Some taxpayers who elected to be “electing real property trades or businesses” based on the provisions of §163(j) prior to amendment by the CARES Act likely regretted their decisions once the Act retroactively changed the limit from 30% of adjusted taxable income to 50% of adjusted taxable income temporarily. The IRS is now giving those taxpayers a chance to undo that election based on guidance in Revenue Procedure 2020-22.[1]

As well, the Procedure covers other new elections that are part of the CARES Act to deal with the changes made by that Act to §163(j).

Modifying §163(j)(7) Elections

The Procedure outlines its scope in Section 3. It begins by stating:

Sections 4 and 5 of this revenue procedure apply to a taxpayer described in section 3.01(1) or (2) of this revenue procedure with respect to an election under section 163(j)(7)(B) to be an electing real property trade or business or under section 163(j)(7)(C) to be an electing farming business (collectively, section 163(j)(7) election). The fact that a taxpayer satisfies the scope requirement of this section 3.01 is not a determination that the taxpayer is a real property trade or business under section 162, 212, or 469 of the Code, or a farming business under section 162, 199A, or 263A of the Code.[2]

Making a Late §163(j)(7) Election

First the IRS deals with the (seemingly less likely) decision that a qualified farming or real estate business would want to make a late election under §163(j)(7) to become an electing farming or real estate business, exempt from the §163(j) limits on business interest, but required to depreciate certain assets using ADS methods and lives.

Taxpayers who can make this late election are:

A taxpayer is described in this section 3.01(1) if the taxpayer did not file a section 163(j)(7) election with its timely filed original Federal income tax return or Form 1065, including extensions, or withdrew an election under section 5 of this revenue procedure, for a taxable year beginning in 2018 (2018 taxable year), 2019 (2019 taxable year), or 2020 (2020 taxable year), was otherwise qualified to make an election when the return was filed, and now wants to make an election for one of those taxable years.[3]

The time for making the late §163(j) election is outlined in the procedure:

A taxpayer within the scope of section 3.01(1) of this revenue procedure may make the section 163(j)(7) election for a 2018, 2019, or 2020 taxable year by filing an amended Federal income tax return, amended Form 1065, or AAR, as applicable. Except as provided in Revenue Procedure 2020-23, 2020-18 I.R.B. 1 (April 27, 2020), released on www.irs.gov on April 8, 2020, regarding the time to file an amended return by a partnership subject to the centralized partnership audit regime enacted as part of the Bipartisan Budget Act of 2015 (BBA partnership) for 2018 and 2019 taxable years, the amended Federal income tax return or amended Form 1065 must be filed on or before October 15, 2021, but in no event later than the applicable period of limitations on assessment for the taxable year for which the amended return is being filed. In the case of a BBA partnership that chooses not to file an amended Form 1065 as permitted under Rev. Proc. 2020-23, the BBA partnership may make a late section 163(j)(7) election by filing an AAR on or before October 15, 2021, but in no event later than the applicable period of limitations on making adjustments under section 6235 for the reviewed year, as defined in § 301.6241-1(a)(8) of the Procedure and Administration Regulations (26 CFR Part 301).[4]

The taxpayer makes the late §163(j) election as follows:

A taxpayer described in section 4.02 of this revenue procedure must make the election on a timely filed amended Federal income tax return, amended Form 1065, or an AAR, as applicable, with the election statement in accordance with the rules and procedures contained in proposed § 1.163(j)-9 of the 2018 proposed regulations and this section 4. The amended Federal income tax return, amended Form 1065, or AAR, as applicable, must include the adjustment to taxable income for the late section 163(j)(7) election and any collateral adjustments to taxable income or to tax liability. Such collateral adjustments also must be made on amended Federal income tax returns, amended Forms 1065, or AARs, as applicable, for any affected succeeding taxable year. An example of such collateral adjustments is the amount of depreciation allowed or allowable in the applicable taxable year for the property to which the late election applies. The taxpayer is subject to all of the other rules and requirements in section 163(j), except as otherwise provided in this revenue procedure. The Treasury Department and the IRS have provided guidance under section 163(j) in the 2018 proposed regulations and will provide additional guidance in forthcoming final regulations and additional proposed regulations under section 163(j). The additional proposed regulations will address issues arising under the CARES Act as well as certain other issues.[5]

