IRS Issues Guidance on Option to Change §163(j) Elections for Real Estate and Farming Businesses

With recent tax law changes contained within the CARES Act, including a technical correction to the definition of Qualified Improvement Property (QIP) and modifications to the limit of deductible interest expense under Section 163(j) of the Internal Revenue Code, many taxpayers have begun to ask whether there will be any provision that allows for the withdrawal of a prior election to "opt-out" of the interest limitation.

Most notable among those taxpayers are property owners that placed in service significant renovations since the effective date of the Tax Cuts and Jobs Act that now meet the corrected QIP definition. Those owners are realizing substantially reduced tax benefits from the corrected definition as a result of the election to be exempt from the interest limitation rules, and might not have made an election had the retroactive QIP definition been in effect as of the TCJA.

On April 10, the IRS issued Revenue Procedure 2020-22, providing guidance on the election to be exempt from the interest limitation rules under IRC Section 163(j) for real property trades or businesses and farming businesses, and allowing certain taxpayers the option to withdraw an election or to make a late election for tax years beginning in 2018, 2019 or 2020. To change or to make a late Section 163(j) election, a taxpayer must file a timely amended tax return, amended form 1065 or administrative adjustment request (AAR), as applicable, for the taxable year on or before October 15, 2021 and any affected succeeding tax years.

To withdraw an election to be exempt from the interest limitation rules under Section 163(j), a taxpayer will determine its depreciation expense in accordance with Section 168 as if the election to be exempt from the Section 163(j) interest limitation rules had never been made, and include an election withdrawal statement with the amended return.

A taxpayer may make a late election to be exempt from the interest limitation rules under Section 163(j) provided the taxpayer was qualified to have made the election in that tax year. The taxpayer must also include any adjustments to taxable income for the late election including the determination of depreciation for certain property in accordance with the alternative depreciation system with the amended tax return.

If you’re interested in learning more about the new provisions allowing for a withdrawal of an election out of Section 163(j) interest limitation rules or to make a late election for the 2018, 2019 or 2020 tax years, or any other strategies to maximize the tax benefits of real estate ownership, contact a member of the Schneider Downs Real Estate Team or email [email protected].

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