The Tax Cuts and Jobs Act made significant changes to section 163(j) rules limiting taxpayers’ ability to deduct interest expense. The new rules were further revised by the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136).
New final and proposed regs published in September 2020 provide comprehensive guidance on the interest deduction limitation, including guidance on its application to partnerships and their partners. This is the fourth article in a series examining guidance for partnerships. The first article focused on a partnership’s calculation of its section 163(j) limitation when all items were allocated to partners on a pro rata basis. (See Tax Notes Int’l, Dec. 7, 2020, p. 1259.) The second article focused on the calculation when pro rata allocations are not available, requiring a more complicated 11-step process that includes a conditional eighth step. (See Tax Notes Int’l, Dec. 14, 2020, p. 1409.) The third article focused on the conditions for the eighth step to apply and the calculations and adjustments necessary when the eighth step is required. (See Tax Notes Int’l, Jan. 11, 2021, p. 109.)
This article addresses how the CARES Act revises the section 163(j) application to partners and partnerships. These rules are generally found in section 163(j)(10)(A)(ii) and prop. reg. section 1.163(j)-6(g)(4).
The TCJA replaced prior section 163(j)(1) through (9) and added section 163(j)(10), effective for tax years beginning after December 31, 2017. The CARES Act further amended section 163(j) by providing special rules for tax years beginning in 2019 or 2020. Specifically, it redesignated TCJA section 163(j)(10) as new section 163(j)(11) and added new rules via a new section 163(j)(10). New section 163(j)(10) increases the deduction threshold from 30 percent of adjusted taxable income to 50 percent.
Final regs published on September 14, 2020 (T.D. 9905), provide considerable guidance on how to implement the new interest deduction limitation but contain no guidance on the CARES Act provisions. Proposed regs (REG-107911-18) published the same day, however, provide guidance on how to apply the section 163(j)(10) rules to partnerships.
Section 163(j)(4)
Section 163(j) generally limits the amount of business interest expense (BIE) that a taxpayer can deduct in the year incurred. Under section 163(j)(1), the amount of BIE allowed as a deduction is limited to the sum of:
the taxpayer’s business interest income (BII);
30 percent of the taxpayer’s ATI; and
the taxpayer’s floor plan financing interest expense.
Under section 163(j)(2), any BIE not allowed as a deduction in a tax year because of the above limitation is carried over to a succeeding tax year.
Section 163(j)(4)(A)-(D) applies to partnerships and S corporations. It generally requires the interest limitation to be applied at the partnership level as a non-separately stated item.
Under carryover rules in section 163(j)(4)(B), any BIE not allowed as a deduction to a partnership is not treated as paid or accrued by the partnership in future years. Instead, it is treated as excess BIE and allocated to each partner in the same manner as non-separately stated taxable income or loss.
If a partner is allocated excess BIE from a partnership, the excess BIE is treated as BIE paid or accrued by the partner in the next tax year during which the partner is allocated excess taxable income from the partnership, but only to the extent of the excess taxable income. Any remaining excess BIE is treated as BIE paid or accrued in succeeding tax years.
Excess taxable income allocated to a partner from a partnership for any tax year is not reduced by any BIE other than partnership excess BIE until all partnership excess BIE for that year and all preceding tax years has been treated as paid or accrued by the partner.
Section 163(j)(4)(B)(iii) addresses partnership interest outside basis adjustments. In general, a partner’s adjusted basis in partnership interest is reduced (but not below zero) by the amount of excess BIE allocated to the partner. This rule is layered on top of the section 705(a) basis adjustment rules, which require increasing a partner’s adjusted basis by its share of a partnership’s taxable income and decreasing the adjusted basis by its share of a partnership’s losses.
