New Limitation on Business Interest Expense Deductions

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tax notes?

New Limitation on Business Interest Expense Deductions

by Angela W. Yu and Daniel J. Paulos

Angela W. Yu is a partner and Daniel J. Paulos is a principal in KPMG LLP's asset management practice in New York. Yu is also a former staff member of the Joint Committee on Taxation. The authors thank Sam Chen for his review and helpful comments and Jason Binder for his assistance.

In this article, Yu and Paulos examine the implications of new rules that curtail the U.S. tax benefits of cross-border intercompany interest payments made by foreign-owned U.S. corporations, and they discuss the new business interest expense limitation rules of section 163(j) in light of the recently proposed regulations.

This article represents the views of the authors only and does not necessarily represent the views or professional advice of KPMG. The information herein is of a general nature and based on authorities that are subject to change. Its applicability to specific situations should be determined through consultation with your tax adviser.

I. Introduction

H.R. 11 (the 2017 Tax Act, also known as the Tax Cuts and Jobs Act) added three new statutory provisions that significantly curtail the U.S. tax benefits of cross-border intercompany interest payments made by foreign-owned U.S. corporations (blockers). The new provisions, effective for tax years beginning after 2017, are sections 59A, 163(j), and 267A. Treasury and the IRS issued proposed regulations in 2018 to

1

P.L. 115-97, 115 Stat. 2054 (Dec. 22, 2017).

implement the new law.2 This is the first of two articles that examine the implications of these new rules. This article discusses three key elements of the new section 163(j) rules that have broad implications for blockers. It is intended to be a practical piece addressing the issues most widely applicable to these taxpayers.

Blockers are typically used by private equity and credit funds in various business contexts including investment in U.S. real estate, infrastructure, loan-origination, and other operating businesses to shield foreign investors from U.S. tax filing obligations. The tax efficiency of a blocker often can be improved if the blocker is funded, in part, with debt that is loaned from the blocker's shareholders to the extent that the interest expense of such debt is deductible by the blocker. Not all those discrete types of businesses, however, are equally affected by the section 163(j) rules.3 Moreover, for blockers that own passthrough businesses that have home-run potential (for example, investment in a start-up), it has never been easy to achieve a high degree of tax efficiency using shareholder debt because interest

2See REG-104259-18 (proposed regulations under section 59A), REG106089-18 (proposed regulations under section 163(j)), and REG-10435218 (proposed regulations under section 267A). Proposed regulations generally may take effect retroactively if they are finalized within 18 months of the date that the statutory provisions are enacted, but the proposed section 163(j) regulations are generally applicable only to tax years ending after the date they are finalized. However, taxpayers may elect to apply the proposed section 163(j) regulations retroactively to the 2018 tax year. See prop. reg. section 1.163(j)-11(c). Taxpayers who so elect must apply all of the proposed section 163(j) regulations consistently.

3

As discussed below, there are exceptions for real estate businesses and many infrastructure investments, and as well the impact may be negligible for any interest-earning enterprise (because interest income increases the section 163(j) limit).

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expense that is accrued at a steady rate is often woefully insufficient to offset a home-run return.4

The new section 163(j) rules can have a profound impact on affected blockers because they disallow deductions of interest payments to foreign and domestic as well as related and unrelated lenders. Although generally structured as a deferral provision, the section 163(j) rules can effectively result in permanent disallowance of a blocker's interest deductions in some circumstances. The limitation generally disallows a U.S. tax deduction for net business interest expense (BIE) (that is, BIE net of business interest income) that exceeds 30 percent of a taxpayer's adjusted taxable income (ATI).5 A blocker may carry forward the amount of disallowed BIE to subsequent tax years.6

The section 163(j) rules apply to any "taxpayer," that is, any person subject to U.S. income tax,7 unless an exemption is available. A taxpayer with annual gross receipts averaging $25 million or less for the three preceding years generally is exempt under the small business exemption.8 The requirements to qualify for this exemption are not intuitive and could surprise

4

Taking appreciated assets out of corporate solution also comes at a price -- the corporation is deemed to have sold the assets at their fair market value. In the start-up context, in rare instances, private equity funds may structure "stripping" transactions with shareholder options to acquire corporate assets, rather than with debt. If there are home-run returns, exercising an option to extract assets out of corporate solution at values significantly below the then FMV can be a valuable planning tool. These transactions are seemingly not covered by the new section 163(j) rules.

