Deducting Business Interest in 2022

• March 2, 2022
• Carey M. Heyman, CPA

In December, we shared that the business interest expense limitation was coming back in 2022. Colleagues Olga Zarney, Rod Mauszycki and Mike Smith recently authored an excellent article titled “Deducting Business Interest: The Quandary for 2022.” Portions of their article, which go deeper than our blog post from December, are included below. You can read the entire article here.

The Tax Cuts and Jobs Act of 2017 revised Section 163(j) by imposing a limitation on the deduction for business interest expense for years beginning after December 31, 2017. Section 163(j) limits business interest payments for taxpayers with gross receipts of $25 million ($26 million for 2019, 2020, and 2021, and $27 million for 2022). The amount of deductible business interest expense cannot exceed the sum of:

• The taxpayer’s business interest income,
• 30% of the taxpayer’s adjusted taxable income (ATI), and
• The taxpayer’s floor plan financing interest.

Any business interest expense not allowed as a deduction due to the Section 163(j) limitation is generally carried forward and treated as business interest paid or accrued in the next taxable year.

In response to the COVID-19 crisis, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) eased the burden of this limitation temporarily. Taxpayers could elect to use 50% of ATI limitation for 2019 and 2020 (rather than the normal 30%) and to use their 2019 ATI to compute their 2020 business interest limitation. The CARES Act relief allowed many businesses to deduct their interest in full.

The business interest limitation returned in 2022, going back to 30% of ATI and with depreciation, amortization, and depletion no longer an addback in the calculation of ATI. These changes may limit the deduction for business interest even if not previously subject to the limitation.

With that historical context, there are two planning opportunities that exist:

1. Qualify for the small business exception – Certain businesses are eligible for a “small business exception” to Section 163(j). To qualify, the business’ gross receipts must be less than the gross receipts threshold amounts and the business cannot be a “tax shelter,” as defined.
2. Consider electing out – Certain real estate businesses may consider making a one-time irrevocable election to opt out of the Section 163(j) limitation. However, these taxpayers would then be required to use the Alternative Deprecation System (ADS) for certain categories of assets, which has longer depreciation periods and lower annual depreciation deductions than under the regular depreciation rules. Further, the affected assets are not eligible for a bonus depreciation deduction.

Real property businesses that elect out of the Section 163(j) limitation can still must depreciate their current and future residential rental property, nonresidential real property, and qualified improvement property using ADS, which means a slightly longer depreciation period for residential and nonresidential properties. Other classes of assets — such as land improvements, 5-year, and 7-year property — continue to be depreciated under the regular depreciation rules and can be eligible for bonus depreciation.

• Nonresidential real property – Depreciable period changes from 39-year life to 40-year life
• Qualified improvement property – No longer eligible for bonus depreciation under ADS and depreciable life extended from 15 years to 20 years
• Residential real property – Depreciable life changes from 27.5 years to 30 years

Before making any decisions, it is recommended that real property businesses consider the cost and benefit analysis of the decrease in depreciation expense due to the extended depreciable life of their assets and the benefit of the additional business interest expense above the limitation.

Tags: 163j, Business Interest Expense, Real Estate, Federal and state taxation, including proposed regulations, Industry best practices, Industry trends/analysis | Comments Off on Deducting Business Interest in 2022