Section 163(j)(4)(C) defines a partnership’s excess taxable income as the amount that bears the same ratio to the partnership’s ATI as the excess (if any) of 30 percent of the partnership’s ATI over the amount (if any) by which the partnership’s BIE (not including floor plan financing interest) exceeds the partnership’s BII bears to 30 percent of the partnership’s ATI. That is:
Excess taxable income = Partnership’s ATI * ((30 percent * ATI) - (BIE - BII))/(30 percent * ATI)
Reg. section 1.163(j)-6(f)(2) provides an 11-step process for allocating a partnership’s deductible BIE and section 163(j) excess items to its partners. Reg. section 1.163(j)-6(f)(1)(i) provides that the 11-step calculation begins when a partnership determines its section 163(j) limitation, total amount of deductible BIE, and section 163(j) excess items under reg. section 1.163(j)-6(f)(2)(i). The partnership applies reg. section 1.163(j)-6(f)(2)(ii)-(xi) — in that order — to determine how the items are allocated among its partners. At the end of the 11 steps, the total amount of deductible BIE and section 163(j) excess items allocated to each partner will equal the partnership’s total deductible BIE and section 163(j) excess items.
Section 163(j) items are defined in reg. section 1.163(j)-6(b)(1) as a partnership’s BIE, BII, and items comprising ATI. Section 163(j) excess items are defined in reg. section 1.163(j)-6(b)(6) as the partnership’s excess BIE, excess taxable income, and excess BII. Excess BII is defined in reg. section 1.163(j)-6(b)(4) as the amount by which a partnership’s BII exceeds its BIE. Deductible BIE is defined in reg. section 1.163(j)-6(b)(5) as the amount of a partnership’s BIE that is deductible in a tax year after applying the section 163(j) limitation.
Section 163(j)(10)
The CARES Act revises section 163(j)(10)(A) and (B) to provide special rules for tax years beginning in 2019 and 2020.
Under section 163(j)(10)(A), except as otherwise provided, section 163(j)(1)(B) allows a more favorable 50 percent ATI threshold instead of the original 30 percent for any tax year beginning in 2019 or 2020.
Section 163(j)(10)(A)(ii) and (iii) provides two exceptions to the general rule that apply to partnerships and taxpayers electing out of its application.
Section 163(j)(10)(A)(ii) provides that the 50 percent threshold does not apply to any partnership’s tax year beginning in 2019. However, unless a partner elects otherwise, of partnership excess BIE for any tax year beginning in 2019 that is allocated to a partner under section 163(j)(4)(B)(i):
50 percent is treated as BIE paid or accrued by the partner in the partner’s first tax year beginning in 2020 notwithstanding the carryover limitations and is not subject to the limits of section 163(j)(1); and
50 percent is subject to the carryover limitations in section 163(j)(4)(B)(ii) in the same manner as any other excess BIE.
Under the second exception in section 163(j)(10)(A)(iii), a taxpayer may elect not to have the 50 percent threshold apply to any tax year. This election is made at the partnership level and only for tax years beginning in 2020.
Section 163(j)(10)(B) provides a second election to use 2019 ATI for tax years beginning in 2020. Subject to an exception, for any tax year beginning in 2020, a taxpayer may elect to apply the interest limitation threshold by substituting ATI for the last tax year beginning in 2019 for ATI for the tax year beginning in 2020.
A special rule in section 163(j)(10)(B)(ii) applies to short tax years. If an ATI substitution election applies to a short tax year, the substituted ATI for the taxpayer’s last tax year beginning in 2019 is equal to the amount that bears the same ratio to ATI as the number of months in the short tax year bears to 12.
Reg. Section 1.163(j)-2(b)
Reg. section 1.163(j)-2(a)-(k) provides general rules addressing the section 163(j) limitation. Reg. section 1.163(j)-2(b)(1)-(4) contains the general rules for calculating the BIE limitation and carryovers, including the specific CARES Act rules increasing the ATI threshold from 30 percent to 50 percent for 2019 and 2020, and the elections to opt out or use the 2019 50 percent threshold.
