Multifamily Tax Advantages: Interest Expense Deductibility for Investors

Key Takeaways

• Permanent EBITDA Limit: Beginning in 2025, the IRS will permanently set the §163(j) cap at 30% of EBITDA (earnings before interest, taxes, depreciation, and amortization) rather than EBIT. This change allows investors to deduct more of their interest expenses upfront, which is especially valuable for properties with large depreciation write-offs ^[2][10].
• Option to Fully Deduct Interest: Real estate sponsors can avoid any cap on interest deductions by making a one-time “real property trade-or-business election.” This choice sacrifices accelerated bonus depreciation for buildings but allows all current-year interest expenses to be fully deducted using slower ADS depreciation schedules ^[7].
• Small-Business Exemption Limitations: Certain LLCs with less than roughly $30 million in gross receipts can bypass §163(j). However, many multifamily syndications don’t qualify because IRS aggregation rules and “tax-shelter” classifications often push combined receipts above the threshold ^[4][5][6].
• Structuring for Bigger Deductions: To maximize deductions, mortgage debt should be structured as business interest rather than investment interest. Business interest falls under §163(j), which is more lenient than the stricter §163(d) rules that limit deductions to net investment income ^[9][8].
• No More Capitalized Interest Loophole: Starting in 2025, the One Big Beautiful Bill Act (OBBBA) closes the workaround that let developers avoid limits by capitalizing interest during construction. Now, even interest incurred during development counts toward the 30% cap, requiring new financial planning during lease-up phases ^[2].
• Strategic Leverage Going Forward: With the EBITDA-based cap and opt-out election, investors can safely use moderate additional leverage without losing the ability to deduct full interest costs. This change improves after-tax cash flow while staying within lender guidelines ^[10].

Introduction

Interest expense has long been one of the most effective tax benefits in multifamily investing. By allowing investors to deduct mortgage interest from rental income, the tax code effectively lowers borrowing costs and boosts cash flow available for distributions.

This advantage became less powerful in 2022 when the Tax Cuts and Jobs Act (TCJA) tightened §163(j) rules, switching from an EBITDA-based limit to a stricter EBIT-based cap. This change, based on amendments to the Internal Revenue Code, meant that properties with significant depreciation suddenly saw large portions of their interest expense deferred, reducing immediate tax benefits.

However, the One Big Beautiful Bill Act (OBBBA), effective January 1, 2025, permanently reverses that limitation by reinstating the EBITDA standard. It also closes a previous loophole that allowed developers to bypass these limits by capitalizing interest during construction. The Internal Revenue Service (IRS) will oversee implementation and compliance with these changes. The new rules apply to tax years and taxable years beginning after January 1, 2025.

Combined with elective strategies and small-business exemptions, these new rules provide high-net-worth investors and family offices with a clearer, more favorable tax framework. Over the coming decade, this update will significantly impact how multifamily investors approach financing, debt structuring, and long-term tax planning.

Business Interest Limitation Under §163(j): EBITDA vs. EBIT Mechanics

What It Is

Under current tax law, Section 163(j) limits how much business interest expense you can deduct each year. The cap equals 30% of adjusted taxable income (ATI) plus any business-interest income.

From 2022 to 2024, ATI was calculated using EBIT (earnings before interest and taxes) meaning that depreciation and amortization were excluded. This restriction often reduced the immediate tax benefit for real estate investors, who typically have large depreciation deductions.

Starting in 2025, the rules permanently revert to EBITDA, meaning depreciation and amortization will once again be included in ATI. This change significantly increases the amount of deductible interest for most multifamily properties^[2].

Why It Matters

In value-add real estate deals, depreciation can exceed 30% of net operating income (NOI). Under the EBIT method, this frequently led to 40–60% of annual interest expense being disallowed, forcing investors to carry those deductions forward.

According to a study by EY, businesses—especially in manufacturing and real estate—nearly doubled their suspended interest deductions during the EBIT years^[3]. By switching back to EBITDA, the U.S. aligns with all other G7 nations, allowing most stabilized multifamily properties to fully deduct interest in the year it’s incurred^[10].

