How OBBBA Changes to Business Interest Expense Limitation Impact Real Estate
The business interest expense limitation under Section 163(j), originally created by the Tax Cuts and Jobs Act (TCJA) in 2017, received significant changes under the recently enacted One Big Beautiful Bill Act (OBBBA).
Given the general debt service on real estate ventures, careful strategizing around these changes is needed to fully realize tax planning opportunities.
Explore how the OBBBA changed Section 163(j), how it impacts the real estate sector, and how to leverage the changes to benefit your business with these insights.
Changes to Business Interest Limitation Computation
When TCJA was passed in 2017, the changes to Section 163(j) significantly restricted the ability to deduct business interest expense. This restriction limited the current deduction to 30% of adjusted taxable income (ATI) plus business interest income.
The original calculation of ATI included an add-back of depreciation and amortization, resulting in ATI that resembled the concept of earnings before interest, taxes, depreciation, and amortization (EBITDA). However, for years beginning after December 31, 2021, taxpayers could no longer add-back depreciation and amortization, an unfavorable change.
Depreciation and Amortization Add-Backs
The OBBBA reinstates and makes permanent the add-back of depreciation and amortization in figuring a taxpayer’s ATI for tax years beginning after December 31, 2024.This favorable change should increase the amount of deductible interest in a tax year for real estate businesses as depreciation deductions may be significant. Given the current interest rate environment, this tax law change is welcomed by most real estate ventures.
Planning Insight
Coupled with 100% bonus depreciation made permanent by the OBBBA, the ability to add-back depreciation with respect to determining ATI for purposes of the Section 163(j) limitation allows a business to take advantage of increased depreciation deductions without sacrificing interest expense deductions.
Elective Capitalization Use
The OBBBA modifies Section 163(j) to require the limitation is applied before any elective capitalization—for example Section 263A for construction of designated property—for tax years beginning after December 31, 2025. This unfavorable change eliminates any potential elective interest capitalization strategies, effectively removing the ability to recharacterize the interest before applying the limitation.
Planning Insight
With the ability to add-back depreciation and amortization in 2025, and the elective capitalization rule changes taking effect in 2026, taxpayers may want to consider increasing 2025 ATI through interest capitalization planning before it’s no longer available.
ATI Exclusions
The OBBBA modifies the Section 163(j) definition for ATI to exclude various foreign-related inclusion and gross-up amounts for tax years beginning after December 31, 2025. This will impact businesses with controlled foreign corporations (CFCs) that have interest expense subject to Section 163(j).
Organizations with foreign entities in their structure should carefully digest these rules. These changes could reduce the anticipated benefit of the add-back of depreciation and amortization to ATI.
Increased Thresholds for Section 163(j) Small Business Exception
Section 163(j) provides an exception for any business which doesn’t have average annual gross receipts for the prior three tax years that exceed a certain threshold. In 2024, that threshold was $30 million. The OBBBA increases that threshold to $31 million for the 2025 tax year.
While the threshold has been adjusted for inflation since Section 163(j) was enacted in 2017, businesses should revisit this exception annually if their gross receipts are materially close to the applicable threshold for the tax year.
Determining whether a taxpayer meets the small business exception can be complex. For example, the exception isn’t available to taxpayers who meet the definition of a tax shelter under Section 448(a)(3). In addition, taxpayers may be subject to aggregation rules under Section 448(c)(2) for purposes of determining whether the gross receipt test is met. Consulting with a tax advisor is key to navigating this area successfully.
Real Property Trade or Business Election
Qualifying real estate businesses can elect to be exempted from the application of Section 163(j) making a one-time, irrevocable real property trade or business (RPTB) election.
While the election exempts a business from the interest expense limitation, the business is required to use the alternative depreciation system (ADS) for certain types of property—and therefore won’t be able to claim bonus depreciation on such property.
Taxpayers who haven’t made a RPTB election should consider all tax law changes made by OBBBA, particularly the changes to the business interest expense limitation and bonus depreciation, before making the election.
Business Expense Limitation
The favorable ATI changes included in the OBBBA may reduce the benefit of making the RPTB election as more interest expense is expected to be deductible. In addition, the OBBBA increases and makes permanent 100% bonus depreciation on bonus-eligible property.
Consider current interest expense limitation calculations, anticipated capital expenditures, the timing of such projects, and the potentially unfavorable impact to depreciation expense when deciding on a RPTB election.
Planning Insight
If a taxpayer currently has a RPTB election in place, it’s generally irrevocable and remains so under the OBBBA. In the past, the IRS has granted a time-limited opportunity to reconsider a past RPTB election in response to tax law changes made by the CARES Act (Rev. Proc. 2020-22).
It’s unclear if the Treasury will provide any guidance on how to revoke a RPTB election made in a prior tax year due to the OBBBA’s tax law changes.
We’re Here to Help
To learn more about the OBBBA’s changes to Section 163(j) and how they can benefit your real estate business, contact your firm professional.