IRS Provides Guidance on Elections Related to Section 163(j) Business Interest Limitation

Revenue Procedure 2020-22 from the Internal Revenue Service provides helpful flexibility for taxpayers in a real property trade or business.

The Internal Revenue Service on April 10 released Revenue Procedure 2020-22, which provides guidance regarding certain new elections that may be made in applying the business interest limitation of Internal Revenue Code Section 163(j), as modified by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). In addition, Revenue Procedure 2020-22 also permits eligible taxpayers to make a late election, or withdraw a previous election, to be treated as an “electing real property trade or business” or an “electing farming business” for purposes of applying the business interest limitation.

Background

As discussed in our March 27 LawFlash, the CARES Act modifies the manner in which the business interest limitation of Section 163(j) may be applied for tax years beginning in 2019 and 2020. The CARES Act also relaxed the taxable income limitation on net operating loss (NOL) carryforwards and permitted NOL carrybacks in respect of certain taxable years, as described in detail in our March 27 LawFlash. In addition, as discussed in our that LawFlash, the CARES Act retroactively corrected the “retail glitch” that was included in the Tax Cuts and Jobs Act (TCJA), thereby shortening the recovery period for “qualified improvement property” and making it eligible for 100% bonus depreciation.

Under the TCJA, if an eligible taxpayer makes an election to be treated as an “electing real property trade or business” or an “electing farming business” that, in either case, is not subject to the business interest limitation of Section 163(j), the taxpayer is required to use the alternative depreciation system for depreciable property used in that business and may not claim bonus depreciation in respect of that property.

As a result, an eligible taxpayer must determine if an election to avoid the application of the Section 163(j) business interest limitation is economically advantageous, taking into account the impact the election will have on the taxpayer’s ability to claim accelerated depreciation deductions (including bonus depreciation). This analysis would also need to take into account the taxpayer’s ability to utilize any NOL that might be created or increased in any given taxable year (including by reason of the COVID-19 economic disruptions), in light of the CARES Act modifications.

Because the CARES Act modifies the operation of the NOL rules, the business interest limitation rules, and the depreciation rules on a retroactive basis, certain taxpayers that previously elected to be treated as an electing real property trade or business or an electing farming business may now find that withdrawing such an election would be advantageous.

Conversely, certain taxpayers that did not previously make such an election may now find that it would benefit them to do so for a prior period. By issuing Revenue Procedure 2020-22, the IRS has provided taxpayers with the flexibility to revisit prior decisions related to their electing real property trade or business or electing farming business status, and has provided guidance as to the time and manner of making other elections under Section 163(j) that were provided as part of the CARES Act modifications.

Rev. Proc. 2020-22: Procedures Related to Section 163(j) Elections

Extension of Time to Make Section 163(j)(7) Elections

• A taxpayer conducting an eligible real property or farming business that did not make an election under Section 163(j)(7) on its timely filed federal income tax return for 2018, 2019, or 2020 may make a late election under Section 163(j)(7) by filing an amended federal income tax return, an amended IRS Form 1065, or an administrative adjustment request (AAR, which is made by filing IRS Form 8082), as applicable. The amended return, amended IRS Form 1065, or AAR must include a late election statement in the form prescribed by Revenue Procedure 2020-22.

Withdrawing Prior Section 163(j)(7) Elections

• A taxpayer conducting an eligible real property or farming business that previously made an election under Section 163(j)(7) on its timely filed federal income tax return for 2018, 2019, or 2020 may withdraw the election by filing an amended federal income tax return, an amended IRS Form 1065, or an AAR, as applicable. The amended return, amended IRS Form 1065, or AAR must include a withdrawal statement in the form prescribed by Revenue Procedure 2020-22. Under Revenue Procedure 2020-22, if a taxpayer withdraws its previously made Section 163(j)(7) election, the election is treated as if it had never been made.

The deadline for making a late election or withdrawing a previously made election by filing an amended return or amended IRS Form 1065 is, generally, October 15, 2021 (but in no event later than the applicable period of limitations on assessment for the tax year for which the amended return is being filed).

However, Revenue Procedure 2020-22 provides an exception for the time to file amended Bipartisan Budget Act of 2015 (BBA) partnership returns for the 2018 and 2019 tax years, as provided in Revenue Procedure 2020-23 and described in greater detail in our April 14 LawFlash. In the case of a BBA partnership that does not file an amended return in accordance with Revenue Procedure 2020-23, the deadline for making a late election or withdrawing a previously made election by filing an AAR is generally October 15, 2021 (but in no event later than the applicable period of limitations on making adjustments under Section 6235 for the reviewed year).

In all instances, the amended federal income tax return, amended IRS Form 1065, or AAR must include any correlative adjustments caused by the late or withdrawn election, including, for example, changes to deductible interest expense, NOLs, and/or depreciation. Taxpayers must also file amended federal income tax returns, amended IRS Forms 1065, or AARs to reflect collateral adjustments for any affected succeeding taxable years.

New CARES Act Elections: Section 163(j)(10)

As described in greater detail in our March 27 LawFlash, the CARES Act amended Section 163(j) to relax some of the restrictions on interest deductibility as follows:

• For purposes of determining a taxpayer’s business interest deductions for tax years beginning in 2019 and 2020, Section 163(j) has been amended to increase the “adjusted taxable income” percentage from 30% to 50%. The 50% limitation does not apply to partnerships for 2019. A taxpayer may elect not to apply the increased adjusted taxable income percentage.
• For purposes of calculating its business interest limitation, a taxpayer may elect to use its adjusted taxable income for its last tax year beginning in 2019 in place of its adjusted taxable income for any tax year beginning in 2020.
• A partner treats 50% of its allocable share of a partnership’s excess business interest expense (EBIE) for 2019 as an interest deduction in the partner’s first taxable year beginning in 2020, without limitation. The remaining 50% of such EBIE remains subject to the Section 163(j) limitation applicable to EBIE carried forward at the partner level. A partner may elect not to have the 50% EBIE rule apply.

Revenue Procedure 2020-22 provides that an eligible taxpayer may make one or more of the above described elections by timely filing its federal income tax return or IRS Form 1065, an amended federal income tax return, an amended IRS Form 1065, or an AAR, as applicable, calculating its taxable income in a manner that reflects the election(s). No formal election statement is required.

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Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Boston
Daniel A. Nelson
Jason P. Traue
Meghan E. McCarthy

Philadelphia
Casey S. August
Daniel F. Carmody

San Francisco
Gregory Hartker
Sarah-Jane Morin

Washington, DC
Jennifer Breen
Sheri A. Dillon
Bill McKee
William F. Nelson