WASHINGTON, DC–Last week the Treasury Department released guidance on the new limitation on the deductibility of business interest under the new tax law.
The notice focuses on on interest expense carryforwards from prior years, corporate interest deductions, and consolidated corporate groups — but it leaves unresolved certain key questions for real estate investors, The Real Estate Roundtable wrote in its weekly newsletter. Namely: whether 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.
For taxpayers with revenue over $25 million, the Tax Cuts and Jobs Act capped the amount of business interest that can be deducted annually to no more than 30% of EBITA. The provision includes several exceptions, including an exception critical to real estate for an “electing real property trade or business.”
For companies to get the most out of the tax reform measure passed at the beginning of the year, it is crucial to have any uncertainty addressed, says Allen Shayanfekr, co-Founder and CEO of Sharestates. “The new IRS/tax laws impacts CRE investors because pass-through entities and sole proprietorships for both individuals and trusts can now deduct additional qualified business income received and can carry over gains from past years,” he tells GlobeSt.com.
“This indefinite carry-forward feature is a large benefit for growing businesses who make investments that likely will exceed their deductions, because they can apply those to a future year in which they have earnings sufficient to absorb the excess.”
What The Notice Does Say
Here is what the guidance, IRS Notice 2018-28, does make clear, according to the Roundtable:
- 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.
These are helpful to C Corporations, Montgomery McCracken Senior Tax law partner Gary M. Edelson tells GlobeSt.com. For example, the notice confirmed that disqualified interest disallowed under the prior version of I.R.C. § 163(j) can be carried over and treated as business interest, he tells GlobeSt.com. “It is also helpful to know that for a C corporation, all interest earned by the C corporation will be business interest and that all interest paid or accrued by the C corporation on indebtedness will be business interest.”
What The Notice Doesn’t Say
For real estate investors, however, the notice leaves unanswered some of the key issues related to real estate financing. Edelson says that the notice did not address whether a partner in a partnership that owns real estate could be in an electing real property trade or business based solely on the ownership of partnership interest. “Except for the issue of how a partner would take into account his share of interest earned by the partnership, the notice did not address partnership issues,” he says.
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. Further guidance is expected.
The Real Estate Roundtable writes:
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.
Edelson advises that taxpayers probably should assume that qualification for being in an electing real property trade or business will be measured at the partnership level and that the partner is not deemed to be in an eligible real estate trade or business. “Accordingly, if a partner borrows money and contributes the money to a partnership that owns real estate, the partner should probably assume that at the partner level, he will be subject to the I.R.C. § 163(j) limitation on the deductibility of the interest on the loans, even if I.R.C. § 163(j) does not apply at the partnership level, because the partnership is in an electing real property trade or business.”