A new rule limiting the deduction for interest expense goes into place in 2018. Under the new rule, a taxpayer can deduct interest only up to 30% of adjusted income. The interest expense in excess of the 30% is carried over to the next year.
Adjusted income means a company’s taxable income with an addback for interest, depreciation and amortization. In 2022 and forward, you no longer add back depreciation and amortization. Therefore, ATI will be significantly lower in 2022 and subsequent years.
The rules apply to every type of business and every type of taxpayer. This includes LLCs, corporations and personal returns. Every LLC will have to compute its own 30% limit and the limit is applied to each separate LLC. Therefore, if you have several LLCs and one is losing money and the other has profit, the money losing LLC cannot deduct any interest expense as each LLC is looked at separately.
The limit does not apply to taxpayers with less than $25 million of gross receipts. The IRS just released guidance that if multiple LLCs or corporations are under common control, you have to add all their revenue together and then compare it to the $25 million mark. Common control means companies where 50% or more of the ownership is owned by the same people.
There is an exception for entities owning real estate. If an LLC or corporation owns and leases out real estate, the LLC can elect to be exempted from the interest limitation rules. The trade-off is that the LLC cannot use the 100% write off depreciation if the election is made.
A very real problem for the skilled care world is that the IRS has taken the position that if a LLC owning real estate leases the real estate to a related operator, the LLC will not be treated as a real estate entity and cannot elect out of the rules. An operator is related to the real estate entity if they are owned 50% or more by the same people.
The denial of the election out for a real estate entity leasing to a related operator is only in proposed form. The IRS will be taking comments from taxpayers until about the end of January and will then issue their final interpretation of the rules.
Denying the election out to related property owners is now the second instance where having a related party rental is bad for your taxes. The first is that the 20% QBI deduction gives you an automatic deduction of 20% of rental income. The 20% QBI deduction is not available if the operator and the property company have 50% or more common ownership.
There are other tax considerations which depend on the ownership. For instance, if an operator and property LLC do NOT have identical ownership, then the property income or loss is treated as passive. This result could be good or bad depending on an individual’s situation and should be considered.
On a go forward basis, skilled care operators should consider structuring their businesses so that one person owns the operator and that same person owns only 49% of the property company. The owners can work out their economics through rent and pay. Doing so gets the 20% deduction on the rental income as well as the ability to elect out of the interest limitation.
As with everything else, the IRS always has the ability to challenge anything which saves you taxes. However, since being on the SNF license imposes some burdens, having people who only own an interest in the property company is fairly common and provides a business purpose for the structure.
Kuno S. Bell, CPA, J.D., is the Director of Tax at Pease & Associates, LLC. He can be reached at firstname.lastname@example.org