Key Data Points

• Cap Formula:
  • 2022–2024: 30% × EBIT
  • 2025 onward: 30% × EBITDA
• Global Alignment: The U.S. was the only OECD country using EBIT for this limitation^[10].
• Cash-Flow Impact: A property generating $10 million in EBITDA with $6 million of annual interest expense can now deduct the full $6 million. Previously, only $3 million was deductible under EBIT, with the remainder carried forward^[1][2].

Real-World Insight

In 2023, a fund acquired a property generating $8 million of EBITDA, $5 million of depreciation, and $2 million of annual interest expense.

EBIT era (2023–24): Because depreciation must be subtracted from EBITDA, adjusted taxable income (ATI) drops to $3 million and the §163(j) cap to $900K (30% × $3 million), forcing $1.1 million of interest into carry-forward status ($2 million in interest expense – $0.9 million limit).

EBITDA era (2025 onwards): Under the One Big Beautiful Bill Act, ATI reverts to EBITDA. The cap rises to $2.4 million (30% × $8 million), so the entire $2 million of current-year interest is now deductible and the fund can also use $400K of its carry-forward each year.

Net result: About $1.1 million of additional deductions per year, worth roughly $400–500K in after-tax cash flow at a 40% combined tax rate.

Real-Property Trade-or-Business Election: Opting Out of the Limit

What It Is

Real estate businesses have a unique option under tax law—they can choose to opt out of the §163(j) interest deduction limitation entirely. By making this one-time, irrevocable election, an investor can deduct all business interest expenses, regardless of the 30% cap^[7].

The trade-off is that once you elect out, you must use the Alternative Depreciation System (ADS) for buildings. This means:

• Residential real estate: Depreciated over 30 years (instead of 27.5)
• Commercial real estate: Depreciated over 40 years (instead of 39)

Additionally, bonus depreciation for these buildings is no longer allowed. However, bonus depreciation for personal property (e.g., appliances, fixtures) remains unaffected.

Why It Matters

For highly leveraged projects, such as ground-up developments or acquisitions financed at 75% loan-to-value (LTV), interest costs can exceed the 30% EBITDA limit. Without the election, this excess interest could be suspended, creating phantom taxable income and reducing cash distributions.

By electing out, investors ensure that every dollar of interest expense is immediately deductible, even though depreciation is recognized more slowly.

Key Data Points

• ADS Depreciation Periods: Residential: 30 years vs. 27.5; Commercial: 40 years vs. 39^[7]
• Bonus Depreciation: Still applies to personal property (not buildings)
• When to Use: The election is most beneficial when interest expenses regularly exceed ~35% of EBITDA or when rising interest rates are anticipated

Real-World Insight

A family office joint venture acquired a property with 75% LTV financing, where projected interest expenses equaled 55% of EBITDA.

• Without the election: A significant portion of interest would have been disallowed, inflating taxable income.
• With the election: Although the first year’s depreciation deduction dropped by about $90,000, it unlocked roughly $1.2 million in additional deductible interest.

The net effect: Positive for cash flow and allowed full investor distributions without unexpected tax liabilities.

Small-Business Exemption: Gross-Receipts Test & Aggregation

What It Is

The tax code provides an exemption from §163(j) for businesses considered “small.” Specifically, an entity qualifies if its average gross receipts over the past three years are less than $30 million (for 2024; indexed for inflation, likely about $32 million in 2025).

However, determining whether you qualify isn’t always straightforward. The IRS requires aggregation of gross receipts across all commonly controlled entities. Meaning, if you own multiple properties through different LLCs but share more than 50% common ownership, those revenues are combined when calculating the threshold^[5][6].

Additionally, there’s a “tax shelter” rule:

• If a partnership allocates more than 35% of its losses to limited partners, it is automatically classified as a tax shelter.
• Tax shelters cannot claim the small-business exemption, even if total receipts are below the threshold.

Why It Matters

At first glance, many single-property LLCs appear small enough to qualify. But once receipts from related entities are aggregated or if the partnership falls under the tax-shelter definition, the exemption is lost.

Failing to plan for this can lead to unexpected §163(j) limitations, additional tax compliance (including filing Form 8990), and potential cash-flow surprises.

Key Data Points

• Indexed Threshold: $30 million for 2024; approximately $32 million expected in 2025^[4]
• Aggregation Rules: Apply when there’s >50% common control among entities^[4]
• Tax Shelter Classification: Occurs if >35% of losses go to limited partners^[5]

Real-World Insight

A syndicator operated 10 separate LLCs, each owning a property that generated roughly $5 million in annual rent. Individually, each LLC looked like a small business. However, because the properties were 80% commonly owned, the IRS required aggregation:

• Combined gross receipts = $50 million → exceeded the small-business threshold.

