Rev. Proc. 2026-17: Withdrawal of Sec. 163(j)(7) elections

Editor: Robert Venables, CPA, J.D., LL.M.

In Rev. Proc. 2026–17, the IRS permits certain business taxpayers to modify interest limitation elections because of subsequent changes made to Sec. 163(j) by H.R. 1, P.L. 119–21, the law known as the One Big Beautiful Bill Act (OBBBA). Specifically, the revenue procedure allows taxpayers to withdraw previously made irrevocable elections to be treated as an electing real property trade or business, electing farming business, or excepted regulated utility trade or business (collectively, Sec. 163(j)(7) elections). The revenue procedure also allows taxpayers withdrawing those elections to make a late Sec. 168(k)(7) election out of bonus depreciation for affected property classes. In addition, it permits certain partnerships subject to the audit procedures of the Bipartisan Budget Act of 2015 (BBA), P.L. 114–74, to file amended partnership returns for tax years beginning in 2022 through 2024 and issue amended Schedules K–1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc., instead of filing an administrative adjustment request (AAR).

After providing some background information, this item discusses who is eligible to modify past elections under Rev. Proc. 2026–17, the relevant rules and deadlines, and various considerations to keep in mind.

Background: Why this revenue procedure was issued

Sec. 163(j), as overhauled by the Tax Cuts and Jobs Act (TCJA), P.L. 115–97, generally limits a taxpayer’s deductible business interest expense to the sum of (1) business interest income; (2) 30% of adjusted taxable income (ATI) (temporarily 50% for 2019–2020 under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116–136); and (3) floor plan financing interest. A key component of ATI originally was an addback of deductions for depreciation, amortization, and depletion, but that addback applied only for tax years beginning before 2022 (the ensuing removal of that addback effectively moved many taxpayers from an “EBITDA–like” (earnings before interest, taxes, depreciation, and amortization) ATI base to an “EBIT–like” base). This change negatively affected taxpayers generally, as the EBIT–like ATI calculation can result in additional disallowed interest expense.

Certain trades or businesses, including real property and farming businesses, can elect out of this section’s interest expense limitations. The Sec. 163(j)(7) election, however, comes with a depreciation trade–off, applies to the year of the election and all subsequent years, and is generally irrevocable. For real property trades or businesses, an election would require the taxpayer to use the alternative depreciation system (ADS) for certain asset classes, including qualified improvement property (QIP), residential rental property, and nonresidential rental buildings. ADS uses a longer recovery period than the general depreciation system (GDS) that would have otherwise applied. Most significantly for nonresidential real estate, QIP (which does not apply to residential buildings) is not eligible for bonus depreciation under ADS, while it is eligible under GDS. For real property trades or businesses, the QIP treatment is likely the most significant difference and where taxpayers might find the most motivation to withdraw these elections.

The OBBBA amended Sec. 163(j)(8) to restore the depreciation/amortization/depletion addback for tax years beginning after Dec. 31, 2024. Because many real property and farming businesses had previously used the Sec. 163(j)(7) election, specifically, after the change to the “EBIT” calculation, Rev. Proc. 2026–17 provides a limited opportunity to withdraw those elections in light of the changed ATI rules and related depreciation considerations. It should be noted that the OBBBA did not retroactively change the calculation of ATI for tax years 2022 through 2024. Therefore, depreciation, amortization, and depletion are not an addback to the ATI calculation for those years.

Who is eligible?

Withdrawal of a Sec. 163(j)(7) election is available to a taxpayer that made, on a timely filed original return (including extensions), such an election for a tax year beginning in 2022, 2023, or 2024. An eligible taxpayer may withdraw a Sec. 163(j)(7) election by attaching the required election withdrawal statement and filing, for the tax year the election was originally made, an amended federal income tax return; an amended Form 1065, U.S. Return of Partnership Income; or (for BBA partnerships) an AAR. The amended return must be filed by the earlier of (1) Oct. 15, 2026, or (2) the end of the applicable statute of limitation on assessment for the year for which the amended return is being filed or, in the case of an AAR, the last day on which the partnership may file an AAR for the tax year the election was made.

Taxpayers, especially those who made the election on their 2022 return, should pay very close attention to the due date. Sec. 6501(a) generally provides that “the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed.” Sec. 6501(b) adds that “a return … filed before the last day prescribed by law … shall be considered as filed on such last day.” Sec. 6227(c) provides a similar three–year rule for filing AARs. Therefore, taxpayers that originally made the election on their 2022 return and filed that return prior to Oct. 15, 2023, will need to complete the withdrawal filing within the three–year window. Calendar–year partnerships and S corporations are potentially the most affected by the due dates provided in the revenue procedure, for a couple of reasons: First and most important, the revenue procedure was not effective until March 18, 2026. As a result, an election made by these taxpayers on their 2022 return that was filed ahead of March 18, 2023, would not be eligible for the relief provided, since the three–year window to amend or file an AAR had already passed. While the revenue procedure does not specifically call this out, it does state the OBBBA did not amend the statute of limitation for assessment or the statute of limitation for claims for credits or refunds. This presumably limited the period in which relief could be provided.

Secondly, the extended due date for these taxpayers is Sept. 15, so any return that was filed for 2022 by the extended due date would require the necessary withdrawal filing to occur by Sept. 15, 2026, at the latest, as opposed to Oct. 15, 2026. Now that the period for the original due date for 2022 returns is past, other types of taxpayers that made an election on their 2022 return, such as individuals, trusts, and corporations, need to confirm when the return was filed to determine whether they are still eligible. Taxpayers that made the election on their 2023 or 2024 returns will have until Oct. 15, 2026, to withdraw their election on an amended return or AAR.

