IRS confirms safe harbor proposed in Notice 2020-59.
While not unexpected, the release of Rev. Proc. 2021-9 provides taxpayers favorable guidance allowing taxpayers managing or operating a qualified residential living facility to treat the business as an electing real property trade or business for purposes of section 163(j), thereby exempting these businesses from the interest deductibility limitations of section 163(j). Rev. Proc. 2021-9 finalizes and clarifies guidance issued by the IRS earlier this year under Notice 2020-59, discussed in our prior alert, IRS proposes 163(j) safe harbor for residential living facilities.
An electing real property trade or business, as defined in section 163(j)(7)(B), is exempted from the business interest limitations of section 163(j). Since enactment of section 163(j), operators and managers of residential living facilities have questioned whether their businesses represented a real property trade or business. Rev. Proc. 2021-9 confirms that a qualified residential living facility business may elect to treat the business as a real property trade or business, eligible to deduct business interest expenses without application of the limit under section 163(j). Also worthy of note is that taxpayers electing real property trade or business are required to utilize the alternative depreciation system (ADS), which is generally less favorable to taxpayers than the modified accelerated cost recovery system (MACRS) method of depreciation. Additionally, satisfying the safe harbor requirements does not mean the taxpayer is engaged in a real property trade or business for purposes of section 469.
Pursuant to the safe harbor under Rev. Proc. 2021-9, a business will qualify if it:
(1) Consists of multiple rental dwelling units within one or more buildings or structures that generally serve as primary residences on a permanent or semi-permanent basis to individual customers or patients;
(2) Provides supplemental assistive, nursing, or other routine medical services; and
(3) Has an average period of customer or patient use of individual rental dwelling units of 30 days or more.
Based on comments received regarding Notice 2020-59 and the proposed safe harbor requirements, Rev. Proc. 2021-9 reduced the average period of customer use from 90 days to 30 days, and also clarified that the test for the safe harbor is on an annual basis (as opposed to a one-time election). In addition, Rev. Proc. 2021-9 provides that residential living facilities qualifying as residential rental property under section 168(e)(2)(A) also satisfy the requirements of the safe harbor.
In conclusion, taxpayers managing or operating a qualified residential living facility now have confirmation that their businesses can represent a real property trade or business exempt from the business interest limitations of section 163(j). However, electing to exempt the business from the business interest limitation rules does require the taxpayer to give up favorable MACRS depreciation rules. As such, taxpayers should consult with their tax advisors when considering electing real property trade or business status under section 163(j)(7)(B) and the safe harbor provided in Rev. Proc. 2021-9.
