AFFORDABLE HOUSING: The latest on Section 163(j) limitation on business interest
The IRS issued final regulations earlier this year regarding the business interest expense limitations included in the Tax Cuts and Jobs Act (TCJA). Additional proposed regulations were also released to clarify some issues not covered in the original proposed regulations (issued in 2018). The regulations are lengthy, and the final regulations are effective for tax years beginning after Nov. 13, 2020, so in 2021 for calendar-year taxpayers. Taxpayers may opt to adopt the regulations early but must apply them consistently going back to 2018.
Here are some of the highlights that are most applicable to the typical affordable housing partnership:
- The final regulations contain a narrower definition of interest expense – debt issuance costs, lender commitment fees, and certain hedging transactions are no longer included.
- The final regulations provide that an excess business interest expense (EBIE) carryforward proportionately increases basis in a partnership interest upon a partial disposition of the interest. The 2018 proposed regulations only allowed EBIE to increase basis in a partnership interest upon a disposition of all or substantially all of the interest.
- The final regulations clarify the treatment of EBIE allocated from a partnership that makes a real property trade or business (RPTOB) election in a year subsequent to the EBIE allocation. The final regulations state that the EBIE carryforward is not treated as business interest expense paid or accrued by the partner in the year that the partnership makes the RPTOB election. Presumably, based on the general carryforward rules, the EBIE would carryforward until disposition of the partnership interest.
- The final regulations clarify that for purposes of determining whether an entity is a tax shelter ineligible for the 163(j) small business exemption, the definition of “syndicate” includes an entity in a taxable year “only if it has net losses in that year and more than 35 percent of those net losses are actually allocated to limited partners or limited entrepreneurs.” The statutory language under Section 1256 uses “allocable” and the regulations under Section 448 use “allocated,” which caused confusion. Additionally, it was unclear previously whether the syndicate determination was made on a year-by-year basis such that an entity that did not have a net loss for a tax year would not be a syndicate for that tax year.
- The final regulations allow a taxpayer to make a protective RPTOB election even if they are currently exempt from 163(j) under the small business exemption. The preamble of the 2018 proposed regulations indicated that an exempt taxpayer could not make the RPTOB election.
- The final regulations state that “a corporate partner in a partnership that conducts a real property trade or business should be allowed to treat its share of the partnership’s real property trade or business as an electing real property trade or business only if the partnership makes the election .” This clarifies that only the partnership with the real property trade or business can make the RPTOB election with respect to the business, and the partners cannot.
- The new proposed regulations adopt an “entity approach” with respect to treatment of EBIE in tiered partnership structures. This means that EBIE from a lower-tier partnership (LTP) allocated to an upper-tier partnership (UTP) remains at the UTP and is not allocated to the UTP partners. The UTP reduces its basis in the LTP interest, and books the EBIE as a nondepreciable capital asset with a fair market value (704(b) basis) of zero and a tax basis equal to the reduction in the basis in the LTP interest. The UTP partners reduce their 704(b) capital accounts in the UTP, but there is no adjustment to their tax basis in the UTP.
For more in-depth information about the new final and proposed regulations, see our full overview. Contact your CohnReznick service team to better understand how these regulations may impact you.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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