The amended filing must include all adjustments to taxable income resulting from treating the election as withdrawn, plus collateral adjustments (including any necessary Sec. 481 adjustments). A common collateral item is the change to depreciation for property that had been required to use the ADS because of the election. Additionally, taxpayers must file amended tax returns or AARs for any affected succeeding tax years to reflect any adjustments to taxable income due to the withdrawn election and any collateral adjustments to taxable income in those years. For example, a taxpayer that made the election on their 2022 return could be required to amend returns for 2022, 2023, and 2024, as well as 2025 if that return has already been filed. A taxpayer that receives an amended Schedule K–1 related to these adjustments should also file an amended tax return and attach a statement that notes the amended filing is a result of receiving an amended Schedule K–1 from an electing taxpayer in accordance with Rev. Proc. 2026–17.

A successful withdrawal causes the taxpayer to be treated as if the election had never been made. For partnerships, the revenue procedure notes that partner capital accounts will not be maintained in accordance with the partnership capital account rules unless the effects of the withdrawal are reflected in partner capital accounts.

As mentioned above, withdrawing the election will likely change which depreciation system applies to property used in the affected trade or business. The taxpayer must recompute depreciation under Sec. 168 for property affected by the withdrawn election, report the resulting changes as part of the amended–year adjustments (and any needed collateral adjustments), and adjust basis for the property to reflect the revised depreciation (and, if applicable, a late Sec. 168(k)(7) election).

The revenue procedure also allows taxpayers withdrawing a Sec. 163(j)(7) election to make a late Sec. 168(k)(7) election to not claim additional first–year depreciation for an affected class of property, if desired by the taxpayer. The late election is made on the same amended return/amended Form 1065/AAR used for the withdrawal, using the manner prescribed in the bonus depreciation regulations and the relevant form instructions (typically, through the depreciation election reporting on Form 4562, Depreciation and Amortization (Including Information on Listed Property)). The amended filing must include adjustments tied to the late election and any collateral adjustments, including changes to depreciation in later years; taxpayers must amend affected succeeding years as needed.

Option for eligible BBA partnerships to file amended Forms 1065 for 2022 to 2024

Further, the revenue procedure allows certain partnerships subject to the centralized partnership audit regime (BBA partnerships) to implement this guidance for partnership tax years beginning in 2022, 2023, and 2024 by filing an amended Form 1065 and issuing amended Schedules K–1 rather than filing an AAR, which can be more cumbersome than filing an amended Form 1065. The option is available only to BBA partnerships that previously filed Forms 1065 and furnished Schedules K–1 for tax years beginning in 2022 through 2024 before Rev. Proc. 2026–17 was issued. A BBA partnership that receives an amended Schedule K–1 from another partnership that filed under this revenue procedure may also use the option if it otherwise qualifies. The amended Form 1065 and amended Schedules K–1 must be filed by the same deadlines applicable to election withdrawals discussed earlier (generally, the earlier of Oct. 15, 2026, or the end of the applicable limitation period). Using the amended–return option does not remove the partnership from the BBA centralized audit regime.

Considerations

Taxpayers considering withdrawing this election should analyze the effect it will have not only for the prior years but also for the current and future years. Taxpayers often made this election to minimize the interest expense limitation, thus maximizing deductions and reducing income or increasing losses. Since the ATI calculation has not changed for the pre–2025 years, withdrawing such an election in most cases will result in fewer losses or more income, resulting in disallowed business interest expense, which does not expire and can be carried forward indefinitely.

If the taxpayer is a partnership, the disallowed business interest expense is referred to as excess business interest expense (EBIE). For the year the election was originally made and subsequent years, the taxpayer will need to generate “excess taxable income” in future years to deduct the EBIE. The adjusted basis of a partner’s partnership interest is reduced (but not below zero) by the amount of excess business interest allocated to the partner. If the partnership interest is disposed of, the partner’s adjusted basis in the partnership interest is increased immediately before the disposition by the amount of the excess (if any) of the amount of the previous basis reduction over the excess business interest previously treated as business interest paid or accrued by the partner.

Taxpayers will also need to consider the effect that withdrawing the election will have on state and local returns.

On the other hand, certain taxpayers may find that withdrawing a previous election will provide current and/or future benefits. In addition to restoring the addback to ATI for depreciation/amortization/depletion, the OBBBA also fully restored 100% bonus depreciation for assets acquired and placed in service after Jan. 19, 2025. The combination of these changes will allow taxpayers with large QIP projects to benefit from bonus depreciation without affecting the deductibility of their business interest expense, since the resulting depreciation will be an addback for purposes of determining ATI. Withdrawing a prior Sec. 163(j)(7) election under this revenue procedure does not prevent taxpayers from making the election again in the future. As such, a taxpayer could withdraw their current election and reelect it in the future if it is advantageous.

Action items

Taxpayers and their advisers should reassess Sec. 163(j)(7) elections that were made on 2022, 2023, or 2024 tax returns. This may require taxpayers and their advisers to model out the effect, past, present, and future, of retaining versus withdrawing the election. Taxpayers that wish to withdraw this election should confirm that amended returns or AARs can be filed by the applicable deadline. Withdrawing an election can change depreciation methods or basis of the assets. It can also require Sec. 481 computations and may require amended filings for multiple years, amended state and local returns, and amended filings by partners. All of this could require substantial work and time but, for some taxpayers, could equate to substantial tax savings opportunities.

Editor

Robert Venables, CPA, J.D., LL.M., is a tax partner with Cohen & Co. Ltd. in Fairlawn, Ohio.

For additional information about these items, contact Venables at rvenables@cohencpa.com.

Unless otherwise noted, contributors are members of or associated with Cohen & Co. Ltd.