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Links Between Worlds: Old Exceptions to New Interest Deduction Limitations

Posted on Mar. 1, 2021
Libin Zhang
Libin Zhang

Libin Zhang is a partner in the New York office of Fried, Frank, Harris, Shriver & Jacobson LLP.

In this article, Zhang examines exceptions to the interest deduction limitations in the Tax Cuts and Jobs Act for investment interest, small business, and real property businesses, and concludes that because they are based on existing provisions, they should be relatively straightforward to apply.

Copyright 2021 Libin Zhang. All rights reserved.

I. Introduction

The Tax Cuts and Jobs Act of 2017 (P.L. 115-97) is a tax reform and simplification law that enacted rules to severely limit taxpayers’ ability to deduct some business interest expenses. This limitation, in new section 163(j), has both substantive tax effects and significant implementation costs, especially after Treasury and the IRS issued several hundred pages of final regulations in late 2020 and early 2021.1 For example, in some cases, a partnership must use an 11-step process to allocate deductible business interest expense, disallowed excess business interest expense, and other section 163(j) items to its partners.2

The section 163(j) business interest deduction limitation applies to most taxpayers, including individuals, partnerships, domestic corporations, and some foreign corporations. As described below, there are three important exceptions for investment interest, small businesses, and real property businesses, which have their own exceptions. The exceptions are based on existing tax provisions, which already have ample guidance and should be relatively straightforward to apply.

This article is a sequel and remake of my article from over two years ago, “Links to the Past: Old Exceptions to New Interest Deduction Limitations.”3 Much like how one can enjoy The Legend of Zelda: A Link Between Worlds on the Nintendo 3DS without having played its predecessor The Legend of Zelda: A Link to the Past on the Super Nintendo, the prior article is not required reading for the section 163(j) adventurer.

II. General Rules

Section 163(j)(1) generally provides that a taxpayer may deduct its net business interest expense up to 30 percent of its adjusted taxable income.4 In 2018 through 2021, ATI is similar to earnings before interest, taxes, depreciation, and amortization, being generally equal to the taxpayer’s business taxable income plus net business interest expense, depreciation, depletion, and amortization.5

Beginning in 2022, ATI is like earnings before interest and taxes, being generally equal to the taxpayer’s business taxable income plus net business interest expense. In contrast to the section 163(j) that existed before the TCJA, taxpayers cannot carry forward their unused ATI to deduct more interest expense in later years, which may encourage some taxpayers to increase their leverage up to the tax limits and not leave tax money on the table. Any disallowed business interest expense is carried over to the next year.6 The section 163(j) disallowed business interest expense carryforward is generally subject to section 163(j) in the next year.

In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136) optionally increased the 30 percent ATI limitation to 50 percent of ATI in 2019 and 2020 and further allowed taxpayers to choose to use their 2019 ATI for 2020.7 The increase to 50 percent of ATI applies only in 2020 for partnerships, with special rules to allow some partnership section 163(j) disallowed business interest expense carryforwards from 2019. The distinctive CARES Act rules for partnerships may have arisen because many partnerships cannot file amended tax returns because of the centralized partnership audit rules as enacted by the Bipartisan Budget Act of 2015,8 which was followed by Treasury and the IRS allowing partnerships to amend their returns to reflect the CARES Act and other changes.9

Capitalized interest expense is not subject to the section 163(j) business interest deduction limitation.10 In contrast — after much negative feedback about the 2018 proposed regulations that only added back deductible depreciation or amortization — the 2020 final regulations provide that the depreciation or amortization addback to ATI in 2018-2021 includes capitalized depreciation or amortization that is recovered as part of cost of goods sold.11 The comments to the 2018 proposed regulations did not mention any need for consistency between capitalized interest and capitalized depreciation.12

To avoid double counting, the logical corollary to the depreciation and amortization addback is that ATI is not increased by depreciation recapture on a direct or indirect disposition of the depreciated or amortized property,13 but generally only to the extent of the gain recognized and to the extent that the depreciation or amortization addback increased the taxpayer’s deductible business interest expense in the first place.14

For a partnership, the section 163(j) business interest deduction limitation is generally applied at the partnership level, with the partnership’s deductible net business interest expense limited to 30 percent of the partnership’s ATI.15 Special carryforward rules apply at the partner level to each partner’s share of the disallowed partnership business interest expense, which are the subject of some interpretive disagreement between Treasury and Congress.16 Conversely, a less leveraged partnership may allocate excess taxable income to its partners, which may allow the partners to increase their ATI and to deduct more business interest expense from other sources.17 Somewhat different rules apply to S corporations, which have disallowed business interest expense carryforwards at the corporate level.18 The section 163(j) entity treatment of partnerships, in contrast to the more prevalent aggregate treatment of partnerships under other code provisions, may have been inspired by similar entity-level interest barrier rules in Germany that limit most entities’ deductible net interest expense to 30 percent of tax EBITDA but with more exceptions. The real world consequences and complexities of implementing originally German ideas are sometimes not fully anticipated.

The section 163(j) regulations define interest broadly.19 It includes stated interest, imputed interest (such as original issue discount and section 483 interest on some deferred payments), and other amounts treated as interest for U.S. federal income tax purposes, including accrued market discount and the implicit interest factor in some leases with uneven rent under section 467. Interest also includes some payments in connection with swaps with significant nonperiodic payments, sale-repurchase agreements, securities lending transactions, and factoring transactions.

The 2020 final regulations removed the 2018 proposed regulations’ treatment as interest of all section 707(c) partnership guaranteed payments for the use of capital. Instead, these guaranteed payments may be subject to an antiavoidance rule, which provides that interest expense includes any expense or loss economically equivalent to interest, if a principal purpose of structuring the transaction is to reduce interest incurred by the taxpayer.20 A purpose may be a principal purpose even though it is outweighed by other purposes taken together or separately. The fact that the taxpayer has a business purpose for obtaining the use of the funds does not matter, nor does it matter that the taxpayer has obtained the funds at a lower pretax cost. Any expense or loss is economically equivalent to interest if it is (i) deductible by the taxpayer, (ii) incurred by the taxpayer in a transaction or a series of integrated or related transactions to secure the use of funds for a period, and (iii) substantially incurred in consideration of the time value of money.21

The interest antiavoidance rule applies to transactions entered on or after September 14, 2020.22 The critical issue is whether the partner providing the capital for the guaranteed payment is there for the wrong reasons.

Example: Arie, Becca, and Colton form a partnership, ABC. ABC is considering acquiring an additional loan from a third party to expand its business operations. However, ABC already has significant debt and interest expense. For the purpose of reducing ABC’s interest expense, Arie agrees to make an additional equity contribution to ABC in exchange for a guaranteed payment for the use of capital. The guaranteed payment — deductible by ABC — is incurred by ABC in a transaction to secure the use of funds for a period of time, and is substantially incurred in consideration of the time value of money. Given that a principal purpose of the guaranteed payment is to reduce ABC’s interest expense, the guaranteed payment is subject to ABC’s section 163(j) business interest deduction limitation under the antiavoidance rule. Conversely, Arie has interest income that increases the amount of his own deductible business interest expense.23

Figure 1.

The interest antiavoidance rule may potentially apply to the dividends paid deductions of a regulated investment company or real estate investment trust regarding its preferred stock. For the purpose of reducing a RIC’s interest expense, a shareholder may agree to make an equity contribution to the RIC in exchange for preferred stock that pays a preferred dividend. The preferred dividend is deductible by the RIC under section 852(b)(2)(D), is incurred by the RIC in a transaction to secure the use of funds for a period, and is substantially incurred in consideration of the time value of money. The 2020 final regulations also contain examples of the antiavoidance rule applying to foreign currency swaps, gold forward contracts, and guarantee fees.24

The lines between guaranteed payments, preferred returns, and distributive shares are not always clear.25

Example: Arie, Becca, and Colton form the ABC partnership. Colton contributes capital to ABC and is entitled to receive 30 percent of partnership income (before any guaranteed payments), but not less than $10,000. If the partnership’s income is $20,000, Colton receives $10,000, of which $6,000 (30 percent of $20,000) is a distributive share, and the remaining $4,000 is a guaranteed payment that is subject to the antiavoidance rule. In contrast, if the partnership’s income is $60,000, Colton’s entire distributive share of $18,000 (30 percent of $60,000) is not a guaranteed payment.

The above example is based on Treas. reg. section 1.707-1(c) Ex. 2, which dates from 1956.26 Treasury and the IRS issued proposed regulations in 2015 that, when finalized, would treat Colton as receiving a $10,000 guaranteed payment in all cases.27

Under the 2021 final regulations, a money market fund or other regulated investment company may pay dividends that are treated as interest income for section 163(j) purposes.28 No similar rule applies to REITs that pay REIT dividends out of underlying mortgage interest or other interest income, although Treasury and the IRS are continuing to consider the issue.

The section 163(j) definition of interest is also used for some global intangible low-taxed income purposes, which therefore incorporate the interest antiavoidance rule.29 All partnership guaranteed payments for the use of capital are treated as interest expense for purposes of the section 861 interest expense allocation and apportionment rules,30 the passive loss rules,31 and the uniform capitalization avoided cost method for interest expense.32 A narrower definition of interest is used in the section 267A anti-hybrid rules that does not include guaranteed payments for the use of capital.33 A simple checklist may be helpful for taxpayers to understand whether their payments are interest or not interest for each code provision.

III. Investment Interest and Trading Partnerships

The section 163(j) business interest deduction limitation applies to business interest, which is defined as any interest paid or accrued on debt properly allocable to a trade or business.34 A trade or business is determined under section 162 principles.35 Debt that is not properly allocable to a trade or business under section 162 is therefore not limited by section 163(j).

