Final and Proposed Reliance Regulations on Business Interest Expense Under Section 163(j)

On July 28, 2020, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued long-awaited final regulations about the limitation on the deduction for business interest expense under Section 163(j) as amended by the Tax Cuts and Jobs Act (TCJA)  and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Concurrent with the issuance of the final regulations, the government also issued a new set of proposed regulations to address certain complex issues that warrant additional study and comments from the public. The final regulations largely adopted the Section 163(j) proposed regulations with major revisions to certain controversial rules provided in the 2018 proposed regulations.

Taxpayers, especially manufacturers and producers of property, may see a significant increase in their ability to deduct business interest expense under Section 163(j), because the final regulations now provide that depreciation, amortization, and depletion capitalized into inventory under Section 263A can be added back for purposes of calculating adjusted taxable income (ATI). Additionally, the final regulations meaningfully narrowed the definition of “interest” in the Section 163(j) context. As a result, commitment fees, debt issuance costs, guaranteed payments for the use of capital under Section 707(c), and hedging gains and losses are generally no longer considered interest to which Section 163(j) may apply.

The final regulations also brought some good news for taxpayers who wish to make the real property trade or business election. Small business taxpayers and taxpayers who are unsure whether their rental real estate activities (such as a triple net lease arrangement) rise to the level of a trade or business under Section 162 can now make an election to be treated as conducting electing real property trades or businesses. Together with the issuance of the final regulations, the IRS issued Notice 2020-59 to provide a proposed safe harbor under which a taxpayer who operates residential living facilities (such as assisted living facilities) may elect to treat such trade or business as a real property trade or business.

Considering that Section 163(j) has broad impacts to all taxpayers that have business interest expense, BDO put together an in-depth analysis that provides guidance on the major provisions of the 2020 final and proposed regulations. Also included in the analysis are BDO’s insights identifying the challenges and opportunities that will affect many taxpayers. Additionally, to meet the needs of different types of taxpayers, BDO separately released tax alerts regarding the Section 163(j) application to partnerships and in the international context.

Our full analysis covers the following issues under the final Section 163(j) regulations:

  • Background: New Section 163(j) and the 2018 proposed regulations
  • Revised adjustments to ATI
  • Narrowed definition of interest
  • Small business exemption and tax shelter
  • Excepted trades or businesses
  • Clarifications to floor plan financing interest
  • Coordination of Section 163(j) with other code provisions
  • Application to C corporations and consolidated groups
  • SRLY and Section 382 impact on disallowed business interest expense carryforwards
  • Application to partnerships
  • Application to S corporations
  • Application to foreign corporations and U.S. shareholders
  • Application to foreign persons with effectively connected taxable income
  • Allocation of interest expense, interest income, and other items of expense and gross income to an excepted trade or business
  • Applicability dates