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IRS issues final regulations for limitation on deduction for business interest expense, code section 163(j)

Lori D. Givens

August 12, 2020

On July 28, 2020, the IRS issued final regulations to code section 163(j) with key changes receptive to taxpayer comments on proposed regulations, that were originally enacted in December 2017.

Background

Certain taxpayers with business interest expenses are limited to 50% of adjusted taxable income (ATI) for tax years 2019 for C and S corporations, and 2020 for partnerships. Prior to the CARES Act, the limitation was 30% of ATI. Business interest expense limitations are carried forward until offset by income from the same entity in future years.

Revised definition of business interest expense:

Proposed regulations – included debt issuance cost, loan commitment fees, and certain hedging cost.

Final regulations – eliminated debt issuance cost, loan commitment fees, and certain hedging cost from the definition of business interest expense.

This provides relief and positive outcomes specific to different industries. Specifically:

Manufacturers:

  • Proposed regulations – taxpayers could not add back depreciation, amortization, or depletion capitalized to inventory under the uniform capitalization rules causing many manufactures to be subject to limitations on deducting business interest expense. 
  • Final regulations – taxpayers can add back cost capitalized to inventory under the uniform capitalization rules when calculating ATI.  This taxpayer win allows for a larger interest expense deduction.

Real Estate:

  • Proposed regulations – real estate trades or businesses exempt under the small business rules could not make an election out of 163(j). When electing out, depreciation for real property is converted to ADS and bonus depreciation is not allowed.
  • Final regulations – a protective 163(j) election can be made by certain rental real estate taxpayers regardless if the activities are deemed trade or business. There was no change to depreciation from the proposed regulations if the election is made.

Healthcare:

  • Proposed regulations – did not address qualified nursing and assisted living facilities.
  • Final regulations – Issued notice 2020-59, providing a safe harbor for nursing and assisted living facilities the ability to elect out of 163(j) by treating them as real property trades or businesses. 

Entities exempt from 163(j):

  • Proposed regulations – partnerships and s corporations exempt from 163(j) were required to report business interest expense to owners for further testing on the next tier of taxpayers returns.
  • Final regulations – removed obligation for testing interest expense from exempt pass-through entities to the partner or shareholder level.

Conclusion

These final and proposed regulations apply to most businesses; therefore, it is important to gain an understanding of how the limitation will apply to your unique set of facts and circumstances. This update covers only a small portion of these rules.

Additional proposed regulations were also issued pertaining to changes under the CARES Act. We will continue to monitor and advise when the related final regulations are issued.

For additional details on the election, click here.

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