The late election statement’s contents are outlined as follows:

The election statement must be titled, “Revenue Procedure 2020-22 Late Section 163(j)(7) Election.” The election statement must contain:

(1) The taxpayer’s name;

(2) The taxpayer’s address;

(3) The taxpayer’s social security number (SSN) or employer identification number (EIN);

(4) A description of the taxpayer’s electing trade or business, including the principal business activity code; and

(5) A statement that the taxpayer is making an election under section 163(j)(7)(B) or 163(j)(7)(C), as applicable. [6]

This portion of the procedure concludes on issues related to depreciation when a late election is made:

A taxpayer within the scope of section 3.01(1) of this revenue procedure that is making a section 163(j)(7) election must determine its depreciation on the amended Federal income tax returns, amended Forms 1065, or AARs, as applicable, for the property that is affected by the late election using the alternative depreciation system of section 168(g), pursuant to section 168(g)(1)(F) or (G). See also section 163(j)(11). Section 4.02 of Rev. Proc. 2019-8, 2019-3 I.R.B. 347, explains how to change to the alternative depreciation system for existing property that is affected by the late election.[7]

Withdrawing an Election Under §163(j)(7)

The more likely scenario is that a taxpayer will want to withdraw a prior election under §163(j). Under the provisions added by TCJA, an election under §163(j)(7) was an election that bound the taxpayer forever, with no opportunity to undo the election. But the IRS reasoned that taxpayers may have made a very different decision had the interest limit been set at 50% of adjusted taxable income rather than 30%.

Section 5 allows for just such a withdraw of the prior election. Those taxpayers eligible for it are:

A taxpayer is described in this section 3.01(2) if the taxpayer filed a section 163(j)(7) election with its timely filed original Federal income tax return or Form 1065, including extensions, or made a late election under section 4 of this revenue procedure, for a 2018, 2019, or 2020 taxable year and now wants to withdraw the election.[8]

The time and manner for withdrawing an election under IRC §163(j)(7) are provided in the procedure:

A taxpayer that wishes to withdraw an election as described in section 5.01 of this revenue procedure for a 2018, 2019, or 2020 taxable year must timely file an amended Federal income tax return, amended Form 1065, or AAR, as applicable, for the taxable year in which the election was made, with an election withdrawal statement. Except as provided in Revenue Procedure 2020-23, regarding the time to file amended returns by BBA partnerships for 2018 and 2019 taxable years, the amended Federal income tax return or amended Form 1065 must be filed on or before October 15, 2021, but in no event later than the applicable period of limitations on assessment for the taxable year for which the amended return is being filed. In the case of a BBA partnership that chooses not to file an amended Form 1065 as permitted under Rev. Proc. 2020-23, the BBA partnership may withdraw the section 163(j)(7) election by filing an AAR on or before October 15, 2021, but in no event later than the applicable period of limitations on making adjustments under section 6235 for the reviewed year, as defined in § 301.6241-1(a)(8). The amended Federal income tax return, amended Form 1065, or AAR, as applicable, must include the adjustment to taxable income for the withdrawn section 163(j)(7) election and any collateral adjustments to taxable income or to tax liability, including any adjustments under section 481. A taxpayer also must file amended Federal income tax returns, amended Forms 1065, or AARs, as applicable, including such collateral adjustments, for any affected succeeding taxable years. An example of such collateral adjustments is the amount of depreciation allowed or allowable in the applicable taxable year for the property to which the withdrawn election applies.[9]