Example: A taxpayer owns net leased commercial real property that is not held in a trade or business.36 The taxpayer does not materially participate in the net lease rental activity. The taxpayer’s interest expense regarding the net leased rental activity is not subject to the section 163(j) limitation because there is no trade or business.37 The interest expense may offset 100 percent of the taxpayer’s income from the net leased real property and potentially 100 percent of the taxpayer’s passive activity income from other sources.

Notice 2019-7 contains a safe harbor that treats some real property as used in a trade or business solely for section 199A purposes, but not for purposes of Form 1099 reporting, section 163(j), or any other tax rule. It is therefore possible for a taxpayer to have a rental property that is allowed the section 199A passthrough business income deduction but is not subject to the section 163(j) business interest deduction limitation and does not need to issue Form 1099 to service providers.

Business interest does not include investment interest under section 163(d),38 which is any noncorporate taxpayer’s interest generally paid or accrued on debt properly allocable to property held for investment, such as stocks, securities, and commodities.

Section 163(d) was originally enacted by the Tax Reform Act of 1969 to limit a noncorporate taxpayer’s investment interest deduction to its net investment income for the year. Any disallowed investment interest is carried over to the next year.39 Because an individual’s investment interest deduction is allowed for up to 100 percent of net investment income, whereas section 163(j) limits his or her business interest deduction to only 30 percent of ATI, an individual may be better off with investment interest expense (and investment income) in some circumstances.

Example: A taxpayer engages in the business of trading stocks and securities, with $400 of short-term capital gain, $600 of long-term capital gain, and $500 of interest expense. The taxpayer’s ATI is $1,000, which allows only $300 of deductible business interest. The remaining $200 of disallowed business interest expense is carried to the next year.

Example: Same as the above example, except that the taxpayer incurs the capital gain and interest expense from holding stocks and securities for investment. The taxpayer can deduct $400 of interest expense (up to the $400 of short-term capital gain). The taxpayer may deduct its remaining $100 of interest expense by electing to tax the $100 of the long-term capital gain at ordinary income tax rates.40

Status as an investor, trader, or dealer in stocks, securities, and commodities has generated a long line of case law ever since the Revenue Act of 1934 created the (previously favored) class of traders.41 Investor status for an individual may have various collateral tax consequences, including the section 67(g) disallowance of some non-interest investment expenses in 2018 through 2025, phase out of various tax benefits based on adjusted gross income, and the section 461(l) excess business loss limitation, which generally provides that net business losses can offset only up to around $500,000 of investment income and wages in 2021 through 2025.42 Moreover, investor status may have adverse consequences for state income taxes, such as New York generally disallowing investment interest expense and most other itemized deductions for higher-income taxpayers, and some states continuing to apply the section 461(l) excess business loss limitation in 2020 and earlier.

The section 163(d) investment interest deduction limitation can apply to activity involving a trade or business that is not a passive activity and regarding which the taxpayer does not materially participate.43 In Rev. Rul. 2008-12, 2008-1 C.B. 520, a partnership was engaged in the business of trading securities, and the IRS concluded that its partner, who did not materially participate in the trading business, was subject to the section 163(d) investment interest deduction limitation at the partner level. The 2021 final regulations provide that a partnership must take a bifurcated approach for the partnership’s tax items regarding its partners, some of whom are subject to section 163(j), while others are subject to section 163(d).44

Example: Two individuals, Link and Zelda, and a domestic C corporation (Salvage Corp.) are equal partners in Triforce Partners LP, which is engaged in the trade or business of trading stocks, securities, rupees, and other foreign currencies. Link materially participates in the trading activities, while Zelda does not participate at all.

Figure 2.

Link materially participates in the trading activities, and his share of the partnership’s interest expense is subject to section 163(j) at the partnership level. Zelda does not materially participate, and therefore her share of the partnership’s interest expense is instead subject to section 163(d) at the partner level. Salvage Corp. is a C corporation and is subject to section 163(j) at the trading-partnership level regarding its share of the partnership’s interest expense.

Triforce Partners LP must determine the material participation of each of its individual partners. The 2021 final regulations provide that trading activities cannot be grouped with other activities (including other trading activities),45 and therefore Link can materially participate generally by spending 500 hours a year on Triforce Partners LP’s trading activities (or by satisfying one of the other material participation tests). This anti-grouping rule may reduce the number of materially participating traders when they have multiple funds or use parallel partnerships.

The preamble to the 2021 final regulations confirmed that the trading partnership material participation test is applied to each direct individual partner only and does not look through to indirect partners. In other words, if a partner is itself an upper-tier partnership, the partner cannot materially participate, and therefore its share of the lower-tier partnership’s interest expense is always subject to section 163(j).

Example: Triforce Partners LP is owned by three upper-tier partnerships. All Triforce Partners LP’s trading business interest expense is subject to section 163(j) at the Triforce Partners LP level, regardless of the material participation of its indirect individual partners.

Figure 3.

The tiered partnership issue drew only one comment from a person in his individual capacity,46 which may suggest that other taxpayers and their tax advisers were comfortable with the same approach in the 2020 proposed regulations.47 Some taxpayers may consider reducing the number of tiered entities and tidying up their partnership structures.48

Treasury and the IRS rejected the commentator’s suggested alternative, that (i) the trading partnership apply section 163(j) at the partnership level and allocate excess business interest expense to the partners; (ii) any corporate partner or any materially participating direct or indirect individual partner would continue to be subject to section 163(j); and (iii) any nonmaterially participating direct or indirect individual partner may fully deduct the excess business interest expense, subject to any partner-level section 163(d) investment interest expense limitation. The alternative was rejected because section 163(j)(5) provides that business interest expense does not include section 163(d) investment interest expense. It is unclear why Treasury and the IRS were unable to think outside the statutory box for this issue when they were able to depart from the statutory language for trading S corporations. Section 163(j) applies to trading interest expense at the S corporation level, and section 163(d) may further apply to the same interest expense at the shareholder level (for shareholders who do not materially participate in the S corporation’s trading activities).49

The anti-grouping rule applies for all passive loss purposes and applies to closely held corporations and personal service corporations, even though the C corporations do not have the section 163(d) issue that prompted the creation of the anti-grouping rule. The anti-grouping rule also applies to all individuals in tiered partnerships that do not benefit from the trading partnership rules.

For C corporations (including a RIC or a REIT), all interest expense or interest income is business interest expense or business interest income, respectively.50 If a C corporation is a partner in a partnership that has investment interest expense or income, the C corporation’s allocable share of these items are recharacterized at the partner level as business interest expense or income.51 In the above example, Salvage Corp. has business interest expense that is disallowed because of insufficient partnership ATI. If the corporation has ATI from other sources, it may be better off with the partnership’s interest expense being investment interest expense, so that the section 163(j) business interest deduction limitation is applied at the corporate partner level instead of at the partnership level.

The 2021 final regulations’ trading partnership rules apply to tax years beginning after March 21, 2021, although the rules may apply to earlier tax years if the taxpayer or any related party elects to apply other aspects of the 2020 or 2021 final regulations to those earlier years.52 A taxpayer favorable transition rule is available for trading partnerships and their partners that relied on the 2018 proposed regulations.53

IV. Small Business Exemption

The section 163(j) business interest deduction limitation does not apply to a taxpayer whose average annual gross receipts for the three prior tax years are $25 million or less.54

Although some commentators have claimed that taxpayers with less than $25 million of gross receipts need not worry about deducting their interest expense, reality is more complicated. The small business exemption is less available than it may initially appear, because some persons and entities are aggregated in counting gross receipts, and the exemption is unavailable for a broadly defined set of “tax shelters.” As shown in the discussion below, it is possible that Congress did not review the cash accounting and mark-to-market hedging rules in detail and did not fully appreciate how many different types of businesses would be classified as tax shelters.

The $25 million gross receipts test is determined by reference to section 448(c), under which some entities with high gross receipts are generally prohibited from using the cash method of accounting. The cash method’s small business exemption has been around since the Tax Reform Act of 1986 and should be familiar to many small taxpayers and their tax advisers.

The section 448 regulations provide detailed rules for computing gross receipts, which includes all sales and all amounts received for services, without any reduction for COGS.55 It also includes interest, dividends, rents, and royalties, even if not derived in the ordinary course of the taxpayer’s trade or business. For sales of capital assets or business assets, only the gain is part of the gross receipts. If a taxpayer has a capital gain and a capital loss, the capital loss does not reduce gross receipts.

An individual is treated as a corporation or partnership for purposes of the section 163(j) small business exemption’s gross receipts test.56 An individual’s gross receipts include all business and nonbusiness receipts, other than inherently personal items, such as Form W-2 wages, Social Security benefits, disability benefits, and personal injury awards.57 Accordingly, an individual’s gross receipts include all of her distributive share of partnership and S corporation items (subject to the aggregation rules described below) and potentially all of her investment income as well.

Example: A non-equity partner in a law firm receives $1 million of guaranteed payments from the law firm, has $2 million of gain from the sale of stocks, and owns a 40 percent interest in a partnership with $20 million of gross receipts. The individual’s total gross receipts are $11 million, including $8 million of the partnership’s gross receipts.58 Although Form W-2 wages are excluded from gross receipts, gross receipts include all guaranteed payments. The non-equity partner counts a net income item of guaranteed payments as gross receipts, while the law firm’s gross receipts would presumably still be counted for all the firm’s equity partners.

A. Aggregation Rules

Some persons and entities are aggregated under section 448(c)(2) in measuring gross receipts.59 The aggregate group must have $25 million or less of total gross receipts for a group member to qualify for the small business exemption, although payments between members are disregarded. Aggregation takes into account the gross receipts of entities or businesses that are otherwise not subject to section 163(j), such as electing farm businesses and electing real property trades or businesses described below.60

Figure 4.

