Every new tax law comes with opportunities and pitfalls. The popular press has provided extensive – if sometimes superficial – coverage of the changes: lower tax rates for businesses, the restrictions on itemized deductions for individuals. Some practitioners have been advising clients to make substantial changes to their business structures while others have been advising caution.

This article touches on a few of the changes that affect real estate operations.

Business Interest Expense Limitation

Business interest was not limited under pre-2018 law. The new law limits the business interest deduction to the sum of:

• Business interest income; plus

• 30% of adjusted taxable income (but not below zero)

The limitation applies at the partnership level, such that the partnership’s ordinary income or loss includes the allowable deduction for business interest. To prevent double counting and potentially increasing the allowable limit for business interest, the adjusted taxable income for a partner does not include the pass-through income from the partnership. However, if the partnership has not met the limit – in other words, if it has not deducted interest up to the maximum amount of 30% of adjusted taxable income – the unused portion, called excess taxable income, may be used by the partners to computer their adjusted taxable income.

Exclusions From the Limitation

The limit on interest deductions does not apply to:

• Small taxpayers – those with gross income not more than $25 million. 

• An electing real property trade or business.

Interest over the limit is carried forward indefinitely. 

Meals and Entertainment Expenses

The deduction for business entertainment has been repealed. Similarly, no membership dues in recreation or social clubs are deductible. The deduction for business meals provided to employees at employer-operated eating facilities (i.e., as a de minimus fringe benefit) remains at 50%. However, meals provided at the convenience of the employer will be nondeductible after December 31, 2025.

Accounting Methods

A C corporation or partnership that has a C corporation as a partner may use the cash method if its average annual gross receipts for the prior three taxable years is less than or equal to $25 million. The threshold amount will be adjusted for inflation beginning in 2019.

Once a qualifying taxpayer begins using the cash method, it does not have to use the inventory method (for example, it can expense inventory costs as supplies) and is exempt from the uniform capitalization rules of Code §263A. Producers and resellers are also exempt from the uniform capitalization rules.

A taxpayer that meets the $25 million test does not have to use the percentage-of-completion method for small construction contracts. 

Qualified Business Income

Under the 2017 Act, members of a pass-through entity may deduct a portion of their qualified business income. The deduction is the lesser of:

1. 20% of qualified business income.

2. The greater of:

• 50% of W-2 wages.

• The sum of 25% of the W–2 wages with respect to the qualified trade or business, plus 2.5%t of the unadjusted basis immediately after acquisition of all qualified property.

Qualified property means tangible property subject to depreciation and includes leased property:

• Used in production of qualified business income.

• Held by the company at the end of the year or “available for use in the qualified trade or business.”

• Acquired within the past ten years, or not yet fully depreciated. Code §199A(b)(6)(A).

Depreciation 

The 2017 Act expands the use of Section 179 immediate expensing and expands bonus depreciation to 100%. One of the big differences between the two is that Section 179 can’t be used to create a net operating loss, while depreciation can. 

Section 179

Under prior law, the maximum deduction was $500,000. The maximum was phased out when taxpayer’s eligible property placed in service for the year exceeded $2 million (adjusted for inflation).

The 2017 Act makes two changes, effective for years beginning after December 31st, 2017: 

• The limit is raised to $1 million, and the phaseout starts at $2.5 million. These amounts will be adjusted for inflation.

• Types of property widened to include qualified improvement property and personal property used in connection with lodging facilities

Bonus Depreciation

Under prior law, bonus depreciation was 50% and only applied to new property. 

Effective for property acquired and placed in service after September 27th, 2017, bonus depreciation is 100% and applies to both new and used property. The bonus depreciation percentage phases out beginning in 2023, down to 80%. It reduces 20% per year until it reaches zero in 2027. 

Like-Kind Property

While like-kind exchanges no longer qualify for tax-deferred treatment after 2017, there is an exception: real property continues to qualify. 

Conclusion

Real estate investments continue to be a tax-favored activity, and careful planning can help an investor navigate the waters and avoid the mine fields along the way.

Dean Surkin, J.D., LL.M., is a principal at Gettry Marcus CPA P.C., Woodbury, N.Y.