top of page
  • Writer's pictureMarcus Williamson

Interest Deductions for Real Estate Entities

With the election looming, the media has put a spotlight on the Biden tax plan. Great - more changes to process (and they are a doozie if passed!). The Tax Cuts and Jobs Act in December of 2017 brought about the most significant piece of tax legislation in decades. Even now at the end of the second tax season under the TCJA’s changes, individuals and businesses struggle to appropriately implement the new rules. One area that real estate investors should ensure they have a solid handle on is the deductibility of interest by real estate entities. In the past, interest was 100% deductible on debt taken to finance a property. Rates are low and lending used to be plentiful - let’s load up on the debt! Alas, the good times are coming to an end.

Changes Ahead

Beginning in 2018, a real estate entity can only deduct its “net interest expense” (defined as interest expense paid/incurred net of recognized interest income) up to 30 percent of its “EBITDA.” EBIDTA is defined as an entity’s earnings before interest, taxes, depreciation, and amortization. Any amount of interest the real estate entity pays or incurs in excess of this 30 percent limitation cannot be currently deducted(it may be carried forward to future tax years, though). Astute mathematicians will tell you that deducting 30% of EBITDA is usually a whole lot less than deducting 100% of the expense. It gets even worse - those rules only apply to 2018 through 2021. Beginning in 2022, interest expense will be capped at 30 percent of earnings before interest and taxes but after depreciation and amortization expenses. If you recall seeing a real estate entity’s balance sheet lately, you’ll likely notice that depreciation makes up a relatively large percentage of the total expenses. For many entities, this will result in a significantly lower allowable amount of currently deductible interest. Since many as visual learners, let’s see a basic example:

There are a few exceptions that exempt entities from the changes.

  • It only impacts entities whose average gross receipts are in excess of $25 million. It will have no impact on entities with average gross receipts less than this threshold.

  • A real estate entity can avoid this limitation, even if their average gross receipts exceed the $25 million threshold if they are engaged in what is defined as a “real property trade or business” under the meaning of IRC §469(c)(7). Accordingly, if a real estate entity is engaged in the following lines of business, they have an opportunity to avoid the limitation:

    • Leasing,

    • Construction,

    • Development,

    • Acquisition,

    • Management,

    • Brokerage.

  • If the real estate entity is not involved in any of those activities, it can make an election to avoid the imposition of the 30 percent rule. However, by making that election, they will be required to depreciate their residential and nonresidential real property in addition to their qualified improvement property utilizing longer depreciation lives known as the Alternative Depreciation System (ADS). ADS comes with its own unique set of challenges and typically does not benefit the taxpayer as much.

As always, investing decisions are never easy. Find a good real estate tax pro to help you navigate the waters.

0 views0 comments


Post: Blog2_Post
bottom of page