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The CARES Act: Elections Under Business Interest Limitation Rules Amended By IRS

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Bill Iannarelli, CPA and Jeff Zawada

Business Interest Limitations

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security “CARES” Act into law. The $2 trillion CARES Act contains an array of tax provisions designed to increase deductions that are available to businesses, and by doing so, generate cash flow during the coronavirus (COVID-19) crisis. The tax rules include:

  • 1) Allowing bonus depreciation or a 15-year recovery period for Qualified Improvement Property (QIP), retroactive to 2018;
  • 2) Permitting a five-year carryback of net operating losses created in 2018, 2019 and 2020 tax years;
  • 3) Suspending the Internal Revenue Code (IRC) section 461(l) limitation until 2021, for taxpayers other than C corporations, on the use excess net business losses;
  • 4) Providing for C corporations to obtain a refund of alternative minimum tax credits in the 2018 and 2019 tax year, instead of 2018 through 2021; and
  • 5) Expanding the limitation on net business interest expense under IRC section 163(j) from 30% of Adjusted Taxable Income to 50% for 2019 and 2020.

The information below highlights recent changes related to the Business Interest Limitation under IRC section 163(j).

BACKGROUND

The 2017 Tax Cuts and Jobs Act amended IRC section 163(j) so that the deduction for business interest expense is limited to the sum of the taxpayer’s:

  • 1) Business interest income;
  • 2) 30% of adjusted taxable income; and
  • 3) Floor plan financing interest.

As noted above, the CARES Act increases the annual limitation on business interest expense from 30% to 50% for years 2019 and 2020.

Certain small businesses with average gross receipts for the three prior years of less than $25 million (inflation adjusted), with some exceptions, are exempt from the section 163(j) business interest expense limitation rules. Additionally, a taxpayer that meets the definition of a Real Property Trade or Business or a Farming Business can make an election under IRC section 163(j)(7) so as to become exempt from the business interest limitation rules (the “section 163(j)(7) election”). However, there is a cost to this election. Certain assets which are used in the business are required to be depreciated under the Alternate Depreciation System (ADS), which generally has longer lives than under normal MACRS depreciation. Additionally, where the ADS method is required on assets, bonus depreciation is not allowed.

Note that, under the Tax Cuts and Jobs Act, for an Electing Real Property Trade or Business, 39-year MACRS life for commercial property and qualified improvement property would be 40-years under ADS; and 27.5-year MACRS life for residential rental property would be 30 years.  However, it should be noted that under the CARES Act, qualified improvement property was retroactively changed to a 15-year MACRS life and a 20-year ADS life. 

Once the election is made, it is irrevocable.

NEW RULES

The IRS recognizes that the CARES Act changes could cause a reconsideration of prior elections.

  • The increase in the limitation percentage to 50% might reduce significantly the current non- deductible nature of the business interest expense limitation rule.
  • More significantly, the retroactive change in the law to permit qualified improvement property to be subject to immediate write-off under bonus depreciation could be a game-changer for real estate businesses.

The IRS has issued Revenue Procedure 2020-22 to effectively permit a “do-over” with respect to the section 163(j)(7) election. Under the procedure, an amended return can be filed by taxpayers in order to make an election if they did not make a section 163(j)(7) election for a prior year.

Partnerships may use a Form 1065X or an Administrative Adjustment Request (AAR), as applicable. Generally, this must be filed on or before October 15, 2021.

Additionally, those who made an election in a prior year can now amend their returns for that year so as to withdraw the election. (The format and contents of the statements are described in the procedure). The allowance of amended returns and the revocation of prior elections allow affected taxpayers the opportunity to review their circumstances in light of the new law to determine whether they are better off changing their prior decisions with respect to these elections.

Do you have questions about elections under the Business Interest Limitation rules, or other tax matters? Please contact Bill Iannarelli or Jeff Zawada in our Tax group at 716.847.2650 or bill.iannarelli@freedmaxick.com or jeff.zawada@freedmaxick.com.

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