5

ATI generally is the taxable income of the taxpayer computed without regard to: (1) any item of income, gain, deduction, or loss that is not properly allocable to a trade or business; (2) business interest expense and income; (3) net operating loss determined under section 172; (4) the deduction for qualified business income under section 199A; and (5) for years beginning before 2022, the deductions for depreciation, amortization, or depletion. See section 163(j)(8)(A). Moreover, ATI may be "computed with such other adjustments as provided by the Secretary." See section 163(j)(8)(B). Technically, the section 163(j) BIE limitation applies to limit a taxpayer's deduction to the amount that equals the sum of its net BIE and floor plan financing interest (not discussed in this article).

6

Section 163(j)(2). Note, however, that unlike the pre-2018 section 163(j) rules, the TCJA section 163(j) rules do not permit taxpayers to carry forward any unused excess limitation.

7Section 7701(a)(14).

8

See section 163(j)(3) and prop. reg. section 1.163(j)-2(d).

taxpayers.9 Also, note that attempts to transmute gross income into net income for these purposes should be considered from an antiabuse perspective with some degree of caution.10 Moreover, some taxpayers may go in and out of the small business exemption from one tax year to the next.11

The section 163(j) rules are very complex. This article focuses on three areas: (1) the expansive definition of "interest" for purposes of section 163(j); (2) the application of the section 163(j) rules to partnerships; and (3) the election available to real property trades or businesses (RPTOBs) to be excepted from the section 163(j) rules and countervailing considerations for such an election.

II. Expansive Definition of Interest

A highly controversial aspect of the proposed section 163(j) regulations is one of the four categories of the definition of interest (both expense and income) adopted for purposes of applying the BIE limitation.12 The first category of the proposed definition of interest is a general principle-based rule (and several items specified within it). Under this category, interest is generally defined as "any amount that is paid, received, or accrued as compensation for the use or forbearance of money under the terms of an instrument or contractual arrangement" -- a definition that reflects a standard established by judicial precedent13 -- as well as an amount that is treated as interest under other provisions of the

9

For example, a taxpayer that is considered a tax shelter may not qualify for the small business exemption. Section 163(j)(3) refers to section 448(d)(3) for the definition of tax shelter. Section 448(d)(3) cross references section 461(i)(3), which defines tax shelter to include a "syndicate" within the meaning of section 1256(e)(3)(B). For this purpose, a syndicate is generally defined as a partnership if more than 35 percent of its losses during a tax year are allocable to limited partners or limited entrepreneurs.

10

See prop. reg. section 1.163(j)-2(h) for the antiavoidance rule.

11

Note that if a partnership qualifies for the small business exemption during a year, the section 163(j) rules would not apply to limit the deduction of BIE at the partnership level; however, a partner would still need to take into account its allocable share of all items of the partnership to determine the partner's own section 163(j) BIE limitation.

12See prop. reg. section 1.163(j)-1(b)(20).

13

See, e.g., Deputy v. du Pont, 308 U.S. 488 (1940).

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code or the regulations thereunder.14 The second category of the proposed definition of interest is the time value component of a significant nonperiodic payment for a notional principal contract (that is, a swap).15 Neither rule comes as a surprise.

However, the third category of the proposed definition of interest includes several "other amounts treated as interest" (each an interest-like amount), each of which presumably falls outside the scope of the general principle-based rule. The interest-like amounts defined as interest include: substitute interest payments; section 1258 gains (amounts recharacterized as ordinary income from the disposition of specific financial transactions); income, deduction, gain, or loss from a derivative (for example, a hedge) that alters an issuer's effective cost of borrowing regarding a liability or that alters a holder's effective yield for a debt instrument; debt issuance costs; commitment fees; guaranteed payments for the use of capital; and factoring income.16

According to the preamble to the proposed section 163(j) regulations, the interest-like amounts are included to treat as interest "certain amounts that are closely related to interest and that affect the economic yield or cost of funds of a transaction involving interest, but that may not be compensation for the use or forbearance of money on a stand-alone basis."17 The intent and effect, therefore, is to broaden the application of the section 163(j) rules to various payments that are not otherwise viewed as interest under general tax principles. However, unlike the other new interest expense deduction limitation provisions, sections 59A and 267A, each of which includes a subsection wherein Congress explicitly mandates that the Treasury secretary "prescribe such regulations or other guidance as may be necessary

TAX PRACTICE

or appropriate to carry out the provisions of" the respective section,18 neither section 163(j) nor section 163 contains a comparable mandate.19 Yet within the new BIE rules, Congress explicitly granted regulatory authority to expand one term's definition. Specifically, section 163(j)(8) includes statutory authority to expand the definition of ATI; that is, that it be computed "with such other adjustments as provided by the Secretary." It is therefore concerning that, in the absence of any statutory mandate for regulations expanding the definition of interest, the Treasury secretary nevertheless did so.

