computational and allocation rules. Taxpayers may rely on the proposed regulations until final ones are published.

Potential Solutions

  • Proposed rules to implement section 163(j): On November 26, Treasury and the IRS issued a notice of proposed rulemaking containing proposed regulations under section 163(j). Taxpayers may rely on the proposed rules until final regulations are published in the Federal Register. Certain key provisions of the proposed regulations affecting real property businesses include:
    • Definitions/scope related to “real property trade or business,” which build upon and attempt to provide more clarity around the existing definition in Code section 469(c)(7)(C);
    • Rules for electing real property businesses, including how to make the election, a safe harbor and special rules for certain REITs, and an anti-abuse provision;
    • Rules for computing items of income and expense for REITs, which, with a few exceptions, follow the computation approach for C corporations; and 
    • Allocation rules for determining the amount of a taxpayer’s interest expense, interest income, and other tax items that are properly allocable to an excepted business (e.g., a real property business) versus a nonexcepted business.
  • Other guidance on section 163(j): Previously, the IRS issued Notice 2018-28 addressing certain high-level issues with respect to section 163(j) (e.g., the limitation applies to consolidated groups of corporations on a consolidated basis, carryforwards of disallowed interest from past years is subject to the limitation, all C corporation interest is treated as “business” interest, and certain rules for computing the application of the limitation to partners in a partnership). 

Resources

Interest Deductibility Fact Sheet 

Steptoe & Johnson Memo on CRE-related Tax Issues, December 4, 2017
CREFC Side-by-Side Comparing Various Tax Vehicles, December 4, 2017

For further Information, visit CREFC’s Resource Center at: https://www.crefc.org/library

Additional Background & History


Under the pre-H.R. 1 tax code, businesses could deduct interest payments on amounts borrowed without limitation (except in certain narrow cases involving payments to foreign related parties), which reduced the cost of investment and facilitated increased economic activity by allowing businesses greater access to capital to maintain and expand their operations. 

Limiting the interest deduction was presented generally in the House Republican Tax Reform Blueprint in 2016 as a trade-off for immediate expensing. 

Because debt financing is particularly important in the real estate industry, CREFC argued during the tax reform debate that restricting this deduction—particularly for real property businesses—risked destabilizing the recovering economy. Beyond the real estate industry, many others, including agriculture, finance, construction, telecommunications, and mining, would be harmed by any new limitations under this provision.

Ultimately—despite tremendous pressure on lawmakers to find revenue to offset various tax reductions in the comprehensive tax reform package—we, along with our industry group partners, were successful in preserving full interest deductibility for electing real property trades and businesses—a big victory for CREFC members and the broader real estate sector.

Disclaimer

The information provided herein is general in nature and for educational purposes only. CRE Finance Council makes no representations as to the accuracy, completeness, timeliness, validity, usefulness, or suitability of the information provided. The information should not be relied upon or interpreted as financial, tax, accounting, investment, commercial or other advice, and CRE Finance Council disclaims all liability for any such reliance. © 2018 CRE Finance Council. All rights reserved.
 

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