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Ezra Dyckman and Charles S. Nelson

As part of the Tax Cuts and Jobs Act (P.L. 115-97) enacted in 2017, Section 163(j) of the Internal Revenue Code was amended to generally place a limit on business interest deductions, and on Nov. 26, 2018, the Treasury Department issued proposed regulations implementing this section. Although the statute contains two important exceptions that could help real estate businesses to continue to deduct interest expense, the rules are very complex and there are a number of potential pitfalls.

Section 163(j)

In general, new Section 163(j) limits a taxpayer’s business interest deductions to the sum of its business interest income and 30 percent of its adjusted taxable income. Interest deductions that are disallowed under this rule may be carried forward indefinitely to future years. The section 163(j) limitation applies to all types of taxpayers, including both corporations and pass-through entities. In the case of a partnership, the rules generally apply at the partnership level.

Real Property Trade or Business Exception

Any real property trade or business can choose to not have the interest deduction limitation apply by making an election to be treated as an “electing real property trade or business.” Once made, the election cannot be undone. The term “real property trade or business” is broadly defined to include many real estate businesses, such as those engaged in rental, development, or brokerage activities. However, some real estate activities, such as triple net leases, may not rise to the level of a “trade or business.” In those cases, section 163(j) would not apply (although other provisions of the Code, such as the investment interest limitation, may instead be applicable).

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