CRE Business Interest Deduction Under OBBBA

The One Big Beautiful Bill Act (OBBBA) has brought about a fundamental shift that directly impacts the bottom line for highly leveraged commercial real estate portfolios. Specifically, the permanent restoration of the EBITDA-based calculation for business interest deductions under Section 163(j) is a game-changer for our industry.

The Return to EBITDA: A New Era for Real Estate Tax Planning

For several years, CRE investors have been navigating a restrictive interest deduction environment. Following the Tax Cuts and Jobs Act (TCJA) of 2017, the rules for calculating “Adjusted Taxable Income” (ATI) shifted in 2022 from an EBITDA-like model to a narrower EBIT-based model. By removing the ability to “add back” depreciation and amortization, the IRS effectively lowered the ceiling on the amount of interest a company could deduct.

The OBBBA has officially reversed this trend. For tax years beginning after December 31, 2024, the law permanently restores the add-back of depreciation, amortization, and depletion when calculating ATI. For our clients, this means a significantly higher limit for interest expense deductions, providing a powerful tailwind for those utilizing leverage to acquire and develop assets.

Understanding the Mechanics: Why the Add-Back Matters

To appreciate the impact, we must look at the formula for the business interest limitation. Generally, Section 163(j) limits the deduction for business interest expense to 30% of a taxpayer’s ATI for the year (plus business interest income and floor-plan financing interest).

Under the restrictive EBIT rules (2022 through 2024), your ATI was essentially your operating profit after depreciation. In commercial real estate, where depreciation is often the largest non-cash expense on the books, this was devastating. It meant that even if a property was performing well from a cash flow perspective, the massive “paper loss” from depreciation reduced the ATI, which in turn capped the amount of mortgage interest you could deduct.

By moving back to an EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) framework, we are now adding those non-cash expenses back into the “bucket” that determines your deduction limit.

An Example of the Impact on a Leveraged Property

Consider a commercial property held in an LLC with the following annual figures:

• Gross Rental Income: $5,000,000
• Operating Expenses (excluding interest/depreciation): $2,000,000
• Interest Expense on Debt: $1,500,000
• Depreciation Deduction: $1,000,000

EBITDA is $3,000.000 ($5M- $2M). After depreciation, EBIT is $2,000,000.

Under the previous EBIT rules, the ATI would be $2,000,000 ($5M – $3M). The maximum interest deduction would be 30%, or $600,000. The remaining $900,000 of interest would be disallowed in the current year and carried forward.

Now, under the OBBBA (EBITDA rules), the ATI increases to $3,000,000. The maximum interest deduction rises to $900,000, allowing an additional $300,000 in interest to be deducted in the current year solely due to the shift of EBITDA.

For highly leveraged real estate portfolios with significant depreciation, this change materially increases current-year interest deductibility.  

Additional Savings through Permanent 100% Bonus Depreciation

The OBBBA not only fixed the interest limitation but also permanently reinstated 100% bonus depreciation for qualifying property placed in service after January 19, 2025. This creates a powerful “double benefit” for CRE owners.

Previously, if you took a massive bonus depreciation deduction, it would hurt you by lowering your EBIT and further restricting your interest deduction. Now, because that bonus depreciation is added back to your ATI, you can maximize your cost recovery through 100% expensing without cannibalizing your ability to deduct interest. This situation is particularly beneficial for “value-add” strategies where significant capital improvements are made to a property shortly after acquisition.

The End of Interest Capitalization Strategies?

Despite all this good news, there is something of a “give and take” within the OBBBA. In the past, some clever taxpayers avoided the 163(j) limitation by “electively capitalizing” interest under Section 263A. By adding interest to the basis of an asset (such as a new construction project) rather than expensing it, they could effectively “bypass” the 30% limit and recover that cost through depreciation.

The OBBBA has closed this door. For tax years beginning after December 31, 2025, any business interest expense that is electively capitalized will retain its character as “interest” for purposes of the Section 163(j) limitation. This means you cannot use capitalization to dodge the cap. However, since the EBITDA-based cap is now so much higher and more permanent, the need for such aggressive capitalization strategies has largely diminished.

Re-evaluating the “Real Property Trade or Business” Election

One of the most critical decisions for a CRE entity has been whether to make the “Real Property Trade or Business” (RPTB) election. Making this election allows a company to opt out of the 163(j) interest limitation entirely. However, the trade-off is that the entity must use the Alternative Depreciation System (ADS), which requires longer recovery periods and disallows bonus depreciation.

With the OBBBA’s restoration of EBITDA, many portfolios that previously felt “forced” into the RPTB election may find it more advantageous to stay under the 163(j) rules. If your EBITDA-based cap is high enough to cover all your interest expense anyway, you are better off not making the RPTB election so you can keep the 100% bonus depreciation and accelerated MACRS schedules.

It is important to remember that RPTB elections are generally irrevocable. If you have already made one, you may be locked in. However, for new acquisitions or entities, we now have a more flexible toolkit to optimize cash flow.

Global Considerations and Foreign Income

For companies with international structures or Controlled Foreign Corporations (CFCs), the OBBBA introduces some complexity. The act excludes certain foreign-related income (including Subpart F income and Net CFC Tested Income) from the ATI calculation for tax years after 2025. This could slightly lower the interest deduction ceiling for multinational real estate groups. If your portfolio includes significant foreign holdings, you should model the specific impact of these “carve-outs” on global interest deductibility.

Strategic Recommendations for CRE Portfolios

The permanence of these rules allows for more confident long-term underwriting. Here is how we recommend approaching the new landscape:

1. Run Comparative Models: Compare your current structure under both the 163(j) EBITDA rules and the RPTB election. In many cases, the “default” 163(j) path is now the clear winner.
2. Audit Your Cost Segregation: Since depreciation is now a “friend” to your interest deduction, performing cost segregation studies on new acquisitions is more valuable than ever. It maximizes both your immediate cash flow and your interest deduction capacity.
3. Review Debt Structures: If you have been avoiding certain high-leverage financing due to tax disallowance concerns, it may be time to revisit those options. The tax cost of that debt has effectively decreased.
4. Plan for Carryforwards: If you have disallowed interest carryforwards from 2022-2024, the shift to EBITDA in 2025 will likely allow you to “burn through” those carryforwards much faster, providing an immediate tax shield against current income.

Planning is More Important Than Ever

The OBBBA represents a significant victory for the commercial real estate sector. By permanently restoring the EBITDA-based calculation, the government has recognized the capital-intensive nature of our industry and the need for leverage to drive development.

The ability to add back depreciation and amortization creates a more equitable tax environment, ensuring that “paper losses” do not unfairly penalize the deductibility of actual cash interest payments. Your focus should now be on leveraging these rules to maximize your after-tax internal rate of return and ensuring your portfolio is structured to take full advantage of this new, more favorable regime.