Category: Interest Deductibility

Roundtable Asks Treasury to Clarify Real Estate Exception to New Limit on Business Interest Deductibility

Posted on by Trey Jackson

The Real Estate Roundtable on Tuesday wrote to the Treasury Department and IRS about the new limitation on business interest deductibility enacted in the Tax Cuts and Jobs Act of 2017 (TCJA).  The provision allows qualifying businesses to continue fully deducting interest related to commercial real estate debt.  (Roundtable comment letter, Feb. 26)

The Roundtable’s Feb. 26 letter on business interest deductibility.

  • Roundtable President & CEO Jeffrey DeBoer sent the  detailed comments as Treasury officials work to finalize proposed regulations implementing TCJA’s new section 163(j), which limits the deductibility of business interest to no more than 30% of modified, adjusted taxable income.  Section 163(j) includes a critical exception for real estate.
  • On December 28, 2018 Treasury published proposed regulations clarifying that partner-level debt may qualify for the real estate exception-if the debt is allocable to a partnership engaged in a real property trade or business (RPTOB). 
  • DeBoer notes in The Roundtable’s Feb. 26 letter, “In light of the clear legislative intent to enact a broad real estate exception and its importance to the health and stability of real estate markets, the final Treasury regulations should build on the proposed rules and not limit unnecessarily the ability of a real property trade or business (RPTOB) to elect out of the provisions of section 163(j).”
  • DeBoer adds, “No issue in tax reform is more important to the health and stability of U.S. commercial real estate than the new rules related to the taxation of business-related borrowing.  U.S. commercial real estate is leveraged conservatively with roughly $14 trillion of total property value and $4 trillion of debt.”

The letter includes detailed comments on several 163(j) implementation issues and makes the following recommendations:

The need to preserve the deduction for income-producing real estate was at the center of Jeffrey DeBoer’s testimony and exchanges with Senate Finance Committee members before final passage of the 2017 tax overhaul law. (Roundtable Statement for the Record, Sept. 19, 2017 and video clips). 

 

  • The real estate exception should extend through all “tiered” investment structures. 
  • The real estate exception should apply fully to non-rental activities. 
  • Treasury regulations should not “whipsaw” corporations/REITs through conflicting definitions of a “trade or business” that can effectively block their ability to use the real estate exception. 
  • Treasury regulations should modify the anti-abuse rule for related-party leases. 
  • The small business exception should not prevent otherwise eligible partners from qualifying for the real estate exception. 
  • Debt allocation rules should not undercount real estate assets for purposes of the real estate exception.
  • Treasury regulations should confirm that senior housing constitutes a real property trade or business.

The economic consequences of changes to the deductibility of business interest expense, and particularly the potential impact on real estate, was a central focus of lawmakers during consideration of the historic tax overhaul in 2017.  The need to preserve the deduction for income-producing real estate was at the center of DeBoer’s testimony and exchanges with Senate Finance Committee Chairman Orrin Hatch – and other members of the committee – during the last congressional hearing on business tax reform prior to votes on the TCJA.  (Roundtable Statement for the Record, Sept. 19, 2017 and video clips).  

Treasury Proposes Detailed Rules for New Restrictions on Deducting Business Interest

Posted on by Trey Jackson

On Tuesday, the Treasury Department released proposed regulations governing the new limitation on the deductibility of business interest expense, including the exception for real estate businesses. 

On Tuesday, the Treasury Department released proposed regulations governing the new limitation on the deductibility of business interest expense, including the exception for real estate businesses. 

  • Under the Tax Cuts and Jobs Act (TCJA), businesses generally can no longer deduct their interest expense to the extent it exceeds 30 percent of their annual earnings before interest, tax, depreciation and amortization (EBITDA).  Business interest deductibility was a key issue in Real Estate Roundtable President & CEO Jeffrey DeBoer’s testimony before the Senate Finance Committee shortly before consideration of the tax bill.  (Roundtable Statement for the Record, Sept. 19, 2017)
  • DeBoer testified that the proposal could have severe unintended consequences.  Noting that the cost of debt is a necessary expense that must be accounted for when measuring income, he testified that our capital markets are the envy of the world and that responsible, appropriate leverage helps entrepreneurs and contributes to economic growth and job creation. (Roundtable Weekly, Sept. 29 and testimony video clips)
  • The final bill included a critical exception from the interest limit for an electing real property trade or business.  An electing real property trade or business is defined broadly to cover: any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. 
  • In February, the Roundtable submitted comments to Treasury with recommendations for how the real estate exception should work in the case of tiered business structures, and in the case of businesses that involve both real estate and non-real estate activities.  (Roundtable Weekly, Feb. 23, 2018)  