Specifically, reg. section 1.163(j)-2(b)(2)(i) provides that for any tax year beginning in 2019 or 2020, the ATI threshold is 50 percent. Reg. section 1.163(j)-2(b)(2)(ii) allows a taxpayer to elect out of the 50 percent ATI limitation.
Reg. section 1.163(j)-2(b)(3)(i) provides the election to use 2019 ATI in 2020. A taxpayer may elect to use ATI for the last tax year beginning in 2019 for any tax year beginning in 2020. Reg. section 1.163(j)-2(b)(3)(ii) addresses short tax years, specifically how to treat an election to use 2019 ATI for a short tax year that began in 2020. The regs repeat the rule in section 163(j)(10)(B)(ii) that ATI for the short tax year is limited to the percentage of 2019 ATI that the number of months in the short tax year bears to 12 months.
Reg. section 1.163(j)-2(b)(4) provides the time and manner of making and revoking either election in reg. section 1.163(j)-2(b)(2) by cross-reference to Rev. Proc. 2020-22, 2020-18 IRB 745.
Prop. Reg. 1.163(j)-6(g)(4)
Prop. reg. section 1.163(j)-6(g)(4) provides guidance on the CARES Act partnership rules for tax years beginning in 2019 and 2020. In the case of a partnership’s excess BIE for any tax year beginning in 2019 that is allocated to a partner under the 11-step process in reg. section 1.163(j)-6(f)(2), 50 percent of the excess BIE is treated as BIE that is (notwithstanding the regular carryover rules in reg. section 1.163(j)-6(g)(2)) paid or accrued by a partner in the partner’s first tax year beginning in 2020.
Also, the excess BIE is not subject to the section 163(j) limitation at the level of the partner. For the basis adjustment ordering rules in reg. section 1.163(j)-6(h)(1), the 50 percent of excess BIE is similar to deductible BIE taken into account before any excess BIE. This rule applies after the rules for self-charged lending transactions between partnerships and partners in prop. reg. section 1.163(j)-6(n).
If a partner disposes of a partnership interest in the partnership’s 2019 or 2020 tax year, its 50 percent of excess BIE is deductible by the partner and does not result in a basis increase under reg. section 1.163(j)-6(h)(3).
A taxpayer may elect not to have the 50 percent threshold apply. The rules and procedures for the time and manner for making or revoking the election are in Rev. Proc. 2020-22.
Prop. reg. section 1.163(j)-6(c)(5) provides guidance on the election to use 2019 ATI for tax years beginning in 2020. A partnership may elect to calculate its section 163(j) limitation by substituting its ATI for the last tax year beginning in 2019 for the ATI for the year beginning in 2020. The time and manner of making or revoking this election is in reg. section 1.163(j)-2(b)(4). An electing partnership determines each partner’s allocable ATI as in reg. section 1.163(j)-6(f)(2)(ii) (step 2) under prop. reg. section 1.163(j)-6(j)(9) in the same manner as an upper-tier partnership.
Prop. Reg. Section 1.163(j)-6(j)(9)
These rules cross-referenced in prop. reg. section 1.163(j)-6(g)(4) provide guidance for upper-tier partnerships determining their partners’ allocable ATI and BII. These rules are part of the general guidance for treatment of BIE of a partnership (lower-tier partnership) allocated to a partner that is a partnership (upper-tier partnership). The calculations for determining a partner’s allocable ATI depends on how the partnership’s tax items comprising ATI compare to the partnership’s ATI.
If an upper-tier partnership’s net amount of tax items that comprise ATI is greater than or equal to its ATI, the partnership determines a partner’s allocable ATI using the rules in prop. reg. section1.163(j)-6(j)(9)(ii)(A). An upper-tier partner’s allocable ATI is equal to the product of the partner’s share of gross income and gain items that comprise ATI minus the partner’s share of loss and deduction items comprising ATI multiplied by a fraction with the upper-tier partnership’s ATI as numerator and its net amount of tax items that comprise ATI as denominator.
