Farmers and real property trades or businesses can withdraw interest elections

Editor: Sally P. Schreiber, J.D.

Real property or farming trades or businesses can withdraw their decision to elect out of Sec. 163(j)’s business interest expense limitation for a 2018, 2019, or 2020 tax year, the IRS said in guidance issued April 10 (Rev. Proc. 2020-22). Those businesses can also make late interest expense elections for those years.

The guidance also addresses how businesses can make certain other interest expense elections for 2019 and 2020 under emergency relief provisions included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136.

Real property or farming trades or businesses

One reason an electing real property or farming trade or business might wish to withdraw its election out of the business interest expense limitation involves bonus depreciation. The Sec. 163(j)(7) election comes with a trade-off, which is that an electing business must depreciate certain property more slowly using the alternative depreciation system and is not eligible for bonus depreciation.

A drafting error in the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97 — the so-called retail glitch — had classified qualified improvement property (QIP) as 39-year property, making it ineligible for bonus depreciation. The CARES Act corrected this error, retroactively reducing QIP’s recovery period from 39 years to 15 years, making it eligible for 100% bonus depreciation through 2022.

Now that 100% bonus depreciation can extend to QIP, retroactive to the effective date of the TCJA, some electing businesses may wish to withdraw their election out of Sec. 163(j)’s interest expense limit; however, the election is irrevocable. The IRS issued Rev. Proc. 2020-22 to provide relief to taxpayers that would not have made the election if QIP had been treated as 39-year property eligible for bonus depreciation before the correction of the drafting error by the CARES Act.

Under Rev. Proc. 2020-22, an electing business that follows the steps outlined in the revenue procedure “will be treated as if the election was never made.” The business should file an amended federal income tax return, an amended Form 1065, U.S. Return of Partnership Income, or an administrative adjustment request, as applicable, for the tax year in which the election was made, with an election withdrawal statement. The deadline for doing so is on or before Oct. 15, 2021 (but not later than the applicable limitation period on assessment for the tax year for which the amended return is being filed), with an exception as provided in recently issued Rev. Proc. 2020-23 regarding the time to file amended Bipartisan Budget Act of 2015 partnership returns for 2018 and 2019 tax years.

Separately, the revenue procedure addresses how to make a late Sec. 163(j)(7) election to be a real property trade or business or farming business for 2018, 2019, or 2020 for businesses that might benefit due to the retroactive increases in the amount of the business interest deduction limits in the CARES Act, which are discussed below.

CARES Act changes to the interest limitation for 2019 and 2020

The CARES Act also retroactively loosened the interest expense limitation to help speed economic relief to businesses during the COVID-19 crisis. For tax years beginning in 2019 and 2020, Sec. 163(j) is amended to increase the adjusted taxable income (ATI) percentage from 30% to 50%. Also, taxpayers can elect to use 2019 income in place of 2020 for the computation.

Rev. Proc. 2020-22 provides the time and manner for certain taxpayers to make relevant elections:

• To not apply the 50% ATI limitation;
• To use the taxpayer’s 2019 income to calculate the interest expense limitation in 2020; and
• For a partner to elect out of the 50% excess business interest expense rule.

The revenue procedure also addresses how to make a late Sec. 163(j)(7) election to be a real property trade or business or farming business for 2018, 2019, or 2020 for businesses that might benefit from making these elections due to these increases in the amount of the business interest deduction limits in the CARES Act.

Rev. Proc. 2020-22 was effective April 10.