The enacted One Big Beautiful Bill (H.R.1, O3B) amends current tax law provisions and adds other provisions that affect real estate investments. This alert is intended to provide a summary of tax items under O3B of interest to real estate developers and investors.
Qualified Business Deduction (20%)
Section 199A1 allows a deduction based on qualified business income (QBI). The deduction is equal to 20% of QBI. While the House attempted to increase the deduction to 23%, the deduction rate remains 20% under O3B. In addition, the definition of QBI remains the same. Therefore, qualified REIT dividends continue to be included in QBI. Qualified REIT dividends are dividends other than capital gain dividends and dividends related to income taxed at the REIT. Most importantly, O3B removes the termination date under former Section 199A(i). As a result, under O3B, Section 199A will continue to apply for tax years beginning after 2025.
Bonus Depreciation
O3B restores 100% bonus depreciation. Prior law phased out bonus depreciation over six years, terminating bonus depreciation for property placed in service after 2025. In permanently restoring 100% bonus depreciation, O3B provides that the cost of any qualifying property may be deducted in the year the property is placed in service if acquired on or after January 20, 2025.
Expensing for Qualified Production Property
O3B contains a new 100% deduction for the cost of qualified production property (QPP). Qualified production property is nonresidential real property that, among other things, is an integral part of a qualified production activity. Qualified production activity means the act of substantially transforming property by manufacturing, producing, or refining that property to create a qualified product. The act of creating qualified products through production is a qualified production activity only if the production activity is agricultural production or chemical production. Obviously, the rules for distinguishing between production on one hand, and manufacturing and refining on the other, matter here. A qualified product means any tangible personal property, except that any food or beverage prepared in the same building as a retail establishment in which that property is sold is not a qualified product. Any part of a property used for office space and other non-production activities cannot be QPP. The taxpayer deducting the cost of QPP must be the taxpayer that first uses that property (that is, the original use of the QPP must commence with that taxpayer). In some cases, the taxpayer can be treated as the original user even if the property is converted from another use. The QPP applies to qualifying property if construction of that property begins after January 19, 2025, and before January 1, 2029, provided that the property is placed in service by January 1, 2031. The 100% QPP depreciation is subject to recapture as ordinary income if, within 10 years of the date it is placed in service, the taxpayer changes the taxpayer’s use of the property such that it is no longer QPP. Congress authorized the Treasury to issue regulations to help taxpayers understand the parameters and technical points of this new provision.
Business Interest Limits Apply to Capitalized Interest
O3B provides that capitalized interest is also subject to the general business interest limits under Section 163(j). Section 163(j) generally limits business interest deductions to 30% of a taxpayer’s adjusted taxable income. This limit is applied at the partnership level, though the true impact of the limit on each partner depends on rules applying at the partner level, especially for business interest of the partnership that exceeds the 30% adjusted taxable income limit (excess business interest). For many real estate partnerships, this limit is not relevant. Many, if not most, real estate partnerships elect to be treated as an electing real property trade or business. Section 163(j) does not apply to an electing real property trade or business. While such an election often makes sense, the election does have a small price. The electing business must depreciate its depreciable real property using the alternative depreciation system (ADS). Under ADS, depreciable nonresidential real property is depreciated over a 40-year useful life, and depreciable residential real property is depreciated over a 30-year useful life. In addition, any property that is depreciated under ADS is not eligible to be qualified production property.
No Retaliatory Tax
The enacted O3B does not contain the House version’s retaliatory tax provision. That provision would have enabled the Executive branch to impose additional taxes on foreign investors from countries that imposed taxes on U.S. investments that the President deemed "unfair." Economists and businesses argued that the tax would have, by itself, deterred foreign investment in U.S. businesses and assets.
Taxable REIT Subsidiary Stock
A REIT must comply with a quarterly asset test under Section 856(c)(4). Part of that test concerns securities in taxable REIT subsidiaries. Under current law, no more than 20% of the REIT’s assets by value can consist of securities in taxable REIT subsidiaries. Under O3B, the limit will increase to 25% of the REIT’s assets by value for tax years beginning after December 31, 2025.
Enhancing Low-Income Housing Tax Credits
O3B increases the amount of 9% low-income housing tax credits that a state can allocate to qualifying affordable housing projects in that state. The present limit is the greater of $2 million or the product of 1.75 times the state’s population. So, for example, if a state’s population is two million, it will be allocated $3.5 million (2 million x 1.75). If that state’s population were 1 million, it would be allocated $2 million. O3B increases that limit by 12.5%.
Reducing Tax-exempt Bond Financing for 4% Credits
Affordable housing projects can qualify for 4% low-income housing tax credits if at least 50% of the aggregate basis of a low-income housing building (land and building) is financed with tax-exempt bonds. O3B provides that affordable housing projects may qualify for 4% low-income housing tax credits if at least 25% of the aggregate basis of a building is financed with tax-exempt bonds. The lower limit applies to projects financed with bonds issued after December 31, 2025.
1All Section references refer to sections of the Internal Revenue Code of 1986, as amended, unless otherwise expressly provided.