The aggregation rules, parts of which date back to the Revenue Act of 1964 (enacted section 1563), the Tax Reduction and Simplification Act of 1977 (enacted section 52), the Miscellaneous Revenue Act of 1980 (enacted section 414(m)), the Miscellaneous Changes in Tax Laws Act of 1980 (enacted section 414(m) again), the Tax Equity and Fiscal Responsibility Act of 1982 (enacted section 414(m)(5)), and the Deficit Reduction Act of 1984 (enacted section 414(o)), generally apply to:

  1. all corporations, partnerships, and other persons that are members of the same parent-subsidiary controlled group, through a chain of ownership of more than 50 percent (by vote or value) of the stock or interests in each entity;61

  2. all corporations, partnerships, and other persons that are members of the same brother-sister controlled group, for which five or fewer individuals own 80 percent or more (by vote or value) of the stock or interests in each entity (and own more than 50 percent when considering the direct or indirect ownership of each individual only to the extent that the ownership is identical regarding each entity);62

  3. three or more entities that are in both a parent-subsidiary controlled group and a brother-sister controlled group;63

  4. a corporation, partnership, or other organization, the principal business of which is the performance of services, and members of its affiliated service group, which generally consists of related organizations that provide services;64

  5. an organization (and related organizations) and any management company whose principal business is regularly performing management functions for those organizations;65 and

  6. some aggregated organizations under section 414(o), which generally cover some employee leasing arrangements.66

Constructive ownership rules apply in determining the ownership of each entity, such as family attribution that sometimes treats an individual as owning the interests owned by a spouse, children, grandchildren, parents, and grandparents.67

Example: An S corporation is owned 40 percent by individual A and 60 percent by individual B. A partnership is owned 70 percent by individual B and 30 percent by B’s 20-year-old child C. C also owns 100 percent of a C corporation. The S corporation, the partnership, the C corporation, individual B, and individual C are in an aggregate group, so that 100 percent of their gross receipts are combined in determining whether any of them qualifies for the section 163(j) small business exemption. Individual A’s gross receipts includes 40 percent of the S corporation’s gross receipts. An entity’s gross receipts may count multiple times in causing other taxpayers to be or not to be small businesses.

Figure 5.

Partnerships and other noncorporate entities are aggregated under (1), (2), and (3) above only if they are engaged in a trade or business. The same aggregation rules apply for other law provisions, such as some ERISA rules and the employee retention tax credit provisions of the CARES Act.68 Some commentators have taken the view that the typical private equity partnership is engaged in a trade or business for purposes of the employee retention tax credit aggregation rules, which would imply that the partnership is also engaged in a trade or business for ERISA purposes and the section 163(j) aggregation rules.

The section 414 aggregation rules in (4), (5), and (6) above can aggregate otherwise seemingly unrelated entities. Although they have their origins in the retirement benefit rules, they have been extended to aggregation rules in many other contexts over the years.

Example: Three individuals are partners in a partnership that provides medical services. One individual decides to form a C corporation to hold his 33.3 percent partnership interest, with the C corporation providing services directly to the customers. The partnership and the C corporation are aggregated in determining their gross receipts for the section 163(j) small business exemption.69

Example: A partnership P is owned by various individuals. Two of the partners form a separate partnership B that provides some services to P. A significant portion of B’s business is the performance of services to C, and the services are of a type historically performed by P’s employees in P’s service field as of December 13, 1980. P and B are aggregated in determining their gross receipts for the section 163(j) small business exemption.

Figure 6.

Further, an antiavoidance rule applies to any arrangement with a principal purpose of avoiding the section 163(j) rules, including the use of multiple entities to avoid the small business exemptions gross receipts test.70 The regulations do not contain an example of how multiple entities can avoid the gross receipts test, which may be challenging given the broad scope of the aggregation rules. The examples cover forming subsidiary entities to segregate business interest expense or to isolate tax losses to increase ATI.71

B. Tax Shelter

Section 163(j)(3) provides that the small business exemption does not apply to a tax shelter, which is broadly defined to include:

  1. any enterprise (other than a C corporation) if interests in that enterprise have ever been offered for sale in any offering that has to be registered with any federal or state agency that regulates the offering of securities for sale;72

  2. any syndicate, which is a partnership or other entity (other than a C corporation) if more than 35 percent of the losses of such entity during the tax year are allocable to limited partners or limited entrepreneurs (generally persons who do not actively participate in the management of the entity);73 and

  3. any partnership or other entity, any investment plan or arrangement, or any other plan or arrangement, if its significant purpose is the avoidance or evasion of federal income tax.74

The tax shelter of the third kind is probably most associated with tax shelters in the popular imagination.75 Tax shelters of the first two kinds are less obvious.

1. Registered Companies

A tax shelter includes any partnership (including an LLC) or S corporation if its interests have ever been offered for sale in any offering that has to be registered with any federal or state securities regulatory body.

The Technical and Miscellaneous Revenue Act of 1988 added that an S corporation is not a tax shelter merely by reason of being required to file a notice of exemption from registration with a state agency that regulates the offering of securities for sale, but only if there is a requirement applicable to all corporations offering securities for sale in the state, that the corporation must file the notice to be exempt from registration.76 The special rule was added to address Ohio S corporations, each of which at the time had to file a certificate of exemption from registration with the state securities law agency.77

Other than for Ohio and similar S corporations, the legislative history and the regulations confirm that a tax shelter can include a partnership that must file a notice of exemption with a federal or state securities regulatory body. The regulations explain that “an offering is required to be registered with a federal or state agency if, under the applicable federal or state law, failure to register the offering would result in a violation of the applicable federal or state law (regardless of whether the offering is in fact registered). An offering is also required to be registered with a federal or state agency if, under the applicable federal or state law, failure to file a notice of exemption from registration would result in a violation of the applicable federal or state law (regardless of whether the notice is in fact filed).”78

In other words, a partnership can fail to qualify for the section 163(j) small business exemption if it must file a notice of exemption under Regulation D with the SEC or a similar form with a state agency, regardless of whether the notice is filed. The SEC’s website states generally that “under the federal securities laws, every offer and sale of securities, even if to just one person, must either be registered with the SEC or conducted under an exemption from registration.”79

Taxpayers who are attempting to qualify for the section 163(j) small business exemption should ensure that they do not have any federal or state securities law filing obligations. Although accountants may practice tax law, they are typically discouraged from practicing other law and therefore should be careful in not arriving at too many nontax legal conclusions when preparing tax returns.

2. Syndicates

The most prevalent type of tax shelter is likely the syndicate, which includes any partnership or LLC that allocates more than 35 percent of its losses to limited partners or non-managing members.80 In other words, an LLC must allocate 65 percent or more of its losses to members who actively participate in the LLC’s management to not be a tax shelter and to be eligible for the section 163(j) small business exemption.

The syndicate rule was created by the Economic Recovery Tax Act of 1981 as part of mark-to-market hedging provisions, but it is substantially similar to the farming syndicate provisions in section 461(k) (formerly section 464(c)) as enacted by the Tax Reform Act of 1976. Withdrawn proposed regulations for farming syndicates once indicated that active participation means either participation in the entity’s operation and management decisions or participation in actual farming operations.81 Former prop. Treas. reg. section 1.464-2(a)(3) helpfully explained that “factors which tend to indicate active participation include participating in the decisions involving the operation or management of the farm, actually working on the farm, living on the farm, or hiring and discharging employees (as compared with only the farm manager). Factors which tend to indicate a lack of active participation include lack of control of the management and operation of the farm, having authority only to discharge the farm manager, having a farm manager who is an independent contractor rather than an employee, and having limited liability for farm losses. . . . lack of fee ownership of the farm land shall not be a factor indicating a lack of active participation.”

Similar factors can apply by analogy to determine active participation in the management of non-farming businesses.

It is unclear how the active participation rules apply to owners that are entities, such as a corporate partner or in tiered partnership situations. In Burnett Ranches Ltd.,82 the Fifth Circuit Court of Appeals rejected the IRS’s argument that only an individual limited partner can actively participate in the management of a farming syndicate. Notwithstanding the decision, the IRS continues to believe that a separate legal entity, such as an S corporation, cannot actively participate in management.83 As noted above, Treasury and the IRS have taken the position that upper-tier partnerships cannot materially participate in the trading activities of lower-tier partnerships, which may lead to the position that upper-tier partnerships cannot actively participate in the management of lower-tier partnerships either.

Fortunately, for most partnerships and LLCs, many letter rulings have clarified that an entity is a tax shelter under the syndicate rule only if it in fact has tax losses.84 In other words, an entity is not a tax shelter if it has net taxable income for the year, because literally no losses are being allocated to limited partners or limited entrepreneurs. The tax shelter determination is made on a year-by-year basis.85 Unsurprisingly, Treasury and the IRS later issued regulations that confirmed the same flexible approach of looking at taxable losses on a year-by-year basis.86

Example: A new partnership is owned 20 percent by a general partner and 80 percent by various limited partners. In year 1, the partnership purchases a $250 million residential rental property, of which $20 million is allocated to personal property and immediately deducted using section 168(k) bonus depreciation. The remaining tax basis is allocated $120 million to land and $110 million to building, of which the latter is depreciated over 27.5 years ($4 million annually). The partnership has $10 million of net operating income (from $20 million of gross rental receipts), $4 million of regular depreciation, and $5 million of interest expense each year.

