Tag: Business Interest Deduction

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.

Real Estate Roundtable Testifies Before Senate on Business Tax Reform

Posted on by Trey Jackson

Rational Taxation of Real Estate Urged to Spur Job Creation, Encourage Business Expansion and Contribute to GDP Growth

WASHINGTON, DC — Real Estate Roundtable President and Chief Executive Officer Jeffrey DeBoer today testified before the U.S. Senate Finance Committee, encouraging modest changes to the current taxation of commercial real estate that would continue to encourage economic growth while cautioning policymakers on specific business tax reform concepts that could cause severe market dislocation.

During today’s Senate hearing on Business Tax Reform, DeBoer testified, “Importantly, commercial real estate markets are largely in balance with supply, only modestly exceeding demand.  Despite our industry’s relative positive health, we know the underlying economy can and should grow more rapidly.”  DeBoer added that The Roundtable is concerned that some concepts under discussion in tax reform are risky, untested and have the potential to cause severe dislocation – not only in real estate markets but in the nations’ capital markets as well.

In his written testimony and his oral statement, The Real Estate Roundtable’s President and CEO addressed specific elements of potential tax reform.  (See Senate Finance Committee webcast and documents at https://www.finance.senate.gov/hearings/business-tax-reform.) Below is a summary of policy issues covered in his testimony:

  • Business interest deduction.  DeBoer noted that interest, the cost of borrowing, is an ordinary and necessary business expense that has always been deductible.  Today, U.S. capital markets are the deepest in the world, but restrictions would deter business formation and expansion.  The impact would fall disproportionately on entrepreneurs and other developers likely to serve small and medium-sized markets.  As interest rates rise, the harm to the economy will grow.
  • Cost recovery / expensing.  Current cost recovery rules need reform, but 100 percent expensing of real estate is a risky and untested proposal.  Accelerated depreciation of real estate in the early 1980s led to tax-driven, uneconomic investment.  Tax rules should reflect the economic life of structures.  Leading research by MIT suggests existing depreciation schedules for real estate are too long.  Shortening depreciation to 20 years would spur sustainable and economically sound investment.   

     

  • Pass-through reform.  U.S. pass-through tax rules create a dynamic, flexible business environment that supports entrepreneurship and productive investment.  Tax reform should provide equitable relief for pass-throughs.  A new, reduced tax rate for pass-through business income should avoid “cliffs”, phase-outs, and carve-outs that discriminate against certain taxpayers and create new economic distortions.    

     

  • Capital gains.  The tax code should encourage entrepreneurial activity and risk-taking through low capital gains rates and continue to recognize that risk can involve more than the contribution of capital.  Reform should also preserve like-kind exchanges, which get properties into the hands of new owners with the time and resources to invest in job-creating property improvements.

     

  • State and local tax deduction.  Tax reform should retain the deductibility of state and local taxes.  Eliminating the state and local tax deduction would undercut the principal source of financing for schools, roads, law enforcement, and other needed infrastructure and public services.

     

  • FIRPTA.  Tax reform should boost job growth and domestic investment by repealing outdated tax barriers to foreign investment in U.S. real estate and infrastructure.

     

  • Infrastructure.  An infrastructure initiative in tax reform is needed to create jobs, reflect the changing transportation needs of Americans and increase productivity, all to benefit the GDP.  

In his testimony, DeBoer said that although tax reform should unleash entrepreneurship, capital formation, and job creation – Congress should also undertake reform with caution, given the potential for economic dislocation and unintended consequences. 

As an example of over-reactive government policies, DeBoer noted past tax reform efforts in 1981 and 1986, which combined, created severe dislocation in real estate markets nationwide; led to job losses and bankruptcies; and contributed to the demise of the savings and loan industry.

The Roundtable’s President and CEO also addressed the federal deduction for state and local property and income taxes. “Ending the federal deduction for state and local property and income taxes could potentially cause significant issues in our nation’s cities, as some businesses relocate for no reason other than taxes. We urge that this idea be rejected,” DeBoer said.

He also testified about the crucial need to preserve interest deductibility.  “Eliminating or limiting the deduction for interest on business debt would cause great dislocation in capital markets, slow economic activity and lessen the unique importance of America’s capital markets,” DeBoer said.

After noting that commercial real estate markets today are estimated to account for nearly 20 percent of America’s GDP and employ millions of Americans, he added that real estate provides local governments with its largest revenue source and plays a key role in the retirement savings and wealth creation of Americans.  “Properly designed tax reform can spur job creation, encourage more robust business expansion and result in a sustainable increase in GDP,” DeBoer testified.  

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