Policy Issues

TAX REFORM IMPLEMENTATION

ISSUE

Tax Reform Implementation - Treasury Rulemaking and Real Estate

Tax reform left many major policy decisions in the hands of the Treasury Department.  Real estate owners and investors need clear and well-designed regulatory guidance from Treasury regarding how the IRS will interpret the new provisions and how they will operate in practice. 

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Position

The Treasury regulatory guidance on key real estate issues will largely determine the effectiveness of the 2017 tax reforms.  The proposed and final guidance issued thus far has thoughtfully approached complex questions and reflects the intent of Congress.  More remains to be done, including final regulations on business interest deductibility and the Opportunity Zone tax incentives. 

Background

Tax reform included 79 explicit grants of regulatory authority.  In response, Treasury created a Tax Reform Implementation Office and updated its priority guidance plan to include 18 new projects related to tax reform.  In early 2018, Congress provided a special appropriation of $320 million to help with the cost of implementing the new law.  Timely guidance from Treasury will help avoid potential disruptions in projects and transactions caused by a lack of certainty regarding tax consequences.      

Pass-through deduction (sec. 199A).  Tax reform includes a new deduction that can reduce the tax rate on pass-through business income to as low as 29.6%.  Taxpayers must meet several requirements to qualify.  The deduction is only available to the extent the trade or business pays wages or owns depreciable assets, such as real estate.  Certain services-related businesses are ineligible. The Real Estate Roundtable’s Tax Policy Advisory Committee (TPAC) submitted multiple comment letters to Treasury regarding the section 199A deduction.  In August 2018, Treasury issued proposed regulations that addressed important questions related to when real estate investment constitutes a qualifying trade or business, how taxpayers can aggregate interests in different real estate entities, and how investment in depreciable assets is measured.  The regulations were finalized and additional clarifications were made in January 2019.  In general, the regulations are positive and put at ease certain concerns that could have rendered the deduction largely ineffective for real estate investment. 

Business interest limitation – real estate exception (sec. 163(j)).  Tax reform included a strict limitation on the deductibility of business interest expense to the extent it exceeds 30% of annual earnings before interest, tax, depreciation, and amortization (EBITDA).  A critical exception is available to an “electing real property trade or business.”  Real estate investors need greater clarity on the scope of the real estate exception.  For example, what if a borrower is engaged in more than one trade or business?  What if the debt is incurred at the partner level, but the business activity occurs at the partnership level?  How is debt allocated among different activities?  TPAC has submitted multiple comment letters to Treasury on section 163(j) with extensive recommendations for how the regulations should address these situations.  Proposed regulations issued by Treasury in November 2018 are largely favorable.  For example, the proposed rules clarify that partner-level borrowing qualifies for the real estate exception and confirm the broad definition of a real property trade or business.  Final regulations are expected before the end of 2019.


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