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Clarifying the Real Estate Exception & Qualified Improvement Property Depreciation

by David Erard

On April 10, the IRS issued Revenue Procedure 2020-22, which answers some open questions regarding the interaction of the §163(j) “electing real property trade or business” exception and depreciation of Qualified Improvement Property (QIP).

Generally, §163(j) limits the business interest expense deduction for some taxpayers. Starting in 2018, taxpayers engaged in real estate trade/business activities and otherwise subject to §163(j) could elect to be exempt from the §163(j) limitation. The tradeoff for making this election is that the taxpayer would have to use ADS depreciation, with no bonus depreciation, for depreciable real property and QIP. Once made, this election was irrevocable.

Prior to the CARES Act, QIP placed in service in 2018 and after had a 39-year life and was not eligible for bonus depreciation. Therefore, the use of ADS on QIP due to the § 163(j) election did not cause a significant loss of tax depreciation. However, due to a technical correction included with the CARES Act, QIP now has a 15-year MACRS life, is eligible for 100% bonus depreciation, and a 20-year life for ADS purposes (no bonus depreciation for ADS). As a result of this major change, tax planning now becomes critical.

Rev. Proc. 2020-22 allows eligible taxpayers to make several elections regarding §163(j), including withdrawing their previously made electing real property trade or business (“ERPTB”) elections. The Rev. Proc. now allows taxpayers significant flexibility, including the ability to:

  • Withdraw ERPTB elections included with 2018 or 2019 tax returns
  • Make late ERPTB elections for the 2018, 2019 and 2020 tax years
  • Revoke original ERPTB elections or even late ERPTB elections made pursuant to Rev. Proc. 2020-22 (yes, you have read this correctly)
  • Elect on an annual basis to use the 30% adjusted taxable income (“ATI”) limitation instead of the CARES 50% limitation in 2019 and 2020 (for partnerships, this is available for the 2020 year, they are required to use 30% for 2018 and 2019)
  • Revoke the above 30% ATI election
  • Deduct at the partner level 50% of the “excess business interest expense” allocated to a partner by partnerships in 2019
  • Elect on 2020 partnership returns to use their 2019 ATI to determine their §163(j) limitation instead of their 2020 ATI (potentially beneficial where financial conditions deteriorated in 2020)
  • Revoke the above 2019 usage election

Please note that Rev. Proc. 2020-22 places time limitations and sets forth specific steps for those wishing to take advantage of the opportunities. Taxpayers should consult their advisors to determine the best course of action to take advantage of these surprisingly flexible relief provisions.

For the latest regulatory changes and other information on keeping your organization running through disruption, visit our COVID-19 Resource Center.

April 29, 2020

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