In our fourth installment, we will discuss the new expansion of the limitation on the deduction of interest expense. For tax periods beginning after December 31, 2017, the limitation has been expanded to include individuals (and businesses owned by individuals). One major consideration, however, is that taxpayers who have gross receipts under $25 million are exempt from this limitation. Real estate businesses that otherwise would have to apply this limitation can elect out by using the alternative depreciation system (ADS), rather than MACRS. ADS lives are longer than MACRS lives (although the residential real estate life has been reduced to 30 years), and assets using ADS lives are not qualified for the 100% bonus depreciation or Section 179 expensing. As such, if the business interest limitation applies to a taxpayer, they need to consider the financing terms and interest expense relative to net income, as well as the implications of cost recovery/expensing of assets, and the QBI deduction.
If the taxpayer is not exempt and does not elect out of the limitation, business interest expense will be limited to the sum of:
- Business interest income and
- 30% of adjusted taxable income.
Adjusted taxable income is taxable income adjusted for income and expenses not related to a trade or business, net business interest, NOLs, QBI deduction, and depreciation. The depreciation addback only applies until January 1, 2022.
This limitation is calculated at the partner level as well as the partnership level, so the partner’s share of income from a partnership will be excluded at the partner level (since the limitation would already have been calculated at the partnership level). Currently, there is little guidance on the potential that a partner might elect out and the partnership might not (or vice versa), and the interplay with the calculation at the partner level.
There is a concept that any “excess taxable income” generated by the partnership can be used to calculate the partner’s individual limitation. Conversely, if the partnership passes through excess business interest expense in a tax year which could not be deducted, the interest will be retained at the partner level and deducted if there is excess taxable income from the partnership in a future tax year.
Due to the fact that this will be considered at the entity as well as owner level, there will be more reporting requirements for the partnership to ensure all the information that is needed to calculate the applicability of this limitation is passed through to owners.