If an upper-tier partnership’s net amount of tax items that comprise ATI is less than its ATI, the partnership determines a partner’s allocable ATI using the rules in prop. reg. section 1.163(j)-6(j)(9)(ii)(B). An upper-tier partner’s allocable ATI is equal to the excess of the partner’s distributive share of income and gain items comprising ATI over the partner’s share of gross loss and deduction items that comprise ATI, increased by the product of the partner’s share of residual profits expressed as a fraction multiplied by the upper-tier partnership’s ATI minus the aggregate of all partners’ amounts.
Under prop. reg. section 1.163(j)-6(j)(9)(iii), an upper-tier partner’s allocable BII is equal to the product of the partner’s distributive share of items that comprise BII multiplied by a fraction with the upper-tier partnership’s BII as numerator and the upper-tier partnership’s amount of items that comprise BII as denominator.
Blue Book
The CARES Act’s blue book (JCX-12R-20) contains useful guidance that includes examples on its revised interest limitation’s application to passthrough entities. The following excerpts are on pages 61-66.
In general, the section 163(j) interest limitation is applied at the partnership level under section 163(j)(4)(A)(i). A partner must usually perform its own section 163(j) calculation at the partner level. To prevent double-counting, the BII and ATI of each partner are determined without regard to a partner’s distributive share of any items of partnership income, gain, deduction, or loss.
However, in cases in which the partnership has excess BII, excess ATI, or both, section 163(j) may allow partnership items to support additional BIE deductions by the partnership’s partners. Specifically, a partner’s section 163(j) limitation is increased by the sum of the partner’s distributive share of the partnership’s excess BII and 30 percent of the partner’s distributive share of the partnership’s excess taxable income.
The section 163(j)(4)(B) special rules for the carryforward of disallowed BIE apply only to partnerships and their partners. In the case of a partnership, the general taxpayer-level carryforward rule does not apply. Instead, any BIE that is not allowed as a deduction to the partnership for the tax year (called excess BIE) is allocated to the partners.
A partner may not deduct excess BIE in the year it is allocated to the partner. A partner may deduct its share of the partnership’s excess BIE in any future year, but only in an amount that is based on the partner’s distributive share of the excess BII and excess taxable income of the partnership that conducted the activities giving rise to the disallowed BIE carryforward.
When excess BIE is allocated to a partner, the partner’s basis in its partnership interest is reduced (but not below $0) by the amount of allocation, even though the excess BIE is not deducted in the year of the basis reduction. However, the partner’s deduction in a subsequent year for excess BIE does not reduce the partner’s basis in its partnership interest.
If the partner disposes of a partnership interest having a basis that has been reduced by an allocation of excess BIE, the partner’s basis in the interest is increased immediately before the disposition by the amount the basis reductions exceed any amount of excess BIE that has been treated as BIE paid or accrued by the partner from an allocation of excess BII or excess taxable income by the same partnership.
The increase in the partner’s adjusted basis in the partnership occurs only if a partner disposes all or substantially all of a partnership interest (whether by sale, exchange, or redemption). These special carryforward rules do not apply to S corporations and their shareholders.
The CARES Act provision permits taxpayers to increase the limit on the deduction of BIE paid or accrued in tax years beginning in 2019 or 2020 in two ways: by increasing the ATI threshold and by substituting 2019 ATI for 2020 ATI in 2020.
For tax years beginning in 2019 or 2020, section 163(j)(10) generally increases the percentage of the taxpayer’s ATI used to calculate the deduction limitation from 30 percent to 50 percent.
The blue book then contrasts the application of the new rules between corporations and partnerships. A corporation with $100 of ATI and $50 of BIE in its 2019 tax year may deduct all $50 of its 2019 BIE on its 2019 return (50 percent * $100 ATI = $50 deductible BIE), including on an amended return. If the corporation has $100 of ATI and $70 of BIE in its 2020 tax year, it may deduct $50 of its 2020 BIE on its 2020 return, and $20 of its 2020 BIE will carry forward ($70 BIE - (50 percent of ATI * $100 ATI) = $20 BIE carryforward).