In year 1, the partnership has $10 million net operating income, $5 million interest expense, and $24 million depreciation (including $20 million bonus depreciation), which results in a potential $19 million net loss. The loss is allocated 80 percent to limited partners, which causes the partnership to be a tax shelter and therefore subject to the section 163(j) business interest deduction limitation. Accordingly, the partnership’s deductible business interest is limited to 30 percent of its $10 million ATI, or $3 million. The partnership allocates a net taxable loss of $17 million to its partners, while $2 million of disallowed interest expense is allocated to the partners and carried to the next year.

In year 2, the partnership has $10 million net operating income, $5 million interest expense, and $4 million depreciation, which results in net taxable income of $1 million. Because no losses are being allocated to any limited partners, the partnership is not a tax shelter and is eligible for the small business exemption because of its $20 million of gross receipts for the prior year. The $5 million of year 2 interest expense is not limited by section 163(j) at the partnership level. Further, the partners’ $2 million of disallowed business interest expense carryforward (from year 1) is treated as paid or accrued by the partners in year 2.87 Some or all of the $2 million of allowed carryforward business interest expense may be subject to section 163(j) at the partner level,88 unless the partner also qualifies for the small business exemption.89 Outcome differences at the partner level can arise depending on when the partnership qualifies for the small business exemption.

In some cases, a partnership may have a net taxable loss if section 163(j) were not to apply, which causes the partnership to be a tax shelter subject to the section 163(j) business interest deduction limitation. But when section 163(j) does limit the partnership’s deductible business interest expense, the partnership has net taxable income and therefore may not be a tax shelter in the first place. In the context of the section 448 limitation on using the cash method of accounting, this circular loop was resolved by providing that the initial computation of net taxable income or loss is determined without regard to section 448.90 Unsurprisingly, Treasury and the IRS later issued regulations similarly providing that the partnership’s net taxable loss should be determined as if all of its interest expense were allowed and without regard to section 163(j).91 Partnerships are more likely to be tax shelters as a result.

The CARES Act allows partnerships and other taxpayers to use their 2019 ATI as their 2020 ATI, but this temporal shift does not apply to the syndicate tax shelter analysis that looks at taxable income or loss. To reduce the effect of fluctuating income and losses, the regulations instead provide that a partnership may elect on an annual basis to use the prior year’s net income or net loss in determining whether it is or is not a tax shelter.92 Syndicate status (or non-syndicate status) is therefore valid for two tax years at a time and may smooth out sharp swings in status.

Although capital gains are included in gross receipts and are sometimes included in ATI, gains and losses from the sales of capital assets and section 1231 assets (i.e., trade or business assets) are disregarded in computing tax losses for tax shelter purposes.93 Losses also include negative section 481 adjustments, including adjustments that may arise from becoming or not becoming a tax shelter.

When a partnership qualifies for the small business exemption, but a partner does not, the 2018 proposed regulations had provided that section 163(j) can apply at the partner level to the partner’s share of the partnership’s items. The 2020 final regulations reverse the government’s second bite at the section 163(j) apple and instead provide that there is no second partner-level section 163(j) business interest deduction limitation for the partner’s share of a small business partnership’s items.94 The partner may also increase its partner-level ATI by its share of the small business partnership’s positive net income and gain, other than from excepted trades or businesses described below.95 The adjustment is one-sided because the small business partnership’s losses do not reduce the partners’ ATI.

A partner can qualify for the small business exemption while the partnership does not, in which case the partner is not subject to the section 163(j) business interest deduction limitation for both partner and partnership business interest expense, except for excess business interest expense carryforwards from the partnership.96

Example: In year 1, a taxpayer owns a 50 percent interest in a partnership that has $100 of ATI and $40 of business interest expense. The taxpayer has $0 ATI and $20 business interest expense at the partner level. The partnership’s deductible business interest expense limit is 30 percent of its $100 ATI or $30, so the partnership allocates to the taxpayer $15 (50 percent) of deductible business interest expense (as a non-separately stated income or loss that is not further subject to section 163(j) at the partner level) and $5 of nondeductible excess business interest expense in year 1. The taxpayer has no partner-level deductible business interest expense because of its $0 ATI, and it has a $20 partner-level disallowed business interest expense carryforward to year 2.

In year 2, the partnership has $100 of ATI, $11.2 of business interest income, and $40 of business interest expense. The taxpayer qualifies for the small business exemption in year 2 and has $0 ATI and $25 business interest expense at the partner level. The partnership’s deductible business interest expense limit is $11.2 of business interest income plus 30 percent of its $100 ATI, or $41.2, which means that all of $40 business interest expense is deductible. The $1.2 excess means that the partnership also has $4 of excess taxable income (i.e., $1.2 divided by 30 percent) that can be allocated to the partners. The partnership allocates to the taxpayer $20 (50 percent) of deductible business interest expense (as a non-separately stated income or loss that is not further subject to section 163(j) at the partner level) and $2 of excess taxable income, which frees up $2 of the taxpayer’s $5 excess business interest expense carryforward from year 1. The taxpayer is not subject to section 163(j) at the partner level and can fully deduct the $20 partner-level disallowed business interest expense carryforward from year 1, the $25 of partner-level business interest expense in year 2, and the $2 of allowed excess business interest expense carryforward from the partnership. The partner continues to have a $3 excess business interest expense carryforward that is deductible only when the partnership has additional excess taxable income or qualifies for the small business exemption.

V. Real Property Trade or Business Election

The small business exemption applies per taxpayer and applies to all the small business taxpayer’s trades or businesses. Section 163(j)(7)(A) contains additional exceptions to the section 163(j) business interest deduction limitation for some excepted trades or businesses:

  1. being an employee;

  2. an electing real property trade or business;97

  3. an electing farming business;98 or

  4. some regulated utilities.99

A single taxpayer may own both excepted and non-excepted trades or businesses. Excepted trades or businesses may fully deduct their business interest expense without regard to section 163(j). Further, the business interest of a partnership’s excepted trade or business is not subject to section 163(j) at the partner level.100

An electing real property trade or business or electing farm business is required to use the alternative depreciation system (ADS) for some properties,101 as described in greater detail below for electing real property trades or businesses. The regulated utilities cannot use bonus depreciation.102

A real property trade or business is defined by reference to section 469(c)(7)(C), as enacted by the Revenue Reconciliation Act of 1993 for passive activity loss purposes, to mean any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.103 Generally, under the passive loss rules, a person who spends at least 750 hours a year in real property trades or businesses (in which she materially participates), which constitutes more than 50 percent of her time spent on personal services performed in trades or businesses, is a real estate professional who may treat rental real estate activities as non-passive if she materially participates in the rental real estate activities.104

Although a timber business might not qualify as an electing farm business, the 2021 final regulations classify a timber business instead as a real property development or redevelopment business for tax years beginning in 2018 and later.105 In contrast, neither electing farm businesses nor electing real property trades or businesses explicitly cover evergreen trees that are more than 6 years old at the time they are severed from the roots, which are known in some non-tax circles as Christmas trees or holiday trees.

The real property trade or business definitions have ample existing guidance. In CCA 201504010 (Dec. 17, 2014), the IRS concluded that a mortgage broker is not in a real property trade or business.106 The IRS noted that section 469(c)(7)(C) does not mention finance operations, whereas that clause was present in earlier, unenacted legislation. A real property brokerage trade or business therefore consists only of real estate brokers and real estate salespersons.107 The prior legislation also included appraisal as a real property trade or business, which was removed from the enacted section 467(c)(7)(C) and therefore is not a real property trade or business either.108

In the landmark case of Stanley v. United States,109 the Federal District Court for the Western District of Arkansas held that an in-house lawyer at a real estate management company can be engaged in a real property trade or business. His time spent on providing legal services may count toward his 750-hour qualification as a real estate professional. A similar argument could be made that real estate professionals include tax lawyers and tax accountants who are involved in the real estate industry and write articles in Tax Notes about the taxation of real estate trades or businesses.

Real property operation and management includes hotels and other lodging facilities,110 which is consistent with the TCJA’s legislative history.111 Listings on short-term rental platforms like Airbnb, HomeAway, and Vrbo should similarly be considered lodging facilities that are real property trades or businesses. A lodging facility can provide some supplemental services, as in an assisted-living facility,112 memory care residence, or continuing care retirement community.113 In contrast, real property operation and management does not include business operations when the principal purpose is the provision of significant or extraordinary personal services, which may include a hospital’s boarding facilities or a boarding school’s dormitories.114

Although the section 163(j) real property trade or business is defined by the statute as being equivalent to the passive activity loss rules’ section 469(c)(7)(C) real property trade or business, some assisted-living facilities are real property trades or businesses only for section 163(j) purposes and not for passive activity loss purposes.115

The election to be an electing real property trade or business is irrevocable.116 The trade-off for making the election is that the electing real property trade or business must claim depreciation deductions for some real property under ADS, which has longer recovery periods and no bonus depreciation.117 The electing real property trade or business may claim any allowable bonus depreciation and continue to use the general depreciation system for all of its personal property and other classes of real properties (that are not qualified improvement property (QIP), residential rental property, or nonresidential real property), such as depreciable land improvements, solar or wind energy property, retail motor fuel outlets, motorsport entertainment complexes placed in service in late 2004 through 2025, and single-purpose agricultural or horticultural structures for livestock, plants, and mushrooms.

