On July 28, the U.S. Department of the Treasury and the IRS released long-awaited final regulations regarding the limitation on deduction of business interest expense under IRC Section 163(j) as amended by the Tax Cuts and Jobs Act of 2017 and the Coronavirus Aid, Relief, and Economic Security Act.
The final regulations adopt the proposed regulations issued in 2018 with significant revisions in response to comments provided. In addition to other changes, the final regulations:
- Allow cost of goods sold depreciation to be added back in calculating adjusted taxable income (ATI) for taxable years beginning before Jan. 1, 2022. Such depreciation is added back to ATI in the year capitalized to inventory even if some of the depreciation remains in ending inventory and has not been recovered through cost of goods sold.
- Narrow the definition of “interest,” which is expected to translate to overall larger business interest expense deductions. Notably, the final regulations exclude items such as debt issuance costs, loan commitment fees, substitute interest payments, guaranteed payments for the use of capital, and hedging gains or losses that affect the yield of a debt instrument, unless the anti-avoidance rule applies.
- Allow a pro rata basis increase upon disposing a partial interest in a partnership for any remaining excess business interest expense (EBIE) previously allocated to the partner. Under the proposed regulations, the basis increase only occurred upon disposing of all or substantially all of the partnership interest.
- Provide that if a partner or an S-corporation shareholder is allocated business interest expense from a partnership or an S corporation that meets the small-business exemption for the taxable year, such business interest expense is not subject to a Section 163(j) limitation at the partner’s or shareholder’s level.
- Clarify the anti-abuse rules for electing real property trades or businesses.
- Clarify the definition of "real property trade or business," particularly with respect to management and operations of real property.