United States

IRS proposes 163(j) safe harbor for residential living facilities

TAX ALERT  | 

The IRS released Notice 2020-59 on July 28, 2020, as part of a package of guidance on the interest expense limitation under section 163(j) (see our alert on the other items of the guidance package here). The Notice offers a proposed revenue procedure with a safe harbor for residential living facilities to be treated as electing real property trades or businesses for purposes of section 163(j).

Background

Recent tax reform legislation codified as Public Law No. 115-97 (commonly referred to as the Tax Cuts and Jobs Act, or TCJA) amended section 163(j) to limit deductions for business interest to 30% of adjusted taxable income for most businesses. The Coronavirus Aid, Relief, and Economic Security (CARES) Act raised the limitation to 50% for most trades or businesses in tax years beginning in 2019 or 2020.

The interest limitation does not apply to certain businesses, including an “electing real property trade or business” as defined under section 163(j)(7)(B). The Code defines qualifying businesses by referencing section 469(c)(7)(C), which covers “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.” Residential living facilities fall into a grey area as they often include the provision of supplemental assistive, nursing, or routine medical services. Prior to Notice 2020-59, it was not clear whether such trades or businesses could qualify as electing real property trades or businesses.

Qualifying residential living facilities

The proposed revenue procedure provides a safe harbor to residential living facilities that qualify by meeting the following requirements.

Qualifying facilities must: 

  1. consist 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. include the provision of supplemental assistive, nursing, or other routine medical services; and
  3. has an average period of customer or patient use of the individual rental dwelling units that is 90 days or more.

The proposed revenue procedure contains rules for determining the average period of customer or patient use; supplemental assistive, nursing, or other routine medical services; and permanent or semi-permanent basis for residence.

If a taxpayer meets those requirements, it qualifies to be treated as an elective real property trade or business for purposes of section 163(j). Note that the safe harbor applies only to section 163(j) and does not treat a taxpayer as engaged in a real property trade or business for purposes of section 469.

Takeaways

Notice 2020-59 and its proposed revenue procedure offer much needed clarity for trades or businesses operating residential living facilities. The election to be treated as an electing real property trade or business is usually favorable for taxpayers with significant business interest, but is irrevocable (with limited exceptions) and requires the taxpayer to use the alternative depreciation system, which also locks the taxpayer out of bonus depreciation. Accordingly, taxpayers are encouraged to consult with their tax advisors prior to making the election. 

The proposed revenue procedure applies retroactively to tax years beginning after Dec. 31, 2017. Notice 2020-59 specifies that taxpayers may rely on the safe harbor until the proposed revenue procedure becomes final, so taxpayers may implement the new guidance immediately.

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