Background
The IRS recently issued guidance affecting the business interest expense limitation under Internal Revenue Code (IRC) Section 163(j), including relief related to certain elections and associated depreciation outcomes. For more details of the IRS guidance, see our FORsights™ alert, “Transition Relief for §163(j) Business Interest Deduction Limitation.”
These recent tax changes may give real estate businesses a valuable second look at a decision made in prior years: whether to elect out of the business interest limitation under §163(j). For some owners, the election was a practical way to avoid a potential §163(j) limitation and fully deduct business interest expense. However, that election also comes with a tradeoff for how certain real estate assets are depreciated. The discussion below summarizes the tradeoff between interest deductibility and depreciation treatment, and explains why recent law changes and IRS transition guidance may cause some taxpayers to revisit whether the election still makes sense.
The Basic Tradeoff Under §163(j)
IRC §163(j) may limit a taxpayer’s deduction for business interest expense. Real property trades or businesses may elect out of the limitation. This election can be helpful when the ratio of debt-to-equity is high, and interest expense might otherwise be limited.
However, making the election comes at a cost. An electing real property trade or business must depreciate certain property using the alternative depreciation system (ADS), which generally results in longer recovery periods and the loss of bonus depreciation. Property subject to ADS includes nonresidential real property, residential rental property, and qualified improvement property (QIP). QIP is commonly defined as an improvement made by the taxpayer to the interior of a nonresidential building after the building was first placed in service. QIP does not include enlargements, elevators or escalators, or the building’s internal structural framework under §168(e).
In practice, this tradeoff can be difficult to evaluate upfront. The value of current interest deductions may outweigh the benefit of faster depreciation in some years, while the opposite may be true in others. Changes in interest rates, financing structures, and taxable income projections can further complicate the analysis. As a result, taxpayers that made §163(j) elections in earlier years may now find that the economics of those elections no longer align with their current facts and circumstances.
What Changed?
The One Big Beautiful Bill Act (OB3) significantly changed the effect of §163(j) election analysis.
First, OB3 made 100% bonus depreciation permanent for qualified property placed in service after January 19, 2025. Second, OB3 restored a more favorable earnings before interest, taxes, depreciation, and amortization (EBITDA) calculation for adjusted taxable income (ATI). For tax years beginning on or after January 1, 2025, depreciation, amortization, and depletion are again added back when computing ATI. Therefore, a larger ATI number usually means a smaller §163(j) business interest expense limitation, meaning businesses may now be able to claim depreciation deductions sooner and still deduct interest expense without needing to make the election.
In addition, the IRS guidance provides a path to revisit prior decisions for tax years 2022 through 2024. Eligible taxpayers may implement changes through amended returns or administrative adjustment requests (AARs), as applicable. Deadlines apply, and taxpayers should consider both the procedural deadline under the guidance, often described as the earlier of October 15, 2026, or the applicable refund statute of limitations, and any other limitations that may apply for the year being amended. From a practical standpoint, this creates an opportunity to unwind a prior §163(j) calculation, recalculate depreciation, and reassess whether the business can now deduct its interest without the election.
Separately, partnerships subject to the centralized partnership audit regime, or Bipartisan Budget Act of 2015 (BBA) partnerships, normally cannot file amended partnership returns, and instead, must use an AAR. The guidance provides that eligible BBA partnerships are allowed to use amended returns instead of AARs, which may be preferable. Therefore, partnerships should pay close attention to whether they qualify, what form of filing is permitted, and when the filing must be made. For more information on the AAR process and its impacts on partnership tax filings, see our FORsights article, “Tax Fundamentals Series: AARs & What You Need to Know.”
Implementation can be administratively heavy. Amending an entity return will generally require issuing amended Schedules K‑1, and owners or investors will generally need to amend their own returns. Partnerships should also consider the procedural differences between amended returns and AARs under the centralized partnership audit regime and the downstream coordination required.
Why Is This Important for Real Estate?
For many real estate businesses, depreciation is a major tax tool. If a prior §163(j) election forced asset classes onto ADS, those asset classes will have lost access to bonus depreciation at exactly the time when accelerated cost recovery is now most valuable. If the election is withdrawn, affected asset classes will generally move back to the regular modified accelerated cost recovery system (MACRS) treatment and, where eligible, regain access to 100% bonus depreciation for qualifying property placed in service after January 19, 2025.
However, withdrawing the election can also reintroduce a §163(j) limitation, so the interest outcome depends on projected ATI, including the EBITDA addback, interest expense levels, and the timing or value of the depreciation deductions. In some cases, taxpayers may still be able to deduct all or most of their business interest expense without the election, but that result is not guaranteed and should be modeled. As a result, some real estate businesses may find that the election is less valuable than it was previously, or that it is no longer worth the depreciation tradeoff, depending on their facts and projections.
What Should Real Estate Owners Do Now?
In prior years, some real estate businesses elected out of §163(j) when projected interest expense was expected to be limited and the cost of slower depreciation was acceptable. Following enactment of OB3, the better answer may be different. The opportunity to restore faster depreciation and potentially still deduct all or most interest could make revisiting prior elections worth the effort. Here is a list of things to think about:
- Inventory prior elections. Identify whether any entity made a §163(j) election for 2022, 2023, or 2024.
- Model the numbers. Compare keeping the election versus revoking it, including bonus depreciation, MACRS depreciation, ATI, projected interest deductions, and costs associated with amending tax returns.
- Coordinate with stakeholders. Changes may affect taxable income, cash tax payments, financial reporting, debt covenants, and investor allocations.
- Watch the deadlines. Deadlines apply, and taxpayers should consider the procedural deadline under the guidance, often described as the earlier of October 15, 2026 or the applicable refund statute of limitations, along with any other limitations for the year being amended.
How Forvis Mazars Can Help
Forvis Mazars regularly assists real estate owners, operators, and investors with §163(j) planning, including modeling the tradeoffs between interest deductibility and depreciation, assessing the treatment of QIP, and navigating the procedural requirements associated with amended returns and BBA partnerships.
If you would like to discuss how recent §163(j) developments may affect your real estate business, contact us to learn more.