For partnership tax years beginning in 2019, however, this rule does not apply. Instead, partners that were allocated a partnership’s excess BIE for any partnership tax year beginning in 2019 are permitted to deduct 50 percent of the excess BIE in the partner’s first tax year beginning in 2020. The other 50 percent of excess BIE is subject to the carryover limitations of section 163(j)(4)(B)(ii).
For example, assume a partnership has $100 of ATI and $70 of BIE in a tax year beginning in 2019. The partnership has $30 of deductible BIE for its 2019 tax year and allocates $40 excess BIE to its partners ($70 BIE - (30 percent * $100 ATI) = $40 excess BIE). A partner in the partnership that was allocated $20 of excess BIE may deduct $10 of the excess BIE in the partner’s first tax year beginning in 2020. The other $10 of excess BIE remains subject to the carryover limitations in section 163(j)(4)(B)(ii).
Taxpayers are permitted to elect out of applying the new 50 percent threshold and the special rule for 2019 excess BIE. For partnership tax years beginning in 2020, the election out of the increase in the ATI percentage is made at the partnership level.
Rev. Proc. 2020-22 describes the time and manner in which some taxpayers may elect out of the 50 percent ATI limitation for tax years beginning in 2019 and 2020, and partners may elect out of deducting 50 percent of excess BIE for tax years beginning in 2020.
Section 163(j)(10) also permits a taxpayer to elect to substitute the ATI for its last tax year beginning in 2019 for its ATI for any tax year beginning in 2020. The election is made at the partnership level.
If the election is made for a tax year beginning in 2020 that is a short tax year, the 2019 ATI amount that is substituted is reduced by multiplying the taxpayer’s 2019 ATI by a fraction with a numerator of the number of months in the short tax year and a denominator of 12.
For example, assume a taxpayer has $200 of ATI in its last tax year beginning in 2019; $10 of ATI in a short tax year from January 1, 2020, to March 31, 2020; and $50 of BIE in the short 2020 year. If the taxpayer makes the election, it may deduct $25 of the BIE ($200 ATI * 3 months in short year/12 * 50 percent ATI threshold = $25).
The Preambles
The preamble to the section 163(j)-6 final regs simply provides that section 163(j)(10) has a special 50 percent rule for excess BIE allocated to a partner in a tax year beginning in 2019. Because this rule is addressed in prop. reg. section 1.163(j)-6(g)(4), the new rule and application of the 2019 ATI rule to partnerships are not addressed in the final regs and taxpayers are directed to the proposed regs.
The preamble to prop. reg. section 1.163(j)-6 preamble has a helpful summary. Section 163(j)(10) has special rules for partners and partnerships. The interest limitation is 50 percent of ATI, instead of 30 percent. The 50 percent threshold does not apply to partnerships for tax years beginning in 2019. A partnership may elect to not apply the 50 percent threshold and apply the 30 percent threshold instead. This election is made by the partnership.
A partner treats 50 percent of its allocable share of a partnership’s excess BIE for 2019 as BIE in the partner’s first tax year beginning in 2020 that is not subject to the section 163(j) limitation (the 50 percent excess BIE rule). The remaining 50 percent of the partner’s share remains subject to the section 163(j) limitation applicable to excess BIE carried forward at the partner level.
Reg. section 1.163(j)-2(b)(3) and (4) provide general rules on the election to use its 2019 ATI amount instead of the 2020 amount in determining its section 163(j) limitation for any tax year beginning in 2020.
Examples
Examples 32 and 33 in prop. reg. section 1.163(j)-6(o) illustrate how the rules for allocating ATI and BII apply to upper-tier partnerships, while examples 34-36 illustrate how the CARES Act provisions apply to partnerships.
Example 32
Example 32 illustrates the result when items comprising ATI are greater than ATI.
