As we near the end of 2024 and look ahead to 2025 and the years to come, it is more important than ever to be thinking strategically about tax planning, particularly as we are still uncertain about the fate of the many provisions of the Tax Cuts and Jobs Act (TCJA) of 2017.
Below are important areas for real estate developers to keep top of mind both now, and as projections are being completed for 2025 and 2026.
1. Interest Expense Limitation
Interest expense limitations continue to be a burdensome consideration for developers. Unless you qualify as a small taxpayer, Section 163(j) limits the deductibility of business interest expense to 30% of adjusted taxable income, without including addbacks for depreciation and amortization. Interest expense not deductible in the current year will carryforward indefinitely, until there is a year where you have excess taxable income to release suspended interest expense.
You are considered a small taxpayer if your annual gross receipts for the three preceding tax years falls below a certain threshold, indexed annually for inflation. For 2024, this threshold was $30 million, and for 2025 this threshold is set at $31 million. When determining if you meet the gross receipts threshold, you must aggregate entities that would be treated as a single employer under Sections 52(a) and 52(b) or Sections 414(m) and 414(o). If you have shifted ownership within your umbrella of entities, ensure you are consistently monitoring the status of your entities and how they fit within the aggregation rules applicable to this code section.
>> Planning Tip: If you find yourself subject to the limitation, consider making the real property trade or business election. Note: this election is irrevocable once you make it. By making the election, you are no longer subject to the interest expense limitations; however, you will be required to depreciate certain real property assets using the Alternative Depreciation System (ADS) method. ADS generally provides a longer depreciation time period and does not allow bonus depreciation. If you make this election, continue to assess debt agreements, refinancing options and intercompany interest tracking to help ensure you do not unknowingly fall under the interest expense limitations.
2. Bonus Depreciation
Year-end also means we are approaching another step down for one of our most popular tax provisions — bonus depreciation. Over the past few years, many businesses have realized an immediate tax benefit on their capital expenditures through the use of bonus depreciation. This provision was initially set to 100% upon the passage of TCJA and has since begun to sunset 20% each year since 2022. For 2024, bonus depreciation is set at 60%; for 2025 it is set at 40%.
>> Planning Tip: It remains to be seen whether Congress will allow bonus depreciation to continue to sunset, as currently scheduled, or whether they will renew thresholds at a higher level. Despite bonus depreciation phasing down, these are some other things to keep in mind when looking at ways to accelerate deductions:
- Conduct Cost Segregation Studies. Consider conducting a study on new development or renovations to existing real property assets to offer accelerated tax savings by way of shorter tax depreciation lives.
- Revisit Repair Regulations. When bonus depreciation was 100%, whether you capitalized improvements and took bonus depreciation or wrote off the work as a repair, you generally ended up in the same position — immediate expensing at the federal level. Now that bonus depreciation is no longer 100%, you may still be able to obtain an immediate write-off of the cost of an improvement. Take a deeper dive into the repair regulations and analyze whether or not the improvement truly rises to the level of being a betterment, a restoration or an adaptation. There are also additional safe harbors, such as the routine maintenance safe harbor, that could benefit your business as well.
- Maximize Section 179. This provision is similar to bonus depreciation and allows for immediate expensing of certain qualifying property up to a maximum annual amount, which is scaled back if you place into service more than a threshold amount of property during the tax year. Qualifying property includes tangible personal property, such as machinery and equipment, and qualifying real property. Qualifying real property includes improvements to nonresidential real property for roofs, HVAC, fire alarm systems and security systems. One significant consideration when deciding whether or not to use this provision revolves around the requirement that you limit the Section 179 deduction to your business’ taxable income. Unlike bonus depreciation, this deduction cannot create a loss for your entity.
- Write Off Abandoned Project Costs. During the pre-development phase of a property, as a real estate developer you often incur significant costs related to engineering, architecture or other services. Sometimes these projects are abandoned and may be eligible for immediate write-off. Discuss with your advisers whether it may be beneficial to write off any capitalized costs related to abandoned projects.
3. Individual State and Local Tax Deduction Cap
The state and local tax cap of $10,000 continues in effect through 2025 with no clear vision whether this provision will be extended, or if it will expire and revert to the pre-TCJA rule that provided no limit on the deduction.
In the meantime, if your real estate company is an eligible pass-through entity, stay up to date on your state’s stance on pass-through entity tax (PTET) filings. PTET filings allow a pass through business to pay the state tax at the entity level on behalf of its owners by deducting certain tax expenses as business expenses. PTET filers should estimate 2024 income and pay the Q4 estimate tax balance by the end of 2024 to line up the tax expense with the associated taxable income.
>> Planning Tip: Take the time to conduct an analysis on whether increased state and local tax deductions at an entity level via a PTET election could negatively impact any of your entity’s interest expense limitations.
4. K-1 Reporting Changes and Considerations
The annual K-1 reporting requirement for partnerships continues to become more complex with each passing year. Partnerships not only have to contend with any new disclosures the IRS requires, such as information on Section 743 adjustments, but each partnership must also understand the specific information potentially required of them based on their investors’ entity types and how they are being taxed. Tax-exempt partners and foreign investors are two key investor types that continue to drive complexity via additional information requirements. It is imperative to request and review W-9s your investors are providing so you do not miss any additional reporting requirements.
New for 2024, partnership taxpayers will now need to report additional information to address the application of corporate alternative minimum tax (AMT). Generally, the concept of partnership distributive income has been part of a corporate partner’s adjusted financial statement income (AFSI) for AMT purposes. However, now the reporting requirement is being stretched to the underlying partnership for their corporate partners.
>> Planning Tip: If your partnership has corporate partners subject to the new 2024 reporting requirements, your entity will also be tasked with creating and maintaining an additional set of books to track capital under the modified AFSI. Be mindful of the extra effort this will entail.
Additional Year-End Considerations
Estate Exemption. The 2025 estate exemption amount has increased to $13.99 million from $13.6 million in 2024. However, the higher exemption is set to expire in 2026 and could revert to the lower pre-TCJA base of $5 million, indexed for inflation.
>> Planning Tip: Consider estate planning and additional gifting in 2025 to "lock in" the increased lifetime exemption amount while it is still available.
Section 199A Qualified Business Income (QBI) Deduction. The popular Section 199A QBI deduction is scheduled to sunset at the end of 2025. It offers a maximum deduction of 20% of qualified business income. Without an extension, business owners who have previously qualified for the full deduction will see a federal tax increase on qualified business income.
Overall, the unknown fate of the TCJA, whether or not Congress takes action, means we remain in a period of uncertainty regarding what the tax code will look like in 2025 and beyond. It is imperative to be proactive with your entity’s tax planning. Consult with your tax advisers to map out a plan of how the potential sunset of these provisions may affect you and any strategies to help maximize opportunities and mitigate potential unfavorable consequences.
Contact Angel Rice, Mike McGivney, Samantha Kite or a member of your service team to discuss this topic further.
