Summary
President Trump's budget permanently extends numerous provisions of the Internal Revenue Code from the Tax Cuts and Jobs Act (TCJA) of 2017 scheduled to expire at the end of 2025 and includes several changes that will have significant tax consequences for housing and other sectors of the real estate industry.
The Upshot
Several provisions of the law—known as the One Big Beautiful Bill Act or OBBBA—have the potential to affect the real estate and housing industry, including key changes to bonus depreciation, depreciation of production property, deductibility of business interest, qualified business income deduction, business losses, Qualified Opportunity Zones, Low Income Housing Tax Credits, and New Markets Tax Credits.
The Bottom Line
Housing and real estate industry participants should review their holdings and tax plans to assess the impact of the OBBBA's changes. Ballard Spahr's Tax Group and Tax-Real Estate team advise on the full range of tax issues related to properties of all types throughout the country.
The budget law President Trump signed on July 4 permanently extends numerous provisions of the Internal Revenue Code from the Tax Cuts and Jobs Act (TCJA) of 2017 that were scheduled to expire at the end of 2025 and includes several changes that could have significant tax consequences for housing and other sectors of the real estate industry. We outline key changes below.
BONUS DEPRECIATION
Current Law
The TCJA temporarily increased the additional first-year bonus depreciation deduction for certain qualified property to 100%. This provision began phasing out starting in 2023 in a manner that reduced the bonus depreciation rate by 20% each year and was scheduled to completely phase out by 2027.
OBBBA Changes to Bonus Depreciation
OBBBA eliminated the phase-out and permanently restored 100% bonus depreciation for certain qualified property that is placed in service after January 19, 2025. Qualified property includes leasehold improvements and nonresidential interior improvements, as well as equipment and machinery.
DEPRECIATION OF PRODUCTION PROPERTY
Current Law
Under current law, most nonresidential real property can be depreciated over 39 years.
OBBBA Changes to Depreciation of Production Property
OBBBA creates a temporary benefit for the construction of manufacturing facilities. Under OBBBA, an elective first-year 100% depreciation allowance is permitted for qualified production property (1) for which construction begins after January 19, 2025, and before January 1, 2029, (2) that is placed in service before January 1, 2031, (3) the original use of which must commence with the taxpayer and (4) that is used by the taxpayer as an integral part of a “qualified production activity.” Qualified production property means any nonresidential real property that is used for a qualified production activity, such as manufacturing, production, or refining. Qualified production property does not include any nonresidential real property used for offices, administrative services, lodging, sales activities, research activities, software engineering activities, or other functions unrelated to manufacturing, production, or refining. As mentioned above, qualified production property must be used by the taxpayer, thus it cannot be leased to a tenant; it must be owner-occupied.
If at any time during a 10-year period beginning on the date the property was placed in service such property stops being qualified production property, the depreciation expense shall be recaptured.
RELAXED LIMITATION ON DEDUCTIBILITY OF BUSINESS INTEREST (Section 163(j))
Current Law
Under current law, business interest expense deductions are generally limited to 30% of adjusted taxable income (ATI). ATI is the taxable income of the taxpayer calculated with certain exclusions (such as non-business income, gain, deduction or loss, any business interest income, any net operating loss, any 199A deduction, or depreciation, amortization or depletion), similar to an EBIDTA—Earnings Before Interest, Taxes, Depreciation, and Amortization—concept. For tax years prior to 2022, ATI was calculated without regard to depreciation, amortization, or depletion. Beginning in 2022, the calculation of ATI shifted to excluding addbacks for depreciation and amortization. This generally resulted in a lower ATI and, subsequently, a lower interest deduction.
OBBBA Changes to Business Interest Expense
OBBBA makes several changes to the calculation of ATI. First, OBBBA reverts to the original, pre-2022 calculation by including depreciation and amortization as an addback for tax years beginning after December 31, 2025, and by permanently increasing the ATI for purposes of calculating the limitation.
On the other hand, OBBBA creates a new category of exclusion that includes certain international tax items (such as subpart F and Global Intangible Low-Taxed Income, or GILTI, inclusions), which will have the opposite effect and will reduce the ATI.
