United States

IRS extends time to make 163(j) real property business elections

TAX ALERT  | 

Summary

Taxpayers that conduct either a real property trade or business (RPTB) or a farming trade or business (FTB) now have an opportunity to reconsider an important tax election. A business meeting the definition of an RPTB or FTB is eligible to make an election that excepts the business from the section 163(j) business interest deduction limitation. This election generally is irrevocable once it is made. 

The IRS has published Rev. Proc. 2020-22, allowing RPTBs and FTBs to either make this election late or withdraw the election if it was previously made. The general deadline for making or revoking an election under this Revenue Procedure is Oct. 15, 2021.

Background and CARES Act legislative changes

For a taxpayer with business interest expense, an RPTB or FTB election under section 163(j)(7) can provide a significant benefit—with the election in place for a real property or farming business, deductions for the taxpayer’s interest expense properly attributable to that business are not subject to limitation under section 163(j). 

The election comes with a cost: an electing RPTB may not use accelerated ‘bonus’ depreciation into account on many of its real estate assets. Instead, the relatively slow ‘alternative depreciation system’ (ADS) method of cost recovery must be used. Similarly, use of ADS is required and bonus depreciation unavailable for certain assets held by an electing FTB. The IRS set out guidance for implementing ADS cost recovery for electing RPTBs and FTBs in rules in Rev. Proc. 2019-8. 

The cost associated with foregoing bonus depreciation was recently magnified by changes to the Tax Code made in the coronavirus relief legislation (the CARES Act). The CARES Act fixed a glitch in the Tax Code that inadvertently excluded many real estate assets (‘qualified improvement property,’ or QIP) from 100% first-year bonus depreciation. (For additional coverage, see our prior Alert CARES Act provides a fix for the retail glitch.)

In addition, the CARES Act increased the maximum amount of interest deductible by many taxpayers under section 163(j) by increasing the section 163(j) limitation to including 50% of adjusted taxable income (ATI) in the limitation amount instead of only 30% of ATI. This increase, however, only applies to certain taxable years. For partnerships, the increase to 50% of ATI applies to all taxable years beginning in 2020 only, and the special partnership rule discussed below applies to years beginning in 2019. For other taxpayers, such as corporations (including S corporations) and individuals, the increase to 50% of ATI applies to all taxable years beginning in 2019 or 2020.  (For additional coverage, see our prior Alerts Section 163(j) interest deduction limitation COVID-19 relief and CARES Act and section 163(j): State tax issues.)

RPTB and FTB election relief

In light of the changes made by the CARES Act, Rev. Proc. 2020-22 allows eligible taxpayers either to make this election late or to withdraw it if previously made. Eligible taxpayers now have a window of opportunity to reconsider their prior tax filings, and make or revoke the election to optimize their tax position under the recently modified rules. A taxpayer that conducts an RPTB that placed QIP in service while QIP was excluded from bonus depreciation eligibility, for example, might consider revoking a previously made RPTB election in order to claim bonus depreciation for that property. Doing so may in some cases allow affected taxpayers to obtain tax refunds with respect to their QIP.

Who may use this relief

To utilize the relief in this Revenue Procedure, a taxpayer must:

  1. Carry on an eligible RPTB or eligible FTB.
  2. If making a late election, have either not made the election or have previous withdrawn the election under this revenue procedure.
  3. If withdrawing an election, have made such election on a timely filed return for a 2018, 2019 or 2020 taxable year.

Procedures for RPTB and FTB election relief

All taxpayers other than partnerships must make or withdraw the relevant RPTB or FTB election on an amended federal income tax return by Oct. 15, 2021, or the date the applicable assessment statute of limitations expires, whichever comes sooner. Partnership taxpayers must either make or withdraw the relevant election on an amended Form 1065, or an administrative adjustment request (AAR); the dates for partnerships’ filings generally parallels other taxpayers (with the AAR deadline of section 6235 substituting for the statute of limitations date for partnerships choosing to file an AAR). Pursuant to Rev. Proc. 2020-23, partnerships which would otherwise be ineligible to file an amended return may be eligible to do so here (see our prior Alerts IRS allows partnerships to file 2018 and 2019 amended returns and Overview of relief provided by Notice 2020-23). Rev. Proc. 2020-22 sets out the form of the statement required to make or revoke the RPTB or FTB election.

In addition to making the election, partnerships must also include the adjustment to taxable income relating to the election (or withdrawal of the election), and any collateral adjustments to taxable income or to tax liability. Rev. Proc. 2020-22 does not prescribe a manner for computing these amounts. If returns for years after the initial year of the late election or election withdrawal have been filed, they also must be amended (or be the subject of an AAR) if changes to taxable income or tax liability would result. The Revenue Procedure indicates that further guidance on this topic will be presented in future proposed regulations.

As noted above, partnerships have the option of either filing an amended Form 1065, or using the AAR process of the new partnership procedural regime. However, as a practical matter, the filing of an amended Form 1065 is the only route which would allow partners to file amended returns for historical years, and obtain refunds without having to wait to file their 2020 returns. In addition, for partners that would report a loss for their 2020 year, amending returns for pre-2020 years typically would be more desirable than following the AAR route.  

Other CARES Act election guidance in Rev. Proc. 2020-22

Rev. Proc. 2020-22 provides procedures for making the following CARES Act related elections (the Other Elections), in addition to RPTB and FTB elections discussed above:

  1. The election to forego the increased business interest expense deduction limitation amount (reverting to 30% of ATI, from 50%). Partnerships may only make this election for a 2020 taxable year.
  2. The election to use a taxpayer’s 2019 ATI, in 2020, for purposes of computing the limitation on 2020 business interest expense deductions.
  3. The election, by a partner in a partnership, to not apply the rule allowing immediate deduction, in 2020, of 50% of the nondeductible business interest expense allocated to them by that partnership. 

This Alert does not discuss these Other Election procedures further; please refer to Rev. Proc. 2020-22 for details. 

Conclusion

Taxpayers that conduct either an RPTB or an FTB now have an opportunity to reconsider whether or not to make a section 163(j) interest deduction limitation election for prior years, thanks to Rev. Proc. 2020-22. Oct. 15, 2021 is the general deadline for making or revoking an election under this Revenue Procedure. Eligible taxpayers should consult their tax advisors and consider whether they should make or revoke these RPTB or FTB elections. 

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