Result: None of the LLCs qualified for the exemption.

Fortunately, with advance tax modeling, the sponsor restructured financing and adjusted leverage levels to minimize disallowed interest deductions and avoid penalties.

Multifamily Mortgage Interest: Business vs. Investment

What It Is

When it comes to deducting interest expenses, the IRS distinguishes between two types:

• Business Interest (§163(j)) – This applies to interest on debt used for an active trade or business, such as operating a rental property.
• Investment Interest (§163(d)) – This applies to borrowing used for investment purposes, like purchasing stocks or other passive investments. The deduction for investment interest is limited to your net investment income, and any unused deductions must be carried forward to future years.

In most cases, rental real estate is treated as a trade or business. This means that mortgage interest on multifamily properties qualifies as business interest, even if the investor is considered passive.

The IRS also has “interest tracing” rules that allow partners to classify interest correctly. For example, if an investor borrows personally (e.g., through a margin loan) and contributes those funds to a real estate partnership that has elected real property trade-or-business status, the loan interest can still qualify as business interest^[8].

Why It Matters

The rules for business interest are generally more favorable than for investment interest.

• Misclassifying debt as investment interest could trap deductions, delaying tax benefits for years.
• By structuring loans properly and ensuring funds are traced to the real estate activity, investors can keep interest expenses under §163(j), where they’re deductible up to 30% of EBITDA.
• This can significantly improve after-tax cash flow and reduce carryforward balances.

Key Data Points

• Investment-Interest Cap: Deduction limited to net investment income (dividends, interest income, certain capital gains)^[9].
• Tracing Rule: IRS Temporary Regulation §1.163-8T determines deductibility based on how loan proceeds are used, with a “look-through” approach for partnership investments^[8].

Real-World Insight

An investor had a $3 million capital call for a new multifamily acquisition. To fund it, they used a margin loan from their brokerage account.

• Without tracing: The margin loan interest would have been treated as investment interest, limited to net investment income.
• With proper tracing: The investor documented that the loan proceeds were contributed to a real estate partnership electing real-property trade-or-business status. As a result, the IRS classified the margin interest as business interest, making it fully deductible under the partnership’s EBITDA capacity and avoiding multi-year deduction delays.

OBBBA Impact: Permanent EBITDA & Capitalized-Interest Inclusion

What It Is

The One Big Beautiful Bill Act (OBBBA), effective for tax years beginning after December 31, 2024, makes two major changes to the business interest deduction rules:

• Permanent Return to EBITDA: The 30% limit will now always be based on EBITDA, making this favorable calculation method a permanent part of the tax code.
• Inclusion of Capitalized Interest: Construction-period interest that is capitalized during development will count toward the 30% deduction limit. Previously, developers could bypass the limit by capitalizing these costs and adding them to the property’s basis^[2].

Why It Matters

These changes have different effects for operating portfolios versus developers:

• Operating Multifamily Properties: The permanent return to EBITDA provides a long-term boost to after-tax cash flow. Investors can plan financing strategies with more certainty, knowing that larger interest deductions will be consistently available.
• Development Projects: Because capitalized interest now counts toward the cap, even during early construction years when income is minimal, developers may face suspended deductions that must be carried forward. This requires new modeling approaches to manage equity needs and projected returns during lease-up phases.

Key Data Points

• Effective Date: Applies to tax years starting after 12/31/2024^[2].
• Economic Impact: According to the Tax Foundation, this change reduces the overall cost of capital and should encourage continued real estate investment^[10].

Real-World Insight

Consider a developer planning a $15 million high-rise build spanning 2024–2026:

• Total capitalized interest: $15 million
• In 2025, during early construction, the project generates near-zero income, meaning approximately 80% of interest expense for that year cannot be deducted immediately.
• Instead, these disallowed amounts must be carried forward and deducted in future years when the property is stabilized. To maintain expected investor returns, the developer adjusts financing and raises additional equity upfront, ensuring that cash flow targets are met despite delayed deductions.