Lastly, OBBBA introduces certain ordering rules for interest expense allocation, which have an effect of decreasing the interest expense deduction allowable to taxpayers.
Ballard Spahr Observation: Overall, it is to be expected that the changes made to the ATI calculation will generally result in an increase to ATI and thus increase the allowable interest expense deductions. This will be beneficial for the real estate industry, where depreciation expense is significant.
QUALIFIED BUSINESS INCOME DEDUCTION (SECTION 199A)
Current Law
Section 199A allows certain individuals, trusts, and estates to deduct 20% of their (1) “qualified business income” from sole proprietorships, partnerships and S corporations, and (2) REIT dividends. For taxpayers with income that exceeds certain threshold amounts, the Section 199A deduction is subject to limitations based on wages paid and unadjusted basis in qualified property. This deduction was set to expire at the end of 2025.
OBBBA Changes to the Qualified Business Income Deduction
OBBBA permanently extended the 20% deduction. In addition, OBBBA made certain taxpayer-favorable changes by relaxing the income-based phase-out of the deduction.
EXTENDED EXCESS BUSINESS LOSSES
Current Law
The excess business loss limitation restricts non-corporate taxpayers from claiming excess business losses in the current tax year against portfolio and wage income. Such losses, however, may be carried forward as net operating losses to following tax years (and therefore may be used against wages and portfolio income), effectively resulting in a deferral of such losses for one year. This limitation was set to expire after 2028.
OBBBA Changes to Excess Business Losses
OBBBA makes this limitation permanent.
REFRESHMENT AND NEW ROUNDS OF OPPORTUNITY ZONES
Current Law
The TJCA introduced the Qualified Opportunity Zone (QOZ) program, an incentive program designed to stimulate economic development in “low-income” zones known as QOZs. For taxpayers who invest capital gains in a qualified opportunity fund (QOF) and comply with the complicated QOZ rules, the QOZ program's benefits include capital gain deferral and capital gain elimination.
Specifically a taxpayer who invests capital gains in a QOF can (1) defer the invested capital gain until the earlier of when the taxpayer sells its QOF interest (or the property owned directly or indirectly by the QOF is disposed of) or December 31, 2026; (2) eliminate 10% of the taxpayer's roll-over gain if the taxpayer holds its QOF interest for at least five years on or before December 31, 2026, and can eliminate an additional 5% of the roll-over gain if the taxpayer holds its QOF interest for at least seven years on or before December 31, 2026 (this partial elimination elapsed several years ago); and (3) eliminate gain recognized on the disposition of the taxpayer's s QOF interest (or the property owned directly or indirectly by the QOF is disposed of ) if the taxpayer holds its interest in the QOF for at least 10 years. The QOZ program was set to sunset on December 31, 2047, and to obtain the benefit of gain elimination on the appreciation in the QOZ investment on an ultimate disposition of the QOZ investment, the taxpayer had to exit the QOZ investment on or before December 31, 2047.
OBBBA Changes to the QOZ Program
OBBBA makes the QOZ program permanent, makes modifications to the eligibility requirements, and allows for creation of new QOZs on a rolling basis.
New Deferral Period: OBBBA provides for a new deferral period for capital gains that are invested in a QOF on or after January 1, 2027. The roll-over gains will be deferred until the earlier of (1) the date of exit from the QOZ investment, or (2) five years after the date of that the taxpayer invested capital gains in a QOF. Under OBBBA, once the taxpayer has held its interest in a QOF for five years, the taxpayer obtains a 10% recognition exclusion of the deferred capital gain. The additional 5% gain elimination for QOF investments held for at least seven years before December 31, 2026, provided by the original QOZ program has been eliminated for new QOF investments. OBBBA also introduced a new enhanced benefit for a new type of QOF, qualified rural opportunity funds (QROF, see below), under which 30% of the deferred gain is excluded for investments in a QROF held for at least five years.
Ballard Spahr Observation: OBBBA does not extend the date for recognition of gain for qualified amounts invested in a QOF prior to January 1, 2027; those gains still will be recognized on December 31, 2026.
