As tax practitioners continue to wade through the Tax Cuts and Jobs Act (TCJA) to determine how to apply it, lobbying and other industry groups are asking for answers as well. Specific to real estate, the Real Estate Roundtable, a nonprofit public policy organization based in Washington D.C., has urged Treasury to provide guidance clarifying aspects of the real estate trade or business election under the new interest limitation rules, specifically calling out structures common to the industry. The Real Estate Roundtable wrote to Treasury Secretary Steven Mnuchin on February 21, 2018; the following content contains key excerpts from the communication.
In the letter, the Real Estate Roundtable specifically asked for clarification that interest (other than investment interest) on debt incurred by an owner of an entity engaged in a real property trade or business, will be treated as interest allocable to that real property trade or business, and therefore exempt from the new business interest limitations - if that real property trade or business has made (or is treated as having made) an election out of the new interest limitation rule.
Why request this guidance? Real estate investments are often structured using more than one entity and/or using tiered structures for investors to fund the costs. For example, a corporation and a partnership may each borrow money to fund their separate investments in another partnership or a REIT (the lower-tier entity) that will be making the ultimate investment in the real estate. Thus, that ultimate investment will be made by that lower-tier entity using a combination of its own money, money it has borrowed directly, and money it received as an investment from the aforementioned corporation and partnership, which those entities obtained through their own borrowings. In such a case, it should not matter whether the debt that is funding the ultimate real estate investment is borrowed by the lower-tier entity or an upper-tier investor.
The letter to Treasury also provides other examples of common scenarios where the financing of a real property trade or business occurs through a tiered structure, including the following:
- Developer Corp and U.S. tax exempt investor agree to form a 50/50 joint venture for the purpose of developing an office building. Developer obtains its 50% cash contribution to the equity of the joint venture by borrowing money, possibly secured by a different real estate investment owned by Developer. The lower-tier joint venture does not incur the debt directly and the U.S. tax exempt investor does not incur any debt.
- Real estate fund projects a 10% return for its equity investors. The fund itself may have its own debt. Individual passive investor has the ability to borrow at a rate of 5%. Thus, the passive investor borrows his own equity contribution from an unrelated lender at a 5% interest rate to make an equity investment he anticipates will yield 10%.
- Public REIT operates through an umbrella partnership (UPREIT) structure where all of its assets are held in a lower-tier operating partnership. The operating partnership in turn owns some of its assets through lower-tier joint venture partnerships or other REITs. The operating partnership borrows in the public debt markets and invests the proceeds to acquire or capitalize an interest in one or more joint venture partnerships or REITs.
- Public REIT owns real estate assets through LLC holding companies (SPEs) owned by one or more subsidiary REITs (Sub REITs) or an UPREIT. REIT, Sub REIT, UPREIT or SPE borrows in the public debt markets to enable the SPEs to buy the real estate investments. Investor that is a REIT or a C Corporation borrows to acquire an interest in the REIT (or to acquire an interest in an UPREIT owned by the REIT or to acquire an interest in a real estate limited partnership that has acquired the interest in the UPREIT or REIT).
As of the date of this posting, the IRS has yet to release any guidance addressing the issues/structures listed above. We will continue to monitor the situation and provide updates as they are available.
Read the full version of the letter now.
Please contact a member of your service team, or contact Kim Palmer at email@example.com for further discussion.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.