FAQs: The Real Estate Industry & The Business Interest Expense Deduction Limitation
posted Apr 11, 2019 by Parul Bansal in the Global Tax Blog
Attention real estate investors…are you aware of the changes December 2017’s Tax Cuts and Jobs Act (TCJA) made to the business interest expense deduction? Below are some frequently asked questions about the limitation on this deduction, also known as the Section 163j limitation, as it relates to the real estate industry.
- What is business interest expense? Business interest expense is the cost of interest that is charged on business loans used to maintain operations.
- So, business interest expenses are deductible? Typically, taxpayers can deduct interest expense paid or accrued in the taxable year.
- How does the Tax Cuts and Jobs Act impact this deduction? Under the TCJA, starting in 2018, the deduction for business interest will generally be limited to 30% of the taxpayer’s adjusted taxable income (ATI) for the tax year.
- What is the Section 163(j) limitation on the deduction for business interest expense? Section 163(j) limits the business interest deduction for all taxpayers who have business interest expense and have average annual gross receipts over $25 million in the previous three years.
- How are tax shelters treated under the new rules? In addition to the $25 million average gross receipt requirement, it is also required that not more than 35% of the losses of a pass-through entity be allocated to limited partners. Something that has been overlooked by some is that this ‘tax shelter’ rule may subject many pass-through entities to Sec 163(j) where losses are generated and capital has been infused by passive investors who are allocated more than 35% of such losses.
- How do you calculate adjusted taxable income (ATI) under the new rules? For tax years 2018 – 2021, adjusted taxable income is taxable income before NOL carryovers, 199A exclusion, depreciation, amortization, business interest expense, business interest income. After 2021 Depreciation & Amortization will no longer be an addback.
- Can a real property trade or business make an election out of 163(j)? Yes. The election is irrevocable and all real property assets must be depreciated using ADS regardless of prior year asset life.
- Is the addback for depreciation, amortization and depletion still allowed? As noted above, part of the calculation in determining ATI is to addback depreciation, amortization, and depletion. For taxable years beginning after 2021, this addback will no longer be available, depreciation, amortization, and depletion will not be taken into account in calculating ATI. Depending on your situation, this could be an issue. Those with 15 year property would need to convert to the longer 30 (applicable to residential property) or 40 year (applicable to non-residential property) life if an election is made. Some taxpayers may want to wait until 2022 before making the election (assuming the depreciation addback helps the taxpayer avoid limitation in 2018 through 2021).
- Does this change represent a change in accounting method? As outlined in Revenue Procedure 2019-8, the IRS considers the election to be a change in use, not a change in accounting method.
Other TCJA changes real estate investors should be aware of
Check out our blog, How will the Tax Cuts and Jobs Act (“TCJA”) Impact Real Estate Owners? You’ll want to read up on changes to the Section 179 deduction and bonus depreciation.
Our tax professionals can help you understand the full impact of the new tax law on your business in 2019 and beyond.
For more tax reform updates, be sure to visit our Tax Reform Center- your “one stop shop” for all things Tax Cuts and Jobs Act (TCJA) related.