 

GDS Recovery Period

ADS Recovery Period

Nonresidential real property

39

40

Residential rental property

27.5

30

QIP (some interior improvements made by the taxpayer to nonresidential real property after it is placed in service)

15, with bonus depreciation

20, no bonus depreciation

Personal property and other real property

Various, with bonus depreciation

Not required to use ADS for section 163(j) electing real property trade or business

QIP placed in service in 2018 or later was originally depreciated over 39 or 40 years under the TCJA because of a typo known as the “retail glitch,” which was retroactively corrected in the CARES Act to be depreciated over 15 or 20 years and to allow bonus depreciation.118 The CARES Act retroactively confirmed that QIP must be made by the taxpayer and therefore cannot be used property (i.e., part of a cost segregation study for a purchased real property), which was a widely anticipated technical correction that should not be an issue for well-prepared taxpayers.119

The Consolidated Appropriations Act of 2021 fixed another TCJA typo and provides that an electing real property trade or business depreciates its residential rental property placed in service before 2018 over 30 years, instead of 40 years under the TCJA.120

Future legislation may eventually fix a third TCJA typo. An electing real property trade or business is supposed to switch to ADS for its qualified leasehold improvement property, qualified restaurant property, or qualified retail improvement property placed in service in 2017 or earlier,121 but there is no explicit statutory requirement to do so. There are some other TCJA typos as well.

Although the statute provides that the real property trade or business election is irrevocable, Treasury and the IRS were able to think outside the statutory box and automatically permit many taxpayers to revoke the election in the wake of the CARES Act, which gave some taxpayers second thoughts about claiming the newly available bonus depreciation for QIP.122

In a reversal from the 2018 proposed regulations, the 2020 final regulations provide that when a taxpayer makes the real property trade or business election, any section 163(j) disallowed business interest expense carryforward continues to be a carryforward,123 rather than becoming deductible as suggested by the 2018 proposed regulations. The carryforward may never be allowed when all the real property trade or business’s income has become exempt from section 163(j).

Example: In year 1, an S corporation purchases commercial rental property. The S corporation spends additional amounts on QIP, which is immediately deducted using bonus depreciation. The S corporation is wholly owned by an individual with more than $30 million of individual gross receipts on average in prior years, which prevents the S corporation from qualifying for the small business exemption under the aggregation rules.

In year 1, the S corporation’s deductible interest is limited to 30 percent of its ATI, and any disallowed interest expense is carried to the next year at the S corporation level.124

In year 2, the S corporation elects to be a real property trade or business. Its year 2 interest expense is not subject to the section 163(j) business interest deduction limitation. The building’s remaining adjusted tax basis is depreciated in year 2 over 39 years, as if the building were originally placed in service in year 1 using the longer ADS period of 40 years.125 The year 1 bonus depreciation is not recaptured in year 2 with the switch to ADS.126

The S corporation’s disallowed business interest expense carryforward (from year 1) continues to be subject to section 163(j) in year 2 and later and may be effectively unusable until a disposition.127 Taxpayers may consider accelerating more income to year 1, by treating the property as not being engaged in a trade or business in year 1, or by having the S corporation earn other sources of income in year 2 and later that are allowed against the carryforwards.

The shareholder’s allocated income or losses from the electing real property trade or business do not affect the shareholder’s ATI, for purposes of determining any shareholder-level section 163(j) business interest deduction limitations.128

Some taxpayers may have real estate activities that do not constitute a trade or business as determined under section 162 and its case law, such as net leased properties. As noted above, the nonbusiness activity is not subject to the section 163(j) business interest deduction limitation. If a taxpayer is unsure whether its real estate activities rise to the level of a trade or business, the taxpayer may nevertheless make a real property trade or business election.129 The preamble to the 2020 final regulations confusingly refers to the election as “protective,” but the election has real effects on the taxpayer’s depreciation of real property.130

The 2018 proposed regulations provided that a partnership that is exempt from section 163(j) under the small business exemption is not allowed to make a real property trade or business election. The partnership would allocate its real estate income, interest expense, and other partnership items to the partners, who may be larger taxpayers and are subject to the section 163(j) business interest deduction limitation at the partner level. The 2020 final regulations allow a small business to make a real property trade or business election to elect out of section 163(j).131 The preamble to the 2020 final regulations also confusingly refers to the election as “protective,” but the election has real effects on the small business taxpayer’s depreciation of real property. The election is useful for a business that is unsure whether it qualifies for the small business exemption, and for a partnership if its partners have partner-level business interest expense that would otherwise be limited by section 163(j).

A partnership’s real property trade or business election allows the partners to deduct their partner-level interest expense allocated to the partnership’s real property trade or business. The preamble to the 2020 final regulations states that if a partnership does not make the real property trade or business election, a partner cannot make a partner-level election that applies regarding the partnership’s real property trade or business. The 2020 final regulations discreetly changed an example in the 2018 proposed regulations that had suggested the partner could make the partner-level real property trade or business election. Specifically, prop. Treas. reg. section 1.469-9(b)(2)(iii)(E) Ex. 5 is an example in which F owns an interest in P, a limited partnership. P owns and operates a luxury hotel. Because the principal purpose of the hotel business operations is the provision of use of the hotel’s rooms and suites to customers, the 2018 proposed regulations conclude that both F and P are engaged in a real property trade or business under section 469(c)(7)(C). The example implied that F can make a real property trade or business election, without regard to whether F owns a limited or general partnership interest in P. The 2020 final regulations changed the example’s conclusion so that only P is engaged in the real property trade or business.132

For purposes of the section 163(j) small business exemption and its aggregation rules in determining gross receipts, aggregation counts the gross receipts of entities or businesses that are otherwise not subject to section 163(j), such as electing farm businesses and electing real property trades or businesses.133 A partnership that makes the real property trade or business election should still provide its gross receipts information to its partners, like all other partnerships.

A. Real Property Trade or Business Election by REIT

Under a safe harbor for REITs that make the electing real property trade or business election, a REIT’s real property is defined consistently with the broader definition of real property under section 856 and Treas. reg. section 1.856-10 (finalized August 30, 2016).134 A REIT’s real property generally includes shares in other REITs that directly or indirectly own real property.135 A REIT can therefore make the real property trade or business election to avoid the section 163(j) business interest deduction limitation for its interest expense allocated to stock of other REITs (to the extent they own real property assets) and other real property assets.

Figure 7.

A REIT’s real property does not include stock and securities of a taxable REIT subsidiary (TRS). However, if 10 percent or less of a REIT’s assets consists of real property financing assets — such as mortgage loans, mortgage-backed securities, shares of mortgage REITs, and debt of publicly offered REITs — the regulations provide that the REIT’s real property trade or business election applies to all the REIT’s assets,136 including TRS stock and securities and other non-real-estate assets. There is no requirement for the TRS stock and securities to be 10 percent or less of the REIT’s assets.

Example: An individual, a C corporation, and a private REIT each borrows money to acquire stock of a publicly traded REIT, which owns real property. The publicly traded REIT pays a $100 REIT ordinary dividend to each shareholder, who has $80 of interest expense. The private REIT also owns stock of a taxable REIT subsidiary.

The individual is not subject to the section 163(j) business interest deduction limitation and is instead subject to the section 163(d) investment interest deduction limitation. The individual has $100 of net investment income (the REIT ordinary dividend) and can deduct all $80 investment interest expense. The investment interest expense is an ordinary deduction that can offset ordinary income subject to 37 percent regular income tax rates, even though the REIT ordinary dividend is effectively taxed at only up to 29.6 percent because of the 20 percent section 199A passthrough business income deduction.137

The C corporation is subject to the section 163(j) business interest deduction limitation, because a C corporation has neither investment interest nor investment income.138 The interest expense is allowed for 30 percent of the $100 ATI, which results in only $30 of deductible interest expense. The corporation likely cannot make an electing real property trade or business election, as holding REIT stock is not a real property trade or business.139

The private REIT is treated like the C corporation in the absence of an electing real property trade or business election, with only $30 of deductible interest expense. However, the privately held REIT can make a real property trade or business election that applies to all its assets, including the TRS stock. With the election, the private REIT can deduct all $80 interest expense. Because the private REIT’s only asset is REIT stock and TRS stock, the election does not affect the private REIT’s depreciation deductions.

The 2020 final regulations extend the REIT safe harbor to partnerships owned at least 50 percent directly or indirectly by one or more REITs and that otherwise meet various REIT and section 163(j) requirements if the partnership were a REIT.140 Accordingly, umbrella partnership REIT (or UPREIT) structures can use the REIT safe harbor to make a real property trade or business election for the operating partnership, even if the operating partnership owns stock of subsidiary REITs.

B. Related Real Property Rentals

The 2018 proposed regulations contain an antiabuse rule that provides that a real property trade or business cannot make the real property trade or business election if at least 80 percent of the business’s real property (determined by fair market value) is leased to a trade or business under 50 percent common control with the real property trade or business.141 The 2018 proposed regulations’ preamble states that the 80 percent antiabuse rule is intended to discourage a taxpayer from entering “into non-economic structures where the real estate components of non-real estate businesses are separated from the rest of such businesses in order to artificially reduce the application of section 163(j) by leasing the real property to the taxpayer or a related party of the taxpayer and electing for this ‘business’ to be an excepted real property trade or business.”

Related-party leases in PropCo/OpCo structures are common for nontax (or at least non-federal-income-tax) reasons in many industries, such as hotels, nursing homes, continuing care retirement communities, independent living facilities, assisted-living facilities, memory care facilities, and skilled nursing facilities, which do not present the same artificial concerns when the lessee qualifies to make a real property trade or business election. The 2020 final regulations show a greater appreciation for commercial realities and provide that the 80 percent antiabuse rule does not apply to the extent that a lessor’s real property is leased or subleased to:

  1. a party that is not under 50 percent common control with the lessor or the lessee;

  2. a party that is under 50 percent common control with the lessor or lessee and has made a real property trade or business election (or farming business election), to the extent the real property is used as part of the electing real property trade or business or electing farm business; or

  3. a party that is under 50 percent common control with the lessor or lessee and uses the real property as part of a regulated utility trade or business.142

The real property trade or business election applies to the real property to the extent it is not subject to the 80 percent antiabuse rule. If 90 percent or more of the real property is leased or subleased to the above parties, none of the real property is subject to the 80 percent antiabuse rule.