Moreover, the proposed definition of interest would include an antiavoidance rule under which any expense or loss, to the extent deductible, incurred by a taxpayer in a transaction or series of integrated or related transactions in which the taxpayer secures the use of funds for a period is treated as interest expense of the taxpayer if the expense or loss is predominantly incurred in consideration of the time value of money.20 The language in this rule appears very broad, and a literal application of this rule could have potentially harsh consequences for relatively common business arrangements.

Among the interest-like amounts treated as interest for purposes of section 163(j), three are of special concern. The first involves the treatment of gains and losses regarding hedging with derivatives.21 Interestingly, of the four specific examples regarding the definition of interest in the proposed section 163(j) regulations, two of the four relate to such hedges. The first of the two examples related to hedges involves an interest rate swap. Treasury and the IRS would seem to be on firm ground when defining amounts received by entering into, or resulting from a termination or other disposition of, an interest rate swap as

14

Prop. reg. section 1.163(j)-1(b)(20)(i). Examples of items that fit into this general principle-based rule include original issue discount, certain qualified stated interest, market discount, repurchase premium, forgone interest under section 7872, as well as payments or amounts treated as interest under sections 483, 467, 988, 163(c), and 636.

15

A cleared swap with significant nonperiodic payments is excluded from this definition. See prop. reg. section 1.163(j)-1(b)(20)(ii)(A). The proposed section 163(j) regulations bifurcate the swap as two separate transactions including a loan that would generate interest. Id.

16Prop. reg. section 1.163(j)-1(b)(20)(iii).

17

See Preamble to REG-106089-18 (emphasis added).

18See sections 59A(i) and 267A(e).

19

Despite that Congress has otherwise provided for such a mandate regarding specific rules within the interest provision. See section 163(i)(5) and (l)(7).

20

Prop. reg. section 1.163(j)-1(b)(20)(iv). Note that this rule does not apply to any items of income or gain.

21

See prop. reg. section 1.163(j)-1(b)(20)(iii)(E).

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interest. The second of the two examples related to hedges involves a foreign currency swap.22 Here, Treasury and the IRS are on shakier ground because it is not altogether clear how all the foreign currency gain or loss resulting from the swap relates to the time value of money. But go a step further and consider a cross currency swap -- which may be tied closely to debt yet involve hedging only of the principal piece of the debt, and treating amounts derived therefrom as interest may be a bridge too far. As stated by the New York State Bar Association Tax Section, that treatment of derivatives raises "significant questions as to their scope."23 For instance, additional guidance is necessary to address the question of "how close of a connection is required between a specific derivative and a borrowing," especially regarding more complex situations such as where taxpayers enter into derivatives that hedge a group of liabilities on a macro level.24

The second of the interest-like amounts of concern is the treatment of debt issuance costs.25 Such costs -- for example, arranger fees and underwriter fees -- are not necessarily paid by borrowers to their lenders and are more appropriately attributable to services provided than to compensation for borrowed funds. The third is the treatment of guaranteed payments to partners.26 The proposed section 163(j) regulations could apply to treat any guaranteed payments for the use of capital that reflect payments for partnership equity to reflect debt instead.27 Other

22

See prop. reg. section 1.163(j)-1(b)(20)(v), example (2). In the example, a taxpayer borrows foreign currency from a bank at an interest rate, 1 percent, that is lower than that applicable to a loan for the U.S. dollar equivalent amount, 5 percent. The taxpayer simultaneously enters into a foreign currency swap transaction (FX Swap), not integrated with the loan under reg. section 1.988-5, that entitles it to receive an amount that is equal to the face amount of the note (in U.S. dollars) by paying 5 percent of the amount thereof (in U.S. dollars) to the bank in consideration for 1 percent of the face amount thereof (in the foreign currency) that it receives from the bank. The example concludes that FX Swap alters the taxpayer's cost of borrowing and, thus, the amounts paid by and to the taxpayer to and from the bank are treated as interest expense and reductions in interest expense, respectively.

