One of the significant changes in the recent tax legislation that I wanted to highlight involves Section 163J and the interest expense limitation. This is good news for our real estate investors who have been dealing with some challenging restrictions over the past few years.
The Background
Let me walk you through how we got here. Originally, with the Tax Cuts and Jobs Act (TCJA), the interest expense limitation used to be based on EBITDA - earnings before interest, tax, depreciation, and amortization.
However, with the Inflation Reduction Act of 2022, that calculation changed to EBIT - earnings before interest and tax. Critically, you weren't getting that benefit of depreciation and amortization anymore.
The Problem This Created
This change caused significant issues for many investors. A lot of folks were having their interest expense limited when they weren't expecting it. They may have had hundreds of thousands in interest expense, but they were only getting to deduct a portion of that because of the adjustment related to depreciation and amortization that they were used to - benefits they hadn't been getting since 2022.
The Solution
The good news is that we're now back to the pre-2022 legislation. The new tax law has moved us back to the old calculation method, which means we're going to see a lot less interest expense limitations.
Why the Change Happened
The whole reason for President Biden's change to EBIT was to discourage taxpayers and investors from accumulating excessive debt. The new legislation has moved on from that approach and gone back to the old calculation.
What You Need to Do
If you are one of those folks that capitalized interest during this restrictive period, this is important: talk to your tax advisor and ask some questions about what needs to be done there. We're definitely in a transition period with a lot of legislation where we need to figure out what the next steps are.
The transition back to the more favorable calculation method should provide relief for many real estate investors who have been dealing with these limitations. However, given the complexity of these rules and the transition period we're in, it's crucial to work with your tax professional to understand how these changes specifically impact your situation.
This change represents a significant shift back to a more investor-friendly approach to interest expense deductions, which should be welcome news for real estate investors who rely on financing for their investment strategies.
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