X and Y are partners in upper-tier partnership UTP that is a partner in lower-tier partnership LTP. LTP allocated $100 income to UTP that LTP had treated as ATI, so that UTP’s allocable ATI was $100. LTP also allocated $50 of excess taxable income to UTP. UTP also has $100 of its own business income and $30 of its own BIE. UTP allocated $100 of its $200 income to X and Y each, and all $30 of its BIE to X.
Partnership-level determinations. UTP has $150 ATI ($100 of its own ATI + $50 excess taxable income from LTP) and its section 163(j) limitation is $45 (30 percent * $150). UTP has $30 of deductible BIE (the $45 limitation exceeds the $30 BIE) and $50 of excess taxable income:
$50 excess taxable income = $150 ATI * $15/$45 ($45 - ($30 BIE - $0 BII))/$45 (30 percent * ATI)
Partner-level computations. To determine each partner’s share of the $50 excess taxable income, UTP must first determine each partner’s allocable ATI and allocable BIE. X and Y’s allocable BIE are $30 and $0, respectively. Because UTP’s $200 net amount of tax items that comprise ATI ($100 of its own ATI + $100 ATI allocated from LTP) is greater than its $150 ATI, UTP must apply the rules in prop. reg. section 1.163(j)-6(j)(9)(ii)(A) to determine each partner’s allocable ATI.
Each of X and Y’s allocable ATI is $75:
$75 = $100 X and Y share of income items that comprise ATI * ($150 UTP ATI/$200 tax items that comprise UTP ATI)
Given this ATI allocation, under the 11-step process in reg. section 1.163(j)-6(f)(2), X is allocated $30 of deductible BIE and Y is allocated $50 excess taxable income.
Example 33
Example 33 illustrates the result when items comprising ATI are less than ATI. It assumes that X and Y share UTP’s residual profits equally.
LTP allocated a $99 loss to UTP that LTP treated as ATI so that UTP’s allocable ATI was the $99 loss. UTP also has $100 of its own business income and $15 of its own BIE. UTP allocated $1 income to X and $0 to Y under 704(c) (from a property contribution), the $99 loss and $99 of remaining income equally, and all $15 of its BIE to X.
Partnership-level determinations. UTP has $100 ATI (from its $100 business income) and its section 163(j) limit is $30 ($30 percent * $100 ATI). Thus, UTP has $15 deductible BIE ($15 BIE is less than $30 limitation) and $50 of excess taxable income:
$50 excess taxable income = $100 ATI * $15/$30 ($30 - ($15 BIE - $0 BII))/$30 ($30 percent * ATI)
Partner-level computations. To determine each partner’s share of the $50 excess taxable income UTP must first determine each partner’s allocable ATI and allocable BIE.
X and Y’s allocable BIE are $15 and $0, respectively. Because UTP’s $1 net amount of tax items comprising ATI ($100 business income + LTP’s $99 loss) is less than UTP’s $100 ATI, UTP must apply the rules in prop. reg. section 1.163(j)-6(j)(9)(ii)(B) to determine each partner’s allocable ATI.
UTP determines X’s allocable ATI is $50.50:
$50.50 = $1 (X’s share of $100 income items - $99 loss items) + $49.40 (X’s 50 percent profit share * $99 ($100 UTP ATI - $1 aggregate partner amounts))
In a similar manner, PRS determines Y’s allocable ATI is $49.50:
$49.40 = $0 (Y’s share of $100 income items - $99 loss items) + $49.50 (Y’s 50 percent profit share * $99)
Given this ATI allocation, under the 11-step process in reg. section 1.163(j)-6(f)(2), X is allocated $15 of deductible BIE and $0.50 of excess taxable income, and Y is allocated $49.50 of excess taxable income.
Example 34
Example 34 illustrates the result when excess taxable income is present and the partnership elects to substitute 2019 ATI for the 2020 tax year, which triggers the tiered-partnership calculations. Its results are similar to those of Example 33.