    Business interest deductibility was a key issue in Real Estate Roundtable President & CEO Jeffrey DeBoer’s testimony before the Senate Finance Committee shortly before consideration of the tax bill.  (Roundtable Statement for the Record, Sept. 19, 2017 and  video clips ). 
  • The proposed regulations are largely favorable.  Most importantly, the regulations clarify that partner-level borrowing qualifies for the real estate exception. Thus, at the election of the taxpayer, the real estate exception can extend to debt that is incurred by a partner to acquire an interest in a partnership that is engaged in a real property trade or business.  In addition, the regulations confirm the broad definition of a real property trade or business.  The regulations also clarify that capitalized interest, which commonly arises during the development of real estate, is not subject to the interest limit.
  • With respect to taxpayers engaged in both real estate and non-real estate activities, the proposed regulations generally would allocate and apportion debt based on the relative amount of the taxpayer’s adjusted basis in assets used in those activities.  However, taxpayers would directly trace and allocate qualified nonrecourse indebtedness to the asset securing the loan (with no apportionment).  This latter rule should result in the allocation of a larger share of debt to assets qualifying for the real estate exception.
  • Some concerns remain.  Notably, the attribution rule that allows partners to qualify for the real estate exception based on partnership-level activities does not extend broadly to all upper-tier borrowing for investment in lower-tier real estate businesses.  Thus, except in limited circumstances, debt incurred by a taxpayer to invest in a corporation (or REIT) that is engaged in a real property trade or business is not eligible for the real estate exception. 

The Roundtable’s Tax Policy Advisory Committee is continuing to review the 439-page regulatory package to understand its full implications for the financing of U.S. real estate.  Comments on the proposed regulations will be due 60 days after their publication in the Federal Register.

Guidance on Business Interest Deduction Limit May Address Real Estate Investment Issues

Posted on by Trey Jackson

The Treasury Department and Internal Revenue Service are close to issuing draft regulations on the new business interest expense limitation, enacted in last year’s tax overhaul.  Regulations related to the Tax Cuts and Jobs Act can be designated for an expedited, 10-day review by the White House Office of Management and Budget before publication and public release, though the timetable can be extended if needed.

A Feb. 21, 2018 Roundtable letterurged Treasury to clarify that interest (other than investment interest) on debt that is allocable to an owner of an entity engaged in a real property trade or business is exempt from the new business interest limitation rule – if that trade or business has elected out of the rule.

  • The Tax Cuts and Jobs Act capped the amount of interest that a business with revenue over $25 million can deduct annually – to no more than 30 percent of earnings before interest, taxes, depreciation, and amortization.  The provision also includes an important exception for an “electing real property trade or business.” 
  • This exception reflects policymakers’ understanding that limits on the deduction for interest expense could have enormous negative consequences for property values, real estate markets, and economic growth.  (Reference: Real Estate Forum, Jan/Feb 2018,  Decoding The New Tax Bill) 
  • The Real Estate Roundtable on Feb. 21, 2018 wrote to Treasury Secretary Steven Mnuchin and offered a number of recommendations to resolve ambiguities in how the new limitation will apply.  The Roundtable requested clarifications to ensure the exception operates as intended for common real estate ownership arrangements – focusing on the scope and application of the exception for an electing real property trade or business. 
  • The letter urged Treasury to clarify that interest (other than investment interest) on debt that is allocable to an owner of an entity engaged in a real property trade or business is indeed exempt from the new business interest limitation rule – if that trade or business has elected out of the rule.  As relevant examples, the letter describes four common scenarios where the financing of a real property trade or business occurs through a tiered structure. Clarifying the rules for real estate in the context of tiered arrangements will help avoid potential disruptions.  (Roundtable comment letter, Feb. 21, 2018)
  • In April, Treasury and the IRS released Notice 2018-28 to provide interim guidance on the new limit until the proposed regulations are issued. For real estate investors, however, the Notice leaves unanswered some of the key issues related to the financing of real estate.  (IRS, April 2 and Roundtable Weekly, April 6)   
  • On Oct. 25, OMB’s Office of Information and Regulatory Affairs (OIRA) acknowledged receipt of the proposed section 163(j) rules from Treasury.  After OIRA completes its review, the proposed guidance will be issued.  A second set of regulations, focused specifically on pass-through entities, is expected in December.

The Roundtable’s Tax Policy Advisory Committee will continue to seek appropriate clarifications as Treasury moves forward with regulatory projects related to implementation of the Tax Cuts and Jobs Act.

Treasury Releases Guidance on New Business Interest Deduction Limit, but Questions for Real Estate Investment Remain

Posted on by Trey Jackson

On Monday, the Treasury Department and the Internal Revenue Service (IRS) released Notice 2018-28, which provides guidance on the new limitation on the deductibility of business interest, (Section 163(j)), enacted in the Tax Cuts and Jobs Act.

In the Feb. 21 letter the Roundtable asked Treasury to clarify     that interest on debt incurred by an owner to fund an investment in a partnership or other entity engaged in a real property trade or business, constitutes interest on debt properly allocable to that real estate business  . 

The Notice focuses on interest expense carryforwards from prior years, corporate interest deductions, and consolidated corporate groups, while leaving unresolved certain key questions for real estate investors.  Taxpayers can rely on the guidance at least until proposed regulations are issued.