The election withdrawal statement contents are described as follows:

The election withdrawal statement should be titled, “Revenue Procedure 2020-22 Section 163(j)(7) Election Withdrawal.” The election withdrawal statement must contain the taxpayer’s name, address, and SSN or EIN, and must state that, pursuant to Revenue Procedure 2020-22, the taxpayer is withdrawing its election under section 163(j)(7)(B) or 163(j)(7)(C), as applicable.[10]

As well, the procedure again discusses the issues that will arise with regard to depreciation when the original election is withdrawn:

A taxpayer that is withdrawing a prior section 163(j)(7) election must determine its depreciation for the property that is affected by the withdrawn election in accordance with section 168 on the amended Federal income tax returns, amended Forms 1065, or AARs, as applicable.[11]

Making an Election Under New §163(j)(10)

The CARES Act added IRC §163(j)(10) that created some new elections to deal with the CARES Act changes to §163(j). This ruling also provides rules for these elections, and the scope is defined in the following paragraph:

Section 6 of this revenue procedure provides the time and manner of making or revoking elections under new section 163(j)(10) applicable to a taxpayer that has timely filed, or will timely file, an original Federal income tax return or Form 1065 for a taxpayer’s 2019 or 2020 taxable year. [12]

The CARES Act added a number of special purpose elections which are described below.

Election Out of the 50 Percent ATI Limitation

Taxpayers have the option to not apply the 50% limitation for the 2019 and/or 2020 tax year, going back to the 30% limit.

Except as otherwise provided in this section 6.01(1), a taxpayer may elect under section 163(j)(10)(A)(iii) not to apply the 50 percent ATI limitation for a 2019 or 2020 taxable year. A partnership can make this election only for a 2020 taxable year because partnerships cannot use the 50 percent ATI limitation for a 2019 taxable year.[13]

The time and manner of making the election is outlined as follows:

A taxpayer permitted to make the election, as described in section 6.01 of this revenue procedure, makes the election not to apply the 50 percent ATI limitation for a 2019 or 2020 taxable year by timely filing a Federal income tax return or Form 1065, including extensions, an amended Federal income tax return, amended Form 1065, or AAR, as applicable, using the 30 percent ATI limitation. No formal statement is required to make the election.[14]

Effectively, this is a “Nike” election—the taxpayer just “does it” and applies the 30% limitation.

The procedure also provides an option for a taxpayer (who may have not been aware of the option to use the 50% limitation or just changes his/her mind) to revoke the election to continue to use the 30% limit:

If a taxpayer made the election, as described in section 6.01(2) of this revenue procedure, not to apply the 50 percent ATI limitation, for a 2019 or 2020 taxable year, and the taxpayer wishes to revoke that election for such taxable year, the Commissioner grants the taxpayer consent to revoke that election, provided the taxpayer timely files an amended Federal income tax return, amended Form 1065, or AAR, as applicable, for the applicable tax year, using the 50 percent ATI limitation.[15]

This section of the procedure concludes:

The election in section 6.01 of this revenue procedure must be made for each taxable year. For a consolidated group, the election is made by the agent for a consolidated group, within the meaning of § 1.1502-77, on behalf of members of the consolidated group. For partnerships, the election is made by the partnership, but only for a 2020 taxable year. For an applicable CFC, as defined in proposed § 1.163(j)-7(f)(2), the election is not effective unless made for the applicable CFC by each controlling domestic shareholder, as defined in § 1.964-1(c)(5).[16]

Election to Use 2019 ATI in 2020 Taxable Year

Given that many taxpayers will have much lower income in 2020 than in 2019, the law allows the taxpayer to elect to use the taxpayer’s 2019 ATI in lieu of using the ATI for 2020.