The 80 percent antiabuse rule does not appear to apply if the related lessee is not engaged in a trade or business, such as an investment activity or a personal activity. The rule has an additional exception for leases of qualified lodging facilities and qualified healthcare facilities from a REIT to a taxable REIT subsidiary, which are generally encouraged under the REIT rules in section 856(d)(8)(B). The 2020 final regulations extend the exception to partnerships owned by REITs.143

Example: A REIT owns a partnership that owns a qualified lodging facility. The partnership leases the facility to a lessee partnership owned in part by a taxable REIT subsidiary of the REIT. The lessee partnership hires an eligible independent contractor to manage and operate the facility. The lessor partnership is not subject to the 80 percent antiabuse rule and may make a real property trade or business election, even if the lessee partnership does not make the same election.

Figure 8.

VI. Foreign Taxpayers

Section 163(j) applies to foreign entities in determining their income effectively connected with the conduct of a U.S. trade or business.144 Section 163(j) also applies to controlled foreign corporations in determining their U.S. shareholders’ subpart F income and GILTI inclusions.145

For subpart F and GILTI purposes, a CFC generally computes its taxable income in the same way as a domestic corporation, which means that it is subject to the section 163(j) business interest deduction limitations and any other limitations in the code. NOL carryovers and capital loss carryovers are not allowed in computing taxable income for subpart F and GILTI purposes.146 However, there is no prohibition on a CFC using section 163(j) disallowed business interest expense carryforwards, section 465 at-risk carryovers, or section 469 passive activity loss carryovers in computing its taxable income for subpart F and GILTI purposes.147 These carryforwards and carryovers may be quantified in the tax due diligence for a foreign mergers and acquisition transaction, although it is unclear whether the carryforwards or carryovers may arise from years in which the foreign corporation was not a CFC.

To simplify CFC computations, the 2021 final regulations provide a CFC group election that generally treats a group of 80 percent or more related CFCs as a single CFC for purposes of computing the group’s section 163(j) limitations and other section 163(j) items.148 The CFC group is inspired by the consolidated group in the domestic context, except that CFC group members may be owned by or connected through partnerships and other noncorporate entities.149

Once the CFC group election is made, all the group’s CFCs are generally treated as a single taxpayer. However, section 163(j) may possibly still apply separately to any partnerships in the chain of CFCs, because only CFCs can be CFC group members.150 Although partnerships are subject to aggregate treatment for other code purposes, such as the section 267A anti-hybrid rules or the section 59A base erosion and antiavoidance tax rules, the section 163(j) statutory language contemplates entity treatment of partnerships for section 163(j) purposes.151 There is no indication that partnerships should be treated differently depending on whether they are in or out of a CFC group.

Example: A domestic corporation owns 100 percent of two CFCs, each of which owns 50 percent of a partnership, which owns 100 percent of a third CFC. The three CFCs are members of a CFC group and are generally treated as a single taxpayer in determining how section 163(j) applies to their subpart F income and GILTI inclusions. However, the partnership is not part of the CFC group, and therefore the partnership-level business interest expense may be subject to its own section 163(j) business interest deduction limitation. Whether the partnership is foreign or domestic,152 the partnership may have to use the 11-step section 163(j) process in computing its section 163(j) items and allocating them to its two CFC partners for subpart F and GILTI purposes, absent guidance to the contrary.

Figure 9.

The application of section 163(j) to CFCs and other foreign entities should include the full panoply of section 163(j) rules, including the small business exemption and the elections for real property trades or businesses and farm businesses. A foreign entity may have a sufficiently low amount of gross receipts that it is a small business that is not subject to section 163(j), if it is not aggregated with other entities and is not a tax shelter as defined in the rules above. For the tax shelter inclusion of companies that must register or file an exemption with a federal or state securities law agency, foreign securities law agencies do not count, which should simplify the analysis.

VII. Conclusion

The above description of the section 163(j) business interest deduction limitation and its exceptions is intended to be a simple and high-level overview. The 2020 and 2021 final regulations provide guidance on many other topics, such as consolidated groups,153 effects on corporate earnings and profits,154 interactions with other deduction rules like the section 465 at-risk rules and the section 469 passive activity loss rules (applied before section 163(j) for computing ATI, but applied after section 163(j) for computing the actual deductible interest expense),155 treatment of section 163(j) disallowed interest expense carryforwards in merger transactions,156 application of sections 382 and 383 loss limitations to section 163(j) disallowed business interest expense carryforwards,157 self-charged interest,158 dispositions of partnership interests,159 remedial allocations of publicly traded partnerships,160 and allocation of interest expense among different assets and businesses.161 The 2020 proposed regulations continue to be outstanding on a few topics such as debt-financed distributions,162 tiered partnerships,163 foreign taxpayers’ income effectively connected with the conduct of a U.S. trade or business,164 and how ATI includes a CFC group’s subpart F and GILTI inclusions under the ATI “roll-up” rules.165 Depending on the effective dates, taxpayers may be subject to the 2018 proposed regulations, the 2020 proposed regulations, the 2020 final regulations, and the 2021 final regulations.

Treasury and the IRS also reserved on some areas to be addressed in future regulations, such as the treatment of cancellation of indebtedness (COD) income166 and the interaction of the section 163(j) limitation with taxable-income-based limitations in section 246(b), section 250, and other code sections that allow and may eventually require the use of simultaneous equations.167

States and localities may apply their own versions of the section 163(j) business interest deduction limitations with variations that may multiply as more states undergo their own efforts at tax reform and simplification. Some states have special rules for related-party interest expense, for which there is sometimes but not always guidance as to how those rules interact with section 163(j). Other states may decouple from section 163(j) in part or in whole. California, for example, has not conformed to most TCJA provisions and therefore does not apply section 163(j) to California taxable income. New York, in contrast, has generally conformed to the TCJA but has decoupled from the CARES Act changes to section 163(j), which means that a taxpayer’s business interest expense is limited to 50 percent of ATI in 2019 and 2020 for federal income tax purposes and 30 percent of ATI in 2019 and 2020 for New York income tax purposes. Further, New York does not conform to the QIP depreciation change in the CARES Act, albeit solely for individual taxpayers. A partnership may need to compute its tax items in several different ways and apply the 11-step section 163(j) allocation method a few different times, based on the location of its business activities and the residence of all of its direct and indirect partners.

Proper advice about the section 163(j) business interest deduction limitation requires some knowledge about various domestic and international code provisions interacting with each other, which is eased by the fact that it is uncommon for a tax practitioner to be compartmentalized or pigeonholed to handle only one code provision or tax topic. Nevertheless, given the complexities in applying the section 163(j) rules, eligible taxpayers may find it beneficial to use one or more of the exceptions to section 163(j) that relate to investment assets, small businesses that are not tax shelters, or real property trades or businesses. Congress has thoughtfully chosen to use frameworks from decades-old tax provisions to make the exceptions easier to use for taxpayers and their tax advisers.

FOOTNOTES

1 T.D. 9905, 85 F.R. 56686 (Sept. 14, 2020); T.D. 9943, 86 F.R. 5496 (Jan. 19, 2021). The two sets of final regulations generally correspond to proposed regulations from 2018 and 2020, respectively: REG-106089-18, 83 F.R. 67490 (Dec. 28, 2018) and REG-107911-18, 85 F.R. 56846 (Sept. 14, 2020).

2 See reg. sections 1.163(j)-6(f)(2)(i), 1.163(j)-6(o)(17) Ex. 17 et seq.

3 Libin Zhang, “Links to the Past: Old Exceptions to New Interest Deduction Limitations,” Tax Notes, Jan. 21, 2019, p. 271. This older article does contain a simplified example of the 11-step process applying to a partnership that eventually gives rise to global intangible low-taxed income inclusions, which is omitted here because of space constraints and because the 11-step process is mostly unchanged in the final regulations and therefore should be familiar to experienced section 163(j) practitioners.

4 The section 163(j) business interest deduction limitation does not apply to floor plan financing, which generally involves debt secured by the inventory of car, boat, and farm equipment dealerships. Section 163(j)(9); reg. section 1.163(j)-1(b)(19). The trade-off is that the dealerships cannot use bonus depreciation for some properties. Section 168(k)(9)(B); and reg. section 1.168(k)-2(b)(2)(ii)(G). Congressional bills contain an important TCJA technical correction to provide that floor plan financing covers debt regarding any trailer or camper, with temporary living quarters, that may be towed by, or affixed to, a motor vehicle. See, e.g., Rules Committee Print 115-87, Text of the House Amendment to the Senate Amendment to H.R. 88, section 504 (Dec. 17, 2018).

5 Section 163(j)(8); and reg. section 1.163(j)-1(b)(1).

6 Section 163(j)(2); and reg. section 1.163(j)-2(c).

7 Section 163(j)(10); and reg. sections 1.163(j)-2(b), 1.163(j)-6(d)(5), 1.163(j)-6(g)(4), 1.163(j)-6(o)(35) Ex. 35, 1.163(j)-6(o)(36) Ex. 36. Controlled foreign corporations can make the same election to use 2019 ATI in 2020. Reg. section 1.163(j)-7(c)(5).

8 Section 6031(b).

9 Rev. Proc. 2020-23.

10 Reg. sections 1.163(j)-3(b)(5), 1.163(j)-3(c)(7) Ex. 7.

11 Reg. sections 1.163(j)-1(b)(1)(iii), 1.163(j)-2(h)(3) Ex 3. Taxpayers may apply the capitalized depreciation addback to earlier tax years without applying other provisions of the final regulations. Reg. section 1.163(j)-1(c).