23

NYSBA, "Tax Section Report on Proposed Section 163(j) Regulations" (Feb. 26, 2019).

24

Id.

25

See prop. reg. section 1.163(j)-1(b)(20)(iii)(H). 26Prop. reg. section 1.163(j)-1(b)(20)(iii)(I).

27

NYSBA has recommended that several of the interest-like amounts, including the three discussed herein, not be treated broadly as interest for section 163(j) purposes. See Recommendation A.2. of the NYSBA report, supra note 23.

commentators have raised concerns that the expansive definition of interest under section 163(j) might be applied elsewhere in the code,28 and they have also questioned whether Treasury and the IRS have the authority to promulgate it.

If guaranteed payments for the use of capital remain subject to the section 163(j) rules, partnership common equity may present an opportunity to avoid the section 163(j) rules. For businesses with stable cash flows, a would-be lender may be willing to take back a partnership interest which returns, say, 95 percent of profits to the lender until it recoups its investment plus a preferred return and thereafter 5 percent (or less perhaps). The section 163(j) rules should not apply to this type of partnership equity unless the IRS were able to successfully assert that such an arrangement should be treated as a guaranteed payment (for example, under standards similar to those articulated in the proposed fee-waiver regulations).

It is not clear to what extent, if any, Treasury and the IRS would narrow the definition of interest in the final section 163(j) regulations. Meanwhile, the TCJA blue book, released around the same time as the proposed section 163(j) regulations were issued, stated that "any amount treated as interest for purposes of the code is interest for purposes of the" section 163(j) provision.29 Thus, it appears that the blue book may support a narrower interpretation of what constitutes "interest" for purposes of section 163(j) -- one coextensive with just the general principle-based rule.

28See, e.g., Emily Foster, "Reg Authority for Broad Interest Definition Questioned," Tax Notes, Jan. 21, 2019, p. 326. This concern is not totally unfounded, given the equally expansive definition of "interest" contained in the proposed section 267A regulations.

29See Joint Committee on Taxation, "General Explanation of Public Law 115-97," JCS-1-18, at 174 (Dec. 2018) (the TCJA blue book).

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III. Extending the Rules to Partnerships

Before 2018 the section 163(j) rules applied only to corporations.30 The TCJA section 163(j) rules, however, also apply to partnerships.31 The extension of the section 163(j) rules to partnerships is the most technically challenging piece of the new regime, at least in part because of their purported treatment of partnerships as entities regarding the taxation of partnership income.32 Consistent with an entity approach, a partner's share of excess BIE from a partnership must be carried forward and may only be used to reduce that partner's share of ATI or business interest income from the same partnership allocated to that partner in a future year. In other words, excess BIE allocated to a partner may not be used by the partner to reduce the partner's directly, or otherwise indirectly, accrued ATI or business interest income from other sources.

A. Application at the Partnership Level

A partnership that incurs BIE must first determine its entity-level section 163(j) BIE limitation,33 total amount of deductible BIE (amounts that may be currently deducted under section 163(j)), and section 163(j) excess items.34 Section 163(j) excess items are the partnership's

30

Under the prior rules, however, a blocker that owned an interest in a partnership did take into account its allocable share of partnership items in determining the corporate-level interest deduction limitation. See former prop. reg. section 1.163(j)-3(b)(3), which was withdrawn by REG-106089-18.

31

See section 163(j)(4). 32This complexity prompted NYSBA to recommend that a statutory amendment be sought to apply the section 163(j) rules at the partner level rather than the partnership level. See Recommendation C.1. of the NYSBA report, supra note 23. These rules can be unwieldly when applied to a blocker that owns interests in a large number of partnerships or tiered partnership structures, which may be a reason the proposed section 163(j) regulations reserved on tiered passthrough structures. 33For purposes of computing a partnership's ATI, the partnership's taxable income is generally determined under section 703(a). See prop. reg. section 1.163(j)-6(d)(1). A partnership is also required to take into account items resulting from adjustments made to the basis of its property in accordance with section 734(b). See prop. reg. section 1.163(j)-6(d)(2). Partner basis items, defined as items from a section 743 adjustment, as well as remedial items are not taken into account in determining the partnership's ATI; instead, the partner that is allocated such items would take them into account in determining the partner's ATI. See prop. reg. section 1.163(j)-6(e)(2).

34

See prop. reg. section 1.163(j)-6(a)(6).

