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Guidance on Internal Revenue Code (IRC) Section 163(j) Elections for Legislation, Farming, Real Property

The IRS has released guidance on making the following elections for the business interest deduction limitation:

  • The election out of the 50% adjusted taxable income (ATI) limitation for tax years beginning in 2019 and 2020 under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
  • The election to use the taxpayer’s ATI for the last tax year beginning in 2019 to calculate the IRC Section 163(j) limit for the 2020 tax year under the CARES Act; and the election out of deducting 50% of excess business interest expense (EBIE) for the 2020 tax year without limitation under the CARES Act.

The guidance also provides transition relief to taxpayers making or revoking the election to be an electing real property trade or business or an electing farming trade or business under IRC Section 163(j)(7).

Business Interest Limit

A taxpayer’s deduction of business interest expenses paid or incurred for any tax year is generally limited to the sum of business interest income, floor plan financing interest, and 30% of ATI. The IRC Section 163(j) limitation is generally increased from 30% to 50% of a taxpayer’s ATI for any tax year beginning in 2019 and 2020 under the CARES Act.

A taxpayer may elect not to have the increased limitation apply in 2019 or 2020. In addition, a taxpayer may elect for any tax year beginning in 2020 to use its ATI from the 2019 tax year to calculate its IRC Section 163(j) limitation. The 50% ATI limitation does not apply to partnerships for the 2019 tax year. Instead, a partner treats 50% of its allocable share of a partnership’s EBIE for 2019 as an interest deduction in the partner’s 2020 tax year without limitation. The remaining 50% of such EBIE remains subject to the IRC Section 163(j) limit applicable to EBIE carried forward at the partner level. A partner may elect out of the 50% EBIE rule.

Election Out of 50% ATI

There is no formal election or statement required to make the election not to apply the 50% ATI limit for the 2019 or 2020 tax year. The election is made by simply filing a federal income tax return (or Form 1065 in the case of a partnership for 2020) by the due date for the return, including extensions, using the 30% ATI limitation. The election may also be made on an amended return or administrative adjustment request (AAR).

The election must be made for each tax year. For a partnership, the election is made by the partnership, not the partners. It is also made by the agent for a consolidated group and for an applicable controlled foreign corporation (CFC) by each controlling domestic shareholder. The taxpayer is granted consent from the IRS to revoke the election by merely filing an amended return and using the 50% limit.

Election to Use 2019 ATI in 2020

There is also no formal election or statement required to make the election to use 2019 ATI in the 2020 tax year. The election is made by simply filing a federal income tax return (or Form 1065) by the due date for the return for the 2020 tax year, including extensions, using the taxpayer’s 2019 ATI. The 2019 ATI used for the calculation is pro-rated if the taxpayer’s 2020 tax year is a short tax year. The election may also be made on an amended return or AAR.

For partnerships, the election is made by the partnership, not the partners. It is also made by the agent for a consolidated group and for an applicable CFC by each controlling domestic shareholder. For a CFC group, the election is not effective for any group member unless made for every tax year of a CFC group member for which the election is available.

Election Out of 50% EBIE Rule

There is also no formal election or statement required by a partner in a partnership to make the election out of the 50% EBIE rule. A partner makes the election by filing its federal income tax return (or Form 1065) by the due date for the return for the 2020 tax year, including extensions, by not applying the 50% EBIE rule in determining the IRC Section 163(j) limitation. The election may also be made on an amended return or AAR. The partner is granted consent from the IRS to revoke the election by merely filing an amended return, Form 1065, or AAR applying the 50% EBIE rule.

Real Property and Farming

The IRC Section 163(j) limit applies to all taxpayers with business interests, except small businesses which meet an average annual gross receipts test. It also does not apply to certain excepted businesses including an electing real property business and an electing farming business.

Under proposed regulations, a taxpayer must make an election for a real property trade or business, or farming business, with respect to each eligible trade business. The election is made by attaching a statement to the taxpayer’s timely filed original tax return (including extensions). A real property trade or business or farming business that elects out of the business interest deduction limit must depreciate certain property using alternative depreciation system (ADS).

In light of the legislative changes, a taxpayer may make the election or revoke an election to be an electing real property trade or business or an electing farming trade or business for the 2018, 2019, or 2020 tax year by filing an amended federal income tax return, amended Form 1065, or amended AAR. The return must include an election statement or withdrawal statement, and any collateral adjustments to taxable income. This include its depreciation of property affected by making a late election or withdrawing the election. The amended federal income tax return, Form 1065, or AAR generally must be filed by October 15, 2021.

For more information about this article, please contact our tax professionals at taxalerts@windes.com or toll free at 844.4WINDES (844.494.6337).

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