Under section 163(j)(10)(B), a taxpayer may elect to use the taxpayer’s ATI for the last taxable year beginning in 2019 (that is, the taxpayer’s 2019 ATI) as the ATI for any taxable year beginning in 2020, subject to modifications for short taxable years.[17]

The time and manner of making the election is described in the Procedure:

A taxpayer makes an election under this section 6.02 for a 2020 taxable year by timely filing a Federal income tax return or Form 1065, including extensions, an amended Federal income tax return,amended Form 1065, or AAR, as applicable, using the taxpayer’s 2019 ATI. A taxpayer revokes an election under this section 6.02 for a 2020 taxable year by timely filing an amended Federal income tax return, amended Form 1065, or AAR by a BBA partnership, as applicable, not using the taxpayer’s 2019 ATI. No formal statement is required to make or revoke the election.[18]

The procedure provides the following information for who makes the election:

For a consolidated group, the election under section 6.02 of this revenue procedure is made by the agent for a consolidated group, within the meaning of § 1.1502-77, on behalf of itself and members of the group. For partnerships, the election is made by the partnership. For an applicable CFC, the election is not effective unless made for the applicable CFC by each controlling domestic shareholder. In the case of a CFC group, as defined in proposed § 1.163(j)-7(f)(6), the election is not effective for any CFC group member, as defined in proposed § 1.163(j)-7(f)(8), unless made for every taxable year of a CFC group member for which the election is available and for which the CFC group member is a CFC group member on the last day of the CFC group member’s taxable year.[19]

The IRS also discusses issues that will arise with a short taxable year:

If an election is made under section 6.02 of this revenue procedure for a 2020 taxable year that is a short taxable year, the ATI for the taxpayer’s applicable taxable year beginning in 2020 is equal to the amount that bears the same ratio to such ATI as the number of months in the short taxable years bears to 12.[20]

Election Out of the 50 Percent EBIE (Excess Business Interest Expense) Rule

A taxpayer wishing to elect out of the 50 percent EBIE rule makes the election at the following time and in the following manner:

A partner makes the election under section 6.03 of this revenue procedure by timely filing a Federal income tax return or Form 1065, including extensions, an amended Federal income tax return, an amended Form 1065, or an AAR, as applicable, for the partner’s first taxable year beginning in 2020, by not applying the 50 percent EBIE rule in determining the section 163(j) limitation. A partner revokes the election under this section 6.03 by timely filing an amended Federal income tax return, amended Form 1065, or AAR, as applicable, for the partner’s first taxable year beginning in 2020, by applying the 50 percent EBIE rule in determining the section 163(j) limitation.[21]

[1] Revenue Procedure 2020-22, April 10, 2020, https://www.irs.gov/pub/irs-drop/rp-20-22.pdf, retrieved April 10, 2020

[2] Revenue Procedure 2020-22, Section 3.01

[3] Revenue Procedure 2020-22, Section 3.01(1)

[4] Revenue Procedure 2020-22, Section 6.02

[5] Revenue Procedure 2020-22, Section 6.03

[6] Revenue Procedure 2020-22, Section 6.04

[7] Revenue Procedure 2020-22, Section 6.05

[8] Revenue Procedure 2020-22, Section 3.01(2)

[9] Revenue Procedure 2020-22, Section 5.02

[10] Revenue Procedure 2020-22, Section 5.03

[11] Revenue Procedure 2020-22, Section 5.04

[12] Revenue Procedure 2020-22, Section 3.02

[13] Revenue Procedure 2020-22, Section 6.01(1)

[14] Revenue Procedure 2020-22, Section 6.01(2)

[15] Revenue Procedure 2020-22, Section 6.01(3)

[16] Revenue Procedure 2020-22, Section 6.01(4)

[17] Revenue Procedure 2020-22, Section 6.02(1)

[18] Revenue Procedure 2020-22, Section 6.02(2)

[19] Revenue Procedure 2020-22, Section 6.02(3)

[20] Revenue Procedure 2020-22, Section 6.02(4)

[21] Revenue Procedure 2020-22, Section 6.03(2)