On Thursday, April 9, the IRS published Revenue Procedure 2020-22, allowing taxpayers who made an irrevocable election out of the interest expense limitation of Section 163(j) as a “real property trade or business” on a 2018 or 2019 tax return to undo the election.
As part of the Tax Cuts and Jobs Act (TCJA), Congress added new Section 163(j) to the Code. Section 163(j) limits the deduction for “business interest expense” to the sum of:
- Business interest income,
- Floor-plan financing interest, and
- 30% of adjusted taxable income.
As part of Section 163(j), a taxpayer that meets the definition of a “real property trade or business” is permitted to make an irrevocable election to avoid the application of the limitation. An electing real property trade or business, however, is required to depreciate its nonresidential rental property, residential rental property, and qualified improvement property using the Alternative Depreciation System (ADS). The ADS system, in addition to requiring straight-line depreciation over longer lives, does not permit bonus depreciation.
As part of the CARES Act passed on March 27, 2020, Congress retroactively corrected the “qualified improvement property” (QIP) glitch. QIP, which is defined as any improvement made to the interior portion of a nonresidential building after the building was placed in service, was intended to have a 15-year life and be eligible for 100% bonus depreciation; however, the TCJA failed to provide for a 15-year life, leaving QIP with a 39-year life and not eligible for bonus depreciation.
As a result, there are taxpayers who made an irrevocable election out of the Section 163(j) limitation in 2018 or 2019 at a time when QIP was not bonus eligible, who would now like to undo the election in order to take advantage of the QIP technical correction. Rev. Proc. 2020-22 allows for such relief.
Under the Rev. Proc., a taxpayer who filed or files a Section 163(j)(7) election as a real property trade or business on its timely filed original federal tax return for 2018, 2019, or 2020 may withdraw the election. If the withdraw is made, the election is treated as if it had never been made.
To withdraw the election, the taxpayer must file an amended federal income tax return for the tax year in which the election was made, and include an election withdrawal statement. The amended return must be filed on or before October 15, 2021. In the case of a BBA partnership that chooses not to file an amended return as permitted under Rev. Proc. 2020-23 (as described in an e-focus sent out last week), the BBA partnership may also withdraw a Section 163(j)(7) election by filing an AAR on or before October 15, 2021.
The amended return must include any adjustment to income caused by the withdrawn Section 163(j) election, including changes to deductible interest expense and depreciation. In addition, if a taxpayer amends a 2018 return and has already filed a 2019 return, the taxpayer must also amend the 2019 return to reflect the impact of the withdrawn election.
The withdrawal election statement must be titled, “Revenue Procedure 2020-22 Section 163(j)(7) Election Withdrawal.” The statement must contain the taxpayer’s name, address, and SSN or EIN, and must state that, pursuant to Revenue Procedure 2020-22, the taxpayer is withdrawing its election under Section 163(j)(7)(B) or Section 163(j)(7)(C), as applicable.
It is important to note, Revenue Procedure 2020-22 also provides guidance on making other Section 163(j) elections provided for in the CARES Act, including electing to forgo replacing the 30% of ATI limitation with 50% on 2019 returns.
By: Tony Nitti, CPA, MST
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