The IRS has issued final regulations providing additional guidance on the limitation on the deduction for business interest. The regulations finalize various portions of the proposed regulations issued in 2020 with only a few modifications. They address the application of the limit in the context of calculating adjusted taxable income (ATI) with respect to depreciation, amortization, and depletion. They also finalize rules on the definitions of real property development and redevelopment, as well as application to passthrough entities, regulated investment companies (RICs), and controlled foreign corporations.

Calculating ATI

A taxpayer’s adjusted taxable income for the 163(j) limit is the taxpayer’s tentative taxable income for the tax year with certain adjustments. For example, depreciation, amortization, and depletion for tax years beginning before January 1, 2022, is added back to tentative taxable income but is subtracted from tentative taxable income if the taxpayer sells or otherwise disposes the property before January 1, 2022.

The final regulations provide that a taxpayer has the option to use an alternative computation method for property dispositions where the ATI adjustment is the lesser of (1) any gain recognized on the sale or disposition, or (2) the greater of the allowed or allowable depreciation, amortization, or depletion deduction of the property sold before January 1, 2022. Similar rules are provided concerning the sale or other disposition of an interest in a partnership or stock of a member of a consolidated group. However, the negative adjustment to tentative taxable income is reduced to the extent the taxpayer establishes that the additions to uncommitted taxable income in a prior tax year did not increase the amount allowed as a deduction for business interest expense the year.

Real Property Development

The final regulations retain the definitions for natural property development and real property redevelopment the proposed rules provided. Thus, to the extent that the evergreen trees may be located on parcels of land covered by forest, the business activities of cultivating and harvesting such evergreen trees are considered a component of a “real property development” “real property redevelopment” trade or business.

Self-Charging Lending of Partnerships

The final regulations adopt the proposed rules for self-charged lending transactions between partners and partnerships without change.

Please call our office to review the impact of the additional guidance on your business interest expense deductions and your overall income tax position. We are here to assist you.