Understanding Business Interest Expense Limitation Changes & Tax Credit Opportunities

Before the 2017 Tax Cuts and Jobs Act (TCJA), section 163(j) of the Internal Revenue Code applied only to certain interests paid or accrued by corporations.  However, the TCJA significantly changed the section 163(j) limitation.

According to the IRS, taxpayers generally can deduct interest expenses paid or accrued in the taxable year.  However, if section 163(j) applies, the amount of deductible business interest expense in a taxable year cannot exceed the sum of:

• The taxpayer’s business interest income for the year;
• (For 2022) 30% of the taxpayer’s adjusted taxable income (ATI) for the year (down from 50%); and
• The taxpayer’s floor plan financing interest expense for the year.

For 2022, updated ATI numbers do not include the add-back for depreciation & amortization expense. This will likely be a substantial challenge for the affordable housing industry.

For example, in 2021 – if you had a $300,000 loss that included $2 million in depreciation, your ATI starting point would be $1.7 million – and the limit would be 50% of that, or $850k would allow room to deduct interest expense. Now, that limit would be zero in this example.

What does this mean?

• It would be prudent to review 163(j) elections for entities that haven’t been completed yet and discuss the potential for changes.
• Additionally, every entity bonus depreciation decision should be reviewed to consider all impact points.

For new projects to begin being built, there are very high incentives for new energy buildings – under 45L tax credits. Credits introduced in the Inflation Reduction Act (IRA), don’t reduce LIHTC basis.

While energy-efficient tax credits aren’t new, they could make it much more viable for projects to go after.

For example, a 100-unit building that installs solar panels could get a $200,000 credit ($2,000 x 100).

To learn more about limitations on deductions for the business interest expense, visit the IRS FAQ page.

Reach out Matt Latham, CPA, Principal, Keith Pfeifle, CPA, Principal, Director, and the affordable housing experts at Maner Costerisan to help review 163(j) elections, and entity bonus depreciation and determine which tax credits might be available for new energy buildings.