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.