12 But see Michael L. Schler, “Still More on Tax Regulations and the Rule of Law,” Tax Notes Federal, Dec. 7, 2020, p. 1633.

13 Reg. sections 1.163(j)-1(b)(1)(ii)(C), (D), (E). Special rules apply when a taxpayer sells interests in a partnership or stock of a consolidated group member that owns the asset with depreciation recapture.

14 Reg. sections 1.163(j)-1(b)(1)(iv)(F), 1.163(j)-1(b)(1)(viii)(A) Ex. 1.

15 Section 163(j)(4); and reg. sections 1.163(j)-6(d), 1.163(j)-6(o)(1) Ex. 1.

16 Compare reg. section 1.163(j)-6(g) with H. Conf. Rep. 115-466, at 391, and Joint Committee on Taxation, General Explanation of Public Law 115-97 (JCT blue book), JCS-1-18, at 177-178 (2018). See Tax Technical and Clerical Corrections Act, section 4(o) (Jan. 2, 2019) (discussion draft).

17 Section 163(j)(4)(C); reg. section 1.163(j)-1(b)(17), 1.163(j)-6(o)(2) Ex. 2.

18 Section 163(j)(4)(D); reg. sections 1.163(j)-6(l), 1.163(j)-6(o)(23) Ex. 23.

19 Reg. section 1.163(j)-1(b)(22).

20 Reg. section 1.163(j)-1(b)(22)(iv). The counterparty may treat the corresponding income or gain as interest income for section 163(j) purposes in some cases. Reg. section 1.163(j)-1(b)(22)(iv)(A)(2).

21 Reg. section 1.163(j)-1(b)(22)(iv)(A)(1).

22 Reg. section 1.163(j)-1(c)(2).

23 Reg. section 1.163(j)-1(b)(22)(v)(E) Ex. 5.

24 Reg. section 1.163(j)-1(b)(22)(v).

25 For analyses that distinguish between preferred returns and guaranteed payments for the use of capital, see, e.g., Lewis R. Steinberg, “Fun and Games With Guaranteed Payments,” 57 Tax Law. 533 (2004); New York State Bar Association Tax Section, “Report on Guaranteed Payments and Preferred Returns,” Report No. 1357 (Nov. 14, 2016); Andrew W. Needham, “GPUCs in a Post-Tax Reform World: The Proposed Taxation of (Some) Preferred Returns as Interest,” University of Chicago 2019 Federal Tax Conference (Nov. 9, 2019).

26 See T.D. 6175, 21 F.R. 3500, 3512 (May 25, 1956).

27 See REG-115452-14, 80 F.R. 43652, 43655 (July 23, 2015).

28 Reg. sections 1.163(j)-1(b)(22)(iii)(F), 1.163(j)-1(b)(35).

29 Reg. section 1.951A-4(b)(1)(ii).

30 Reg. section 1.861-9(b)(1)(i).

31 Reg. section 1.469-2(e)(2)(ii).

32 Reg. section 1.263A-9(c)(2)(iii).

33 Reg. section 1.267A-5(a)(12).

34 Section 163(j)(5); reg. section 1.163(j)-1(b)(2).

35 Reg. section 1.163(j)-1(b)(44).

36 Compare Pinchot v. Commissioner, 113 F.2d 718 (2d Cir. 1940); Lewenhaupt v. Commissioner, 20 T.C. 151 (1953), aff’d, 221 F.2d 227 (9th Cir. 1955); and Herbert v. Commissioner, 30 T.C. 26 (1958).

37 See below for a real property trade or business election that can be made by taxpayers who are unsure whether their real property activity rises to the level of a trade or business.

38 Section 163(j)(5).

39 Section 163(d)(2).

40 Section 163(d)(4)(B)(iii); section 1(h)(2).

41 See, e.g., Wood v. Commissioner, 16 T.C. 213 (1951); and King v. Commissioner, 89 T.C. 445 (1987).

42 The disallowed net business losses are treated as NOLs in the next year, which effectively defers their deductibility by around a year.

43 Section 163(d)(5)(A)(ii).

44 Reg. sections 1.163(j)-6(c)(1), 1.163(j)-6(c)(2), 1.163(j)-6(d)(4).

45 Reg. section 1.469-4(d)(6).

46 Libin Zhang, “Individual Considers Passive Loss Rules Under Interest Deduction Regs” (Oct. 21, 2020).

47 See Lee Sheppard, “Trader Funds and Interest Barriers,” Tax Notes Federal, Jan. 25, 2021, p. 537.

48 For other benefits from tidying up partnership structures, see generally Zhang, “The Life-Changing Magic of Tidying Up Partnerships,” Tax Notes, Mar. 11, 2019, p. 1171.

49 86 F.R. 5505 (Jan. 19, 2021).

50 Reg. sections 1.163(j)-4(b)(1), 1.163(j)-4(c)(7)(i) Ex. 1.

51 Reg. sections 1.163(j)-4(b)(3), 1.163(j)-4(c)(7)(ii) Ex. 2, 1.163(j)-6(k).

52 Reg. sections 1.163(j)-6(p)(2), 1.469-11(a)(1).

53 Reg. section 1.163(j)-6(c)(3).

54 Section 163(j)(3); and reg. section 1.163(j)-2(d)(1). The threshold is adjusted annually for inflation and increases to $26 million in 2019 and 2020. Rev. Proc. 2018-57, Rev. Proc. 2019-44. Section 448(c)(3) provides rules for entities that have been in existence for less than three years or have short tax years.

55 Reg. section 1.448-1T(f)(2)(iv).

56 Section 163(j)(3).

57 Reg. sections 1.163(j)-2(d)(2)(ii), 1.163(j)-2(h)(6) Ex. 6.

58 Reg. section 1.163(j)-2(d)(2)(iii).

59 Reg. section 1.448-2(c).

60 Reg. section 1.163(j)-2(h)(8) Ex. 8.

61 Sections 448(c)(2), 52(a), 52(b), 1563(a)(1); and reg. sections 1.52-1(c), 1.1563-1(a)(2).

62 Sections 448(c)(2), 52(a), 52(b), 1563(a)(2), 1563(f)(5); and reg. sections 1.52-1(d), 1.1563-1(a)(3). See Complete Finance Corp. v. Commissioner, 80 T.C. 1062 (1983), aff’d, 766 F.2d 436 (10th Cir. 1985); and United States v. Vogel Fertilizer Co., 455 U.S. 16 (1982).

63 Sections 448(c)(2), 52(a), 52(b), 1563(a)(3); and reg. sections 1.52-1(e), 1.1563-1(a)(4).

64 Section 414(m); and prop. reg. section 1.414(m)-2.

65 Section 414(m)(5). See Elliot Pisem and David J. Snyder, “A Trap in the Interest Limit’s Small Business Exemption,” Tax Notes Federal, Aug. 26, 2019, p. 1381.

66 See prop. reg. section 1.414(o)-1.

67 Sections 1563(d), 1563(e); and reg. section 1.1563-3.

68 P.L. 116-136, section 2301(d).

69 Cf. Garland v. Commissioner, 73 T.C. 5 (1979). See also Kidde v. Commissioner, 69 T.C. 1055 (1978).

70 Reg. section 1.163(j)-2(j)(1).

71 Reg. section 1.163(j)-2(j)(2).

72 Sections 448(a)(3), 448(d)(3), 461(i)(3)(A).

73 Sections 448(a)(3), 448(d)(3), 461(i)(3)(B), 1256(e)(3)(B).

74 Sections 448(a)(3), 448(d)(3), 461(i)(3)(C), 6662(d)(2)(C)(ii); and reg. section 1.448-1(b)(2)(i).

75 See Monte A. Jackel, “Small Business Tax Shelters Under the Business Interest Expense Limitation,” Tax Notes Federal, Oct. 28, 2019, p. 607.

76 Section 448(d)(3).

77 See GCM 39781 (Feb. 8, 1989); and Letter from Assistant Treasury Secretary Chapoton to Senator Glenn, Tax Notes, Aug. 29, 1988, p. 960.

78 Reg. section 1.448-2(b)(2)(ii); and reg. section 1.448-1T(b)(2). See also H. Rep. 98-432, at 1260 (1984) (“The committee intends that an offering required to be registered with any Federal or State agency will include any offering filed with, or with respect to which notice is given to such agency.”).

79 U.S. Securities and Exchange Commission, “Information for Small Business” (updated July 16, 2019).

80 Section 1256(e)(3)(B); and reg. section 1.448-2(b)(2)(iii). Active participation is deemed to occur if the owner has actively participated in the entity’s management for five prior years, or if the owner’s spouse, children, grandchildren, or parents actively participate in the management of the entity. Section 1256(e)(3)(C).

81 See 48 F.R. 51936 (Nov. 15, 1983) (notice of proposed rulemaking) and 63 F.R. 71047 (Dec. 23, 1998) (withdrawing the 1983 proposed regulations).

82 Burnett Ranches Ltd. v. United States, 753 F.3d 143 (5th Cir. 2014).

83 See Action on Decision 2017-01 (Feb. 13, 2017); and CCA 200840042 (Oct. 3, 2008). See also Joint Committee on Taxation, “General Explanation of the Economic Recovery Tax Act of 1981,” at 301 (1981): (“the Act delegates to the Treasury the authority to determine whether certain other interests should be treated as active interests. The Treasury may allow an interest to be treated as an active interest if it determines that an interest should be treated as held by an individual who actively participates in the management of the entity and that neither the entity nor the interest are used (or will be used) for tax-avoidance purposes.”).

