NMHC and NAA called on the Treasury Department and IRS to revisit proposed interest deductibility regulations that could harm developers of multifamily housing through a letter sent on March 18. As currently drafted, the regulations could deny certain developers the ability to fully deduct their business interest.
The Tax Cuts and Jobs Act generally limits the amount of business interest firms may deduct. Small businesses (i.e., firms with average annual gross receipts of $25 million in the previous three years) are exempt, and real property trades or businesses, which are not small businesses, may elect out of the limitation.
The inability of a small business to elect out of the interest deductibility limits could harm developers who own multiple small business real estate partnerships. While small businesses are exempt from limits on interest deductibility at the entity level, if such small business is a partnership or an S corporation, business interest expense flows through to the partners or shareholders for purposes of determining whether they are subject to limits on interest deductibility at the partner or shareholder level. Thus, a partner or shareholder who does not meet the small business definition may be subject to interest disallowance from interest flowing from an interest in a small business (even if that business could otherwise be an electing real property trade or business).
To correct this, NMHC and NAA requested that Treasury modify the proposed regulations in one of the following ways:
- provide that business interest expense of a partnership or S corporation that qualifies as a small business does not flow-through to partners or shareholders for purposes of determining any business interest limitation of the partners or shareholders;
- allow a small business to elect to be an electing real property trade or business if it so qualifies; or
- allow partners and shareholders who receive business interest expense from a small business to make the real estate trade or business election for such items at the partner or shareholder level.
Notably, the rules governing the deductibility of business interest also impact the depreciation of multifamily buildings. Whereas small businesses can continue to depreciate multifamily buildings over 27.5 years, the consequence of making an election out of the interest deductibility limits is that buildings will have to be depreciated over 30 years, or 40 years for property placed in service prior to 2018. NMHC and NAA are working to apply a 30-year depreciation period to pre-existing property as the industry believes Congress intended.
Finally, the multifamily industry called on the government to enable UPREITs (i.e., partnerships in which REITs hold significant interests) to use a business interest deductibility safe harbor that is currently available to REITs. The safe harbor treats a REIT as qualified to be an electing real property trade or business. This modification would provide similar treatment between REITs that own real property directly and REITs that own real property indirectly through a partnership, as well as reduce the administrative burden on UPREIT structures.
For more information on NMHC and NAA’s efforts regarding business interest deductibility, please visit our advocacy page.