The Treasury Department and Internal Revenue Service (IRS) on July 28 issued final business interest deductibility regulations that favorably address issues NMHC and NAA raised in March 2018 comments. The multifamily industry was concerned that the proposed regulations could have limited a real estate partner’s ability to deduct business interest if the partner had invested in multiple real estate partnerships qualifying as small businesses but did not itself qualify as a small business. The final regulations appear to preserve interest deductibility for such taxpayers.
By way of background, the Tax Cuts and Jobs Act limits the ability of entities to deduct business interest to 30 percent (50 percent in 2019 and 2020) of adjusted taxable income (EBITDA through 2021 and EBIT thereafter). Small businesses (entities whose average annual gross receipts do not exceed $26 million for the three preceding years are exempted to the degree they are not tax shelters. Treasury and IRS released FAQs on how to apply aggregation rules to those with interests in multiple entities.
Real property trades or businesses, including multifamily firms, may also make an irrevocable election out of the limitation on interest deductibility so long as they agree to depreciate their real property under the Alternative Depreciation System (30 years of 40 years for multifamily property) as opposed to the Modified Accelerated Cost Recovery System (27.5 years for multifamily property).
Unfortunately, the proposed regulations could have prevented certain multifamily taxpayers invested in multiple real estate partnerships that qualify as small businesses from fully deducting business interest if the taxpayer was not itself a small business. This was a result of the proposed regulations denying the ability of a multifamily small business to elect out of interest deductibility regulations as a real property trade or business while, at the same time, requiring that business interest flow through to partners and shareholders as a separately stated expense for determining whether they are subject to a business interest limitation at the partner or shareholder level.
The final regulations address this issue by providing that interest allocable to partners of entities that are either small businesses or that elect out of interest deductibility limits as real property trades or businesses is excluded from any limitation at the partner level. Additionally, the final regulations enable real property trades or businesses to elect out of limits on interest deductibility even if they are small businesses.
Finally, NMHC and NAA’s comments on the proposed regulations noted that a significant number of REITs are structured as “UPREITS,” whereby the REITs hold significant interests in partnerships as both a general and limited partner.
The partnerships themselves hold most of the actual real property interests, and most of the interest expense in the UPREIT structure is at the partnership level. It did not appear that the proposed regulations applied the REIT safe harbor to a partnership controlled by a REIT. Accordingly, the multifamily industry requested that the REIT safe harbor be made available to any partnership where the REIT owns a significant interest in the partnership. The final regulations adopt this proposal if, among other requirements, the REIT owns at least 50 percent of the partnership’s capital and profits.
For more information on this topic, please visit the NMHC Advocacy webpage.
- Joint Trades Coalition Letter on 199A Main Street Tax Certainty Act of 2023
- Treasury and IRS Issue Clean Energy Tax Credit Guidance
- Business Coalition Letter Regarding 199A
- NMHC and NAA Statement for House Committee on Ways and Means Field Hearing on the State of the American Economy: The South
- NMHC Advocates for Tax Policy as Solution to Housing Affordability Crisis