84 LTRs 9335041, 9407030, 9415005, 9535036.

85 LTRs 8911011 and 9535036.

86 Reg. sections 1.448-2(b)(2)(iii), 1.1256(e)-2.

87 Reg. section 1.163(j)-2(c)(2), 1.163(j)-6(m)(3).

88 Reg. section 1.163(j)-6(m)(3), 1.163(j)-2(h)(7) Ex. 7, 1.163(j)-6(o)(15) Ex. 15.

89 Reg. section 1.163(j)-6(o)(15) Ex. 15.

90 Reg. section 1.448-1T(b)(3).

91 Reg. sections 1.163(j)-2(d)(3), 1.448-2(b)(2)(vi), 1.1256(e)-2(b).

92 Reg. section 1.448-2(b)(2)(iii)(B).

93 Reg. section 1.448-2(b)(2)(iii)(A).

94 Reg. sections 1.163(j)-6(m)(1), 1.163(j)-6(o)(11) Ex. 11.

95 Reg. sections 1.163(j)-6(m)(1), 1.163(j)-6(o)(12) Ex. 12, 1.163(j)-6(o)(13) Ex. 13. The increase is of the partnership’s net income and not the partnership’s ATI.

96 Reg. section 1.163(j)-6(o)(14) Ex. 14.

97 Section 163(j)(7)(B); and reg. section 1.163(j)-1(b)(14).

98 Section 163(j)(7)(C); and reg. section 1.163(j)-1(b)(13).

99 Section 163(j)(7)(A)(iv); and reg. section 1.163(j)-1(b)(15).

100 Reg. sections 1.163(j)-6(m)(2), 1.163(j)-6(o)(13) Ex. 13.

101 Sections 168(g)(1)(F), 168(g)(1)(G), 168(g)(8).

102 Section 168(k)(9)(A); and reg. section 1.168(k)-2(b)(2)(ii)(G).

103 Rev. Proc. 2018-59 provides that a real property trade or business generally includes some infrastructure property that is, or will be, available for use by the public and is subject to contracts of more than five years between a government and a private trade or business.

104 Section 469(c)(7).

105 Reg. section 1.469-9(b)(2)(ii)(A).

106 See also Guarino v. Commissioner, T.C. Summ. Op. 2016-12; and Hickam v. Commissioner, T.C. Summ. Op. 2017-66.

107 See Agarwal v. Commissioner, T.C. Summ. Op. 2009-29. But see Treas. reg. section 1.199A-5(b)(2)(x) (brokerage for section 199A purposes means stockbrokers and similar financial professionals, but not real estate agents and brokers or insurance agents and brokers).

108 H.R. 3732, 101st Cong. 2d Sess. 1989; and S. 2384, 101st Cong. 1989-1990.

109 116 AFTR 2d 2015-6766, No. 5:14-cv-05236 (W.D. Ark. 2015), non acq. 2017-42, IRB 311 (on other grounds, relating to a required 5 percent ownership in the employer and the taxpayer’s section 469 grouping elections).

110 Reg. section 1.469-9(b)(2).

111 H. Rep. 115-466, at 392 n. 697.

112 JCT blue book, at 178 n. 883.

113 See Congressional Record — Senate, at S8109-S8110 (Dec. 19, 2017).

114 Reg. sections 1.469-1T(e)(3)(iv), 1.469-1T(e)(3)(v).

115 Rev. Proc. 2021-9; and Notice 2020-59.

116 Section 163(j)(7)(B); and Treas. reg. section 1.163(j)-9(c)(2). The election may be terminated after some business changes. Treas. reg. sections 1.163(j)-9(e), 1.163(j)-9(g).

117 Sections 168(g)(1)(F), 168(g)(8); and Treas. reg. section 1.163(j)-9(c)(3).

118 CARES Act section 2307, amending sections 168(e)(3)(E)(vii) and 168(g)(3)(B).

119 Section 168(e)(6)(A). See JCT blue book, at 138 n. 633 (2018); and Tax Technical and Clerical Corrections Act, section 4(m)(2) (discussion draft). See also Zhang, supra note 3, fn. 56.

120 P.L. 116-260, Consolidated Appropriations Act, 2021, Division EE — Taxpayer Certainty and Disaster Tax Relief Act of 2020 section 202. Other pre-2018 residential rental properties that use ADS, such as foreign property, continue to use 40 years for ADS.

121 See JCT blue book, at 138 n. 636 (2018); and Tax Technical and Clerical Corrections Act, section 4(m)(4) (discussion draft).

122 Rev. Proc. 2020-22. See also Rev. Proc. 2020-25 (depreciation of QIP).

123 Treas. reg. sections 1.163(j)-6(m)(3), 1.163(j)-6(m)(4), 1.163(j)-6(o)(16) Ex. 16.

124 Treas. reg. section 1.163(j)-6(l)(5).

125 Rev. Proc. 2019-08 section 4.02(2); and Treas. reg. section 1.168(i)-4(d)(4); Treas. reg. section 1.168(i)-4(d)(6) Ex. 3.

126 Rev. Proc. 2019-08 section 4.02(2); and Treas. reg. section 1.168(k)-1(f)(6)(iv)(A); Treas. reg. section 1.168(k)-1(f)(6)(v) Ex. 2.

127 Treas. reg. section 1.163(j)-6(m)(4).

128 Treas. reg. section 1.163(j)-6(m)(2).

129 Treas. reg. section 1.163(j)-9(b)(2)(ii).

130 The more common understanding of a protective election is that such an election has no real effect until a contingency occurs or becomes true.

131 Treas. reg. section 1.163(j)-9(b)(2)(i).

132 Treas. reg. section 1.469-9(b)(2)(iii)(E) Ex. 5. The 2020 final regulations’ changes to the section 469 rules generally apply to tax years beginning on or after November 13, 2020. Treas. reg. section 1.469-11(a)(4).

133 Treas. reg. section 1.163(j)-2(h)(8) Ex. 8.

134 Treas. reg. section 1.163(j)-9(h).

135 Treas. reg. section 1.163(j)-9(h)(4)(iii).

136 Treas. reg. section 1.163(j)-9(h)(2).

137 But see Tax Technical and Clerical Corrections Act, section 4(b) (discussion draft) (the same REIT ordinary dividends cannot be allowed the section 199A deduction and be allowed a deductible investment interest expense).

138 Treas. reg. section 1.163(j)-5(c).

139 Treas. reg. sections 1.163(j)-4(b)(1), 1.163(j)-4(b)(3).

140 Treas. reg. section 1.163(j)-9(h)(7).

141 Prop. Treas. reg. section 1.163(j)-9(j)(1).

142 Treas. reg. sections 1.163(j)-9(j)(2), 1.163(j)-9(j)(4)(i) Ex. 1 et seq.

143 Treas. reg. section 1.163(j)-9(h)(2).

144 Prop. Treas. reg. section 1.163(j)-8.

145 Treas. reg. section 1.163(j)-7.

146 Treas. reg. section 1.952-2(c)(5).

147 Section 465 at-risk carryovers apply only to CFCs that are closely held corporations under section 465(a)(1)(B), while section 469 passive activity loss carryovers apply only to CFCs that are (or have been) closely held corporations or personal service corporations under section 465(a)(1)(B) or section 469(j)(2).

148 Treas. reg. sections 1.163(j)-7(c)(2), 1.163(j)-7(e)(5), 1.163(j)-7(h) (simplified safe harbor election). But see Treas. reg. section 1.163(j)-7(f) (separate rules for CFC group members with income effectively connected with the conduct of a U.S. trade or business).

149 Treas. reg. section 1.163(j)-7(d)(2)(ii).

150 Treas. reg. sections 1.163(j)-7(d)(2)(i), 1.163(j)-7(e)(2)(ii).

151 See section 163(j)(4).

152 See also Notice 2009-7, Notice 2010-41, Treas. reg. section 1.951-1(h).

153 Treas. reg. sections 1.163(j)-4(d), 1.163(j)-4(e), 1.163(j)-5(b)(3).

154 Treas. reg. section 1.163(j)-4(c).

155 Treas. reg. sections 1.163(j)-1(b)(3), 1.163(j)-3(b)(4), 1.163(j)-3(c). Sections 465 and 469 presumably do not limit a partnership’s ATI given that those provisions apply at the individual partner level.

156 Section 381(c)(20); Treas. reg. sections 1.163(j)-5(c), 1.381(c)(20)-1.

157 Section 382(d)(3); Treas. reg. sections 1.163(j)-5(e), 1.163(j)-11(c), 1.382-2(a)(1), 1.382-2(a)(7), 1.382-6(a)(2), 1.382-6(b)(4), 1.383-1(d)(1), 1.1502-91(e)(2) Ex., 1.1502-98(b).

158 Treas. reg. section 1.163(j)-6(n).

159 Treas. reg. sections 1.163(j)-6(h), 1.163(j)-6(o)(9) Ex. 9.

160 Treas. reg. sections 1.163(j)-6(d)(3), 1.163(j)-6(e)(5), 1.163(j)-6(f)(1)(iii).

161 Treas. reg. section 1.163(j)-10.

162 Prop. Treas. reg. section 1.163-14.

163 Prop. Treas. reg. section 1.163(j)-6(j).

164 Prop. Treas. reg. section 1.163(j)-8.

165 Treas. reg. section 1.163(j)-7(j).

166 For views on how section 163(j) should treat COD income and interact with section 108, see New York State Bar Association, “Report No. 1447 — Report on Section 163(j) and the COD Income Rules” (Jan. 25, 2021).

167 See generally Zhang, “Simultaneous Equations: The Statute Strikes Back,” Tax Notes Federal, Sept. 21, 2020, p. 2211.

END FOOTNOTES

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