Conclusion

The ability to deduct interest expenses has always been a cornerstone tax benefit for multifamily real estate investors. By allowing owners to offset rental income with mortgage interest, the tax code effectively lowers borrowing costs and enhances cash flow.

With the passage of the OBBBA, investors now have even more clarity and flexibility. The permanent shift back to EBITDA-based limits restores larger, real-time deductions that were temporarily reduced under the EBIT regime. Additionally, the option to elect out of the cap gives highly leveraged investors a reliable way to fully deduct interest costs while still managing depreciation trade-offs.

However, maximizing these benefits requires careful tax planning. Understanding aggregation rules, small-business exemptions, interest tracing, and the new treatment of capitalized development interest is critical. When applied strategically, these rules can transform interest expense from a simple cost of borrowing into a powerful driver of after-tax investment returns.

Ultimately, by combining prudent leverage with smart tax elections, multifamily investors can protect distributions, preserve cash flow, and strengthen portfolio performance well into the next decade.

FAQ: Multifamily Interest Deduction under §163(j)

Q. How will the 30% cap be calculated starting in 2025?
A. Beginning in 2025, the 30% limit will be based on EBITDA (earnings before interest, taxes, depreciation, and amortization), plus any business-interest income. This change allows more interest to be deducted compared to the EBIT calculation used in recent years ^[1][2].

Q. Does capitalized construction interest still avoid the §163(j) limit?
A. No. Starting in 2025, even capitalized interest during the construction phase will count toward the 30% limit. Developers can no longer bypass the limitation by simply capitalizing interest costs ^[2].

Q. When does it make sense to use the real-property trade-or-business election?
A. This election is most beneficial when projected interest expenses regularly exceed about 35% of EBITDA. By making the election, you can deduct all current-year interest costs, though you’ll give up bonus depreciation and use longer ADS depreciation schedules for buildings ^[7].

Q. Can a single-asset LLC qualify for the small-business exemption?
A. Possibly—but only if combined receipts from commonly controlled entities stay below the inflation-adjusted threshold, and the LLC is not classified as a tax shelter (i.e., more than 35% of losses are not allocated to limited partners). Many multifamily syndications fail one of these tests and thus don’t qualify ^[4][5].

Q. What happens to disallowed interest under §163(j)?
A. Any disallowed interest isn’t lost; it carries forward indefinitely. In partnerships, these carryforwards are allocated to each partner and can only be used against future income from the same partnership ^[1].

Q. If I take a personal loan to fund a capital call in a real estate partnership, is the interest deductible?
A. Yes, potentially. If the loan proceeds are properly traced to a partnership that has made the real-property trade-or-business election, the IRS typically allows that interest to be treated as business interest, making it fully deductible under §163(j) ^[8].

Q. Do mezzanine financing or preferred-equity returns count as interest for §163(j) purposes?
A. Generally, no. Only amounts legally characterized as interest fall under §163(j). However, always confirm that the financial instrument’s substance matches its stated form to avoid surprises.

Q. Do all states follow the federal §163(j) rules?
A. Not always. While many states conform to federal rules, some partially or fully decouple, meaning state-level interest deductions may differ. It’s important to model both federal and state impacts before finalizing financing strategies.

Footnotes

1. IRS – Section 163(j) Limitation Q&A (2023). (irs.gov)
2. Baker McKenzie – OBBBA Interest-Deductibility Changes (2025). (bakermckenzie.com)
3. EY / National Association of Manufacturers – Economic Impact of EBIT vs. EBITDA Limit (2023). (nam.org)
4. IRS FAQ – Aggregation Rules for Gross-Receipts Test (2020). (irs.gov)
5. The Tax Adviser – Small-Business Gross-Receipts & Tax-Shelter Trap (2019). (thetaxadviser.com)
6. Dembo Jones CPAs – Deducting Business-Interest Expense (2024). (dembojones.com)
7. Weaver – Real-Property Trade-or-Business Election (2025). (weaver.com)
8. Real Estate Roundtable – Final Treasury Rules on Business-Interest Deduction (2020). (rer.org)
9. The Tax Adviser – Maximizing the Investment-Interest Deduction (2022). (thetaxadviser.com)
10. Tax Foundation – One Big Beautiful Bill Act: Business-Tax Provisions (2025). (taxfoundation.org)

This material is for informational purposes only and does not constitute tax, legal, or investment advice. Consult your professional advisors regarding your specific situation.