In general, for taxpayers with revenue over $25 million, the Tax Cuts and Jobs Act capped the amount of business interest that a business can deduct annually to no more than 30 percent of earnings before interest, taxes, depreciation, and amortization.  The provision includes several exceptions, including an exception critical to real estate for an “electing real property trade or business.”  

Notice 2018-28 addresses a concern that partners in partnerships could effectively double-count certain interest income when calculating the limitation on partner-level borrowing.  Other highlights of the Notice include:

  • Carryforward of interest expense.  The Notice states that forthcoming regulations will allow taxpayers with disqualified interest under the old law to carry forward such interest as business interest under the new law.  Such interest could be disallowed under the new limitation in the same manner as any other business interest. 

  • Corporate business interest.  The Notice clarifies that interest paid by a C corporation is business interest for purposes of the interest limit.  Forthcoming regulations will address whether and when interest paid by a partnership, including a partnership with a corporate partner, should be treated as business interest for the corporate partner. 

  • Consolidated groups.  The Notice confirms that the business interest limit properly applies at the level of a consolidated group.  Forthcoming regulations will address how the interest limit applies to a consolidated group when one of the members is an electing real property trade or business, and to a consolidated group in which a member holds an interest in a partnership that is engaged in a real property trade or business.

  • Earnings and profits.  The Notice clarifies that a disallowed business interest deduction will not affect whether or when the interest expense reduces a C corporation’s earnings and profits.

For real estate investors, however, the Notice leaves unanswered some of the key issues related to the financing of real estate.  For example, The Real Estate Roundtable has asked Treasury to clarify that interest on debt incurred by an owner to fund an investment in a partnership or other entity engaged in a real property trade or business, constitutes interest on debt properly allocable to that real estate business (Comment Letter, Feb 23; Roundtable Weekly, Feb. 23).

The Treasury Department and the IRS are expected to issue additional guidance and regulations in the future, and request comments on the rules described in the notice and what additional guidance should be issued to assist in computing the business interest expense limitation under Section 163(j). (IRS, April 2)

Depending on the outcome of the rule-making process, the new limitation on business interest expense (Section 163(j)) could have significant implications for real estate markets and the financing of real estate transactions.  Clarifying the rules for real estate in the context of tiered arrangements will help avoid potential disruptions.

The Roundtable and TPAC will continue to play an active role in seeking appropriate clarifications affecting the most significant changes to the tax code.

Roundtable Proposes Framework for Implementing the Real Estate Exception to the New Business Interest Deduction Limit

Posted on by Trey Jackson

The Real Estate Roundtable on Wednesday wrote to Treasury Secretary Steven Mnuchin regarding the new limitation on business interest deductibility created in the Tax Cuts and Jobs Act, including rules that allow taxpayers to continue fully deducting interest related to commercial real estate debt. (Roundtable letter, Feb. 21)

The Feb. 21 Roundtable letter urges that Treasury clarify that interest (other than investment interest) on debt that is allocable to an owner of an entity engaged in a real property trade or business is exempt from the new business interest limitation rule – if that trade or business has elected out of the rule.

The exception for interest allocable to a real property trade or business reflects policymakers’ understanding that limits on the deduction for interest expense could have enormous negative consequences for property values, real estate markets, and economic growth.  (Reference: Real Estate Forum, Jan/Feb 2018, Decoding The New Tax Bill)

The Feb. 21 comment letter requests clarification to ensure the real estate exception operates as intended for common real estate ownership arrangements – focusing on the scope and application of the exception for an electing real property trade or business. 

The letter urges that Treasury clarify that interest (other than investment interest) on debt that is allocable to an owner of an entity engaged in a real property trade or business is exempt from the new business interest limitation rule – if that trade or business has elected out of the rule.  

As relevant examples, the letter describes four common scenarios where the financing of a real property trade or business occurs through a tiered structure.  The letter demonstrates why treating the interest expense of an upper-tier entity as properly allocable to the real property trade or business of a lower-tier entity is consistent with the legislative intent and conforms with existing tax rules and principles.  

The letter also addresses the allocation of indebtedness within entities, requesting that Treasury guidance apply the tracing rules found in existing authorities, which are already used for purposes of the passive loss rules.  

During a Feb. 20 tax conference, both Treasury’s Deputy Tax Legislative Counsel Krishna Vallabhaneni and Deputy Assistant Secretary for Tax Policy Dana Trier said a notice on language limiting interest expenses under the new tax law will be issued soon. (Bloomberg Law, Feb. 20).  

This week’s letter is a follow-up to a Jan. 18 Roundtable letter, which identified several areas where Treasury rulemaking would reduce uncertainty and facilitate continued investment. [Roundtable Weekly, Jan. 19]   

As Treasury and Congress continue to focus on implementation and technical corrections to the new tax law, The Roundtable and TPAC will play an active role in seeking appropriate clarifications affecting the most significant changes to the tax code in more than three decades.