X and Y are equal partners in partnership PRS and share its profits equally. In 2019 PRS had $100 ATI. In 2020 PRS’s only tax item is $1 income allocated to X under section 704(c) (for a property contribution).
Partnership-level determinations. In 2020 PRS makes the election to use its 2019 ATI in 2020, and so it has $100 of ATI in 2020. PRS has $0 BIE and therefore $100 of excess taxable income in 2020:
$100 = $100 ATI * $30/$30 ($30 - ($0 BIE - $0 BII)/$30 (30 percent * ATI)
Partner-level computations. PRS allocates the $100 excess taxable income to X and Y under reg. section 1.163(j)-6(f)(2). To determine each partner’s share of the $100 excess taxable income, PRS must determine each partner’s allocable ATI. Because PRS made the election to use 2019 ATI in 2020, PRS must first determine first the allocable ATI of each partner under the rules for upper-tier partnerships.
The PRS $1 item comprising ATI before the election is less than the $100 ATI after the election. PRS must apply prop. reg. section 1.163(j)-6(j)(9)(ii)(B) to determine each partner’s allocable ATI. PRS determines that X’s allocable ATI is $50.50:
$50.50 = ($1 X share income items - $0 loss items) + $49.50 (50 percent X profit share * $99 ($100 PRS ATI - $1 aggregate of all partner amounts)).
In a similar manner, PRS determines Y’s allocable ATI is $49.50:
$49.50 = ($0 Y share income items - $0 loss items) + $49.50 (50 percent Y profit share * $99).
Given this ATI allocation, under the 11-step process in reg. section 1.163(j)-6(f)(2), X is allocated $50.50 excess taxable income and Y is allocated $49.50 of excess taxable income.
Example 35
Example 35 shows how excess taxable income affects the section 163(j) limitation and the ATI percentage thresholds.
Partner X in partnership PRS is allocated $20 excess BIE in 2018, $10 excess BIE in 2019, and $16 excess taxable income in 2020.
X treats 50 percent of its $10 2019 excess BIE as paid or accrued by X in 2020, and that $5 is not subject to the limitation at X’s level. X treats $16 (2020 excess taxable income) of its $25 total excess BIE ($20 from 2018 and $5 from 2019) as subject to the regular carryover rules in reg. section 1.163(j)-6(g)(2).
In computing its section 163(j) limitation for 2020, X has $16 ATI (from the excess taxable income allocation), $0 of BII, and $16 of BIE ($16 of excess BIE treated as paid or accrued in 2020). Under reg. section 1.163(j)-2(b)(2)(i), X’s limitation is $8 (50 percent * $16 excess BIE). X has $8 deductible BIE. The $8 BIE not allowed as a deduction is treated as BIE paid or accrued in 2021. At the end of 2020, X has $9 of excess BIE from PRS ($20 excess BIE from 2018 + $10 excess BIE from 2019 - $5 deducted excess BIE from prop. reg. section 1.163(j)-6(g)(4) - $16 excess BIE from reg. section 1.163(j)-6(g)(2)).
Example 36
Example 36 illustrates the basis adjustment rules.
Partner X’s outside basis in partnership PRS was $100 at the beginning of 2018. X is allocated $20 excess BIE in 2018 and $10 excess BIE in 2019. X’s basis in PRS has been reduced to $70. X sold its PRS interest in 2019 for $70.
X treats 50 percent of its $10 excess BIE in 2019 as paid or accrued in 2020 under prop. reg. section 1.163(j)-6(g)(4), and so $5 of its BIE is treated as paid or accrued in 2020 not subject to the limitation at X’s level.
Under reg. section 1.163(j)-6(h)(3)’s basis adjustment rules, immediately before the disposition X increases the basis of its PRS interest from $70 to $95 and has a $25 section 741 loss on the sale ($70 sales price - $95 basis). The $5 BIE treated as paid or accrued in 2020 does not increase the basis.