Maximize Real Estate Tax Savings with Section 163(j) EBITDA

Reclaiming the EBITDA Standard

The return to an EBITDA-based calculation represents a major victory for leveraged real estate entities. For the past several years, firms were forced to calculate their interest limits based on EBIT, a “narrower” figure that did not account for the massive depreciation typical in property ownership. By adding back depreciation and amortization, firms essentially broaden the pool of income used to determine their 30% cap.

For example, a firm with $10 million in operating income and $5 million in depreciation would have been limited to a deduction based on $10 million under the old rules. Now, that same firm calculates its limit based on a $15 million EBITDA figure. This Section 163(j) interest expense limitation relief ensures that profitable, asset-heavy businesses are not unfairly penalized for the very depreciation that makes real estate such an attractive asset class.

Example:

To illustrate the impact of the restored EBITDA-based rules, consider a real estate investment firm that holds a multifamily apartment complex with the following year-end financials:

• Operating Income (EBIT): $2,000,000
• Depreciation & Amortization: $1,500,000
• Interest Expense: $950,000

Under the restrictive EBIT-based rules (active from 2022–2024), the firm’s interest deduction would have been capped at 30% of its $2,000,000 EBIT, or $600,000. This would leave the firm with $350,000 in non-deductible interest that must be carried forward, creating a significant tax drag on current cash flow.

Financial Impact Comparison

With the restored EBITDA-based interest limitation, the firm adds back its $1,500,000 in depreciation. This raises their Adjusted Taxable Income (ATI) to $3,500,000, resulting in a new deduction cap of $1,050,000. Because this cap now exceeds their actual interest expense, the firm can deduct the full $950,000 in interest.

By using this restored standard, the firm avoids the “phantom income” that occurs when interest remains non-deductible. More importantly, because the 30% limit is now high enough to cover their debt service, the firm does not need to make an RPTOB election. This preserves their ability to use 100% bonus depreciation on the property, creating a massive dual tax benefit that significantly improves the project’s after-tax internal rate of return (IRR).

Moving Away from the RPTOB Election

Historically, many real estate companies felt pressured to make the “Electing Real Property Trade or Business” (RPTOB) election to bypass interest limits entirely. While this election removed the 30% cap, it came with a heavy cost: the mandatory use of the Alternative Depreciation System (ADS). Under ADS, property owners are forced to use longer recovery periods—such as 30 or 40 years—and are strictly prohibited from claiming bonus depreciation.

With the restored EBITDA add-back, the 30% limit is now high enough for many firms to deduct their full interest expense while remaining under the General Depreciation System (GDS). This allows firms to avoid mandatory ADS depreciation and keep their accelerated write-offs intact. By skipping the RPTOB election, firms can maximize both their interest deductions and their first-year depreciation, a “best of both worlds” scenario that was difficult to achieve just a few years ago.

Navigating New Rules for Capitalized Interest

While the restoration of EBITDA is a net positive, 2026 brings new complexities regarding how firms must account for newly capitalized interest. Under the latest updates to the tax code, interest that is capitalized into the basis of a project—such as during a major construction or renovation phase—must now be included when testing against the 30% limitation.

This “ordering rule” means that you cannot simply capitalize interest to bypass the 163(j) cap. Capitalization no longer removes interest from the limitation calculation. Firms must be diligent in tracking these costs, as any interest that exceeds the 30% limit will still be subject to the limitation and carried forward as disallowed business interest expense.

Strategic Advantages for High-Debt Portfolios

For firms maintaining heavy debt-service ratios, these rules provide a vital buffer for maintaining high deductibility thresholds. In a higher-interest-rate environment, the cost of borrowing can easily eat into a project’s margins. The ability to add back depreciation creates a “flex” in the tax code that scales with the size of the portfolio.

• Cash Flow Preservation: Higher deductions lead to lower taxable income, keeping more cash within the firm.
• Leverage Optimization: Investors can take on higher levels of debt with the confidence that their interest will remain deductible.
• Investment Velocity: By avoiding the slower ADS schedules, firms can recycle capital faster through the use of 100% bonus depreciation.
• Simplified Compliance: Staying within the 163(j) framework avoids the administrative burden of an irrevocable RPTOB election.

Ultimately, the shift back to an EBITDA-based model provides the stability and liquidity necessary for firms to navigate the market. By assisting firms with heavy debt-service ratios in staying below the 30% cap, the tax code now supports the natural lifecycle of real estate investment—from high-leverage acquisition to aggressive depreciation and, finally, to optimized tax-free cash flow.

Disclaimer: This article provides general information and should not be considered professional financial or tax advice. Please consult with a qualified CPA or financial advisor for guidance specific to your individual business needs.