30-Year Gain Elimination: With respect to new investments, OBBBA eliminates the December 31, 2047, sunset of the QOZ program and provides for a rolling 30-year exclusion of future appreciation of QOZ investments as follows:
- For investment that are sold or otherwise disposed of prior to 30 years from the date the investor invested in the QOF, the taxpayer can elect not to recognize the gain on disposition of the investment (i.e., the entire gain would be excluded).
- For investments held for 30 years or more, only the inherent gain on the 30-year anniversary of the taxpayer's investment in the QOF can be excluded when the investment is disposed of—any appreciation after the 30-year period will be recognized and tax will be due on such gain when the QOZ investment is disposed of.
Designation of New Zones: Effective July 1, 2026, OBBBA provides for governors to designate new QOZs, which new QOZs will be in effect from the immediately following calendar year for a period of 10 years (i.e., the first designation period will be January 1, 2027, through December 31, 2036). A new designation period will start every 10 years thereafter. In addition, OBBBA changes the requirements applicable to a governor's designation of a QOZ by changing the definition of low-income community to tighten the requirements by making the zones more likely to be low-income areas.
Ballard Observation: OBBBA does not address the treatment of an investment made in property that is in a zone when the investment is made, but for which the zone expires before the investment is disposed of. We anticipate that such investments would continue to be good investments but that new investments in an expired zone would not be eligible for QOZ benefits. However, clarification from the Treasury Department is needed.
New Qualified Rural Opportunity Funds and Enhanced Benefits: OBBBA creates a new type of QOF, a QROF. A QROF is a fund that more than 90% of its assets (including through QOZ businesses) are invested in rural areas. In general, rural areas are areas that are thinly populated. As mentioned above, investors in a fund that is a QROF would be eligible to exclude 30% of the deferred gain (instead of 10% in case of regular QOFs). In addition, a QROF is entitled to certain more lenient qualification requirements pertaining to the level of improvements that are required when making certain investments.
Expanded and New Reporting Requirements: OBBBA expands the reporting and tax return requirements for both existing and new QOFs and adds reporting requirements on QOZ businesses. Increased penalties were also added to ensure compliance with these rules.
Effective Date: Most of the new QOZ provisions take effect after December 31, 2026, the date on which of the original program's investment period ends and the date when deferred gains are recognized under current law.
LOW INCOME HOUSING CREDITS
Current Law
9% Allocations. The amount of 9% allocations of the Low Income Housing Tax Credit (LIHTC) under Code Section 42 is limited. Code Section 42 provides for an annual increase based on a formula comprising a number of factors, including population and a cost-of-living adjustment.
Tax-Exempt Bond Financing Requirement. Current law under Code Section 42(h)(4) requires that 50% or more of the aggregate basis of a building and the land on which it is located must be financed with tax-exempt bonds subject to volume cap to be eligible for 4% allocations of LIHTC (the so-called “50% Test”).
OBBBA Changes to the LIHTC
9% Allocations. For calendar years after 2025, OBBBA provides for a permanent, annual 12% increase of LIHTC allocation for 9% allocations under Code Section 42.
Tax-Exempt Bond Financing Requirement. For buildings placed in service in taxable years after 2025, OBBBA provides for a new “25% Test” which requires that (1) 25% or more of the aggregate basis of a building and the land on which it is located is financed by tax-exempt bonds subject to volume cap; and (2) one or more of such tax-exempt bonds (a) are part of a bond issue the issue date of which is after December 31, 2025, and (b) provide the financing for not less than 5% of the aggregate basis of such building and the land on which it is located. OBBA clarifies that for purposes of a rehabilitation meeting the placed-in-service timeframe requirement, both the existing building and the expenditures treated as a separate building under Code Section 42(e)(4) will be treated as placed in service on the date the expenditures are placed in service under that section.
NEW MARKET CREDITS
Current Law
The New Markets Tax Credit (NMTC) under Code Section 45D was established in 2000 as a temporary credit to spur investment, job creation, and economic growth in emerging areas. It had been extended multiple times, but, most recently, it was set to expire at the end of 2025.
OBBBA Changes to the New Market Credits
For calendar years after 2025, OBBBA makes the NMTC permanent, with an annual credit allocation amount of $5 billion.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