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excess BIE,35 excess taxable income (ETI),36 and excess business interest income.37 The amount of deductible BIE is taken into account in determining the "non-separately stated" taxable income and loss of the partnership, which is then allocated to the partners.38

The amount of deductible BIE so allocated at the partnership level is not subject to any further section 163(j) limitation at the partner level.39 A partnership that has any section 163(j) excess items must allocate such items to each partner in the same manner as it allocates each partner's share of non-separately stated taxable income or loss.40 Because the term non-separately stated taxable income or loss is not defined, the proposed section 163(j) regulations adopt a complex 11-step process to calculate these amounts.41

B. Application at the Partner Level

A partner that is allocated any nondeductible excess business interest expense from a partnership in a tax year would carry forward such excess at the partner level. In a later year, the partner may deduct any of the carried forward excess business interest expense, but only to the extent it is allocated any ETI or any excess business interest income generated by the same partnership in the later year.42 The partner first uses its share of ETI against any carried forward excess BIE from the partnership and may use any excess ETI to calculate its own section 163(j) limitation on BIE incurred outside the partnership.43 The partner is generally required to reduce its tax

35

Generally defined as the amount of disallowed BIE of the partnership for a tax year by reason of the section 163(j) BIE limitation. See prop. reg. section 1.163(j)-1(b)(14).

36

Generally defined as the amount of the partnership's ATI that has not been applied to its own section 163(j) BIE limitation. See prop. reg. section 1.163(j)-1(b)(15).

37Generally defined as the excess of the partnership's business interest income over its BIE in a tax year. See prop. reg. section 1.163(j)6(b)(4).

38

See prop. reg. section 1.163(j)-6(f).

39

See prop. reg. section 1.163(j)-6(c).

40

See prop. reg. section 1.163(j)-6(f)(1)(i).

41

See prop. reg. section 1.163(j)-6(f)(2). 42Prop. reg. section 1.163(j)-6(g)(2).

43

Section 163(j)(4)(B)(ii). This rule incorporates an element of a partnership aggregate approach, but one that applies only after the determination of ETI at the partnership level (i.e., an entity approach).

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basis in the partnership interest by the amount of excess BIE allocated.44 Immediately before it disposes of all or substantially all the partnership interest, a partner would increase the tax basis in its partnership interest by the amount of unused excess BIE from the partnership.45

A special "no double counting" rule ring fences each partner's respective share of partnership ATI and business interest income so that those partnership-level amounts generally may not be used again in computing ATI or business interest income at the partner level.46 According to the TCJA blue book, "in the absence of such rules, items of business income or adjusted taxable income of a partnership might be viewed as generating additional interest deductions when the partnership items are passed through to the partners."47 The blue book also contains an example that illustrates how this rule is intended to operate.48

Section 163(j) limits the deduction of BIE only and, hence, does not apply to the deduction of investment interest expense, which continues to be limited under section 163(d).49 Depending on its activities (or lack thereof), a partnership's interest expense may be BIE, or it may be investment interest expense. Yet all interest expense and interest income of a C corporation is per se BIE and business interest income, respectively, for purposes of section 163(j).50 Thus, any partnership-level investment interest expense or investment interest income allocable to a blocker is transformed at the corporate partner level; these amounts are treated as BIE or business interest income of the blocker, which takes them

into account in determining its own section 163(j) BIE limitation.51

The section 163(j) rules effectively eliminate the corporate taxpayer exception from the investment interest expense limitations of section 163(d), with an unfavorable rule that treats all interest expense, including investment interest expense, of a corporation as BIE. Assume that blocker is a partner in an investment partnership that generates passive income -- for example, dividends and capital gains. The partnership borrows funds and incurs interest expense. Before 2018 blocker would have been able to deduct all its allocable share of the partnership's investment interest expense because section 163(d) expressly does not apply to corporate taxpayers.52 As a result of the TCJA amendments and the proposed section 163(j) regulations, beginning in 2018, blocker may only be able to deduct a portion of the investment interest expense allocated from the partnership, because such interest would be recharacterized as BIE at the blocker level.53

IV. Electing Out of the Section 163(j) Rules

Taxpayers that engage in RPTOBs54 may elect not to be subject to the section 163(j) rules (excepted business).55 Section 163(j) defines a RPTOB by reference to section 469(c)(7)(C) as any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operations, management, leasing, or brokerage trade or business. The proposed section 163(j) regulations define "real property operation" and "real property management" but reserve on the other categories

44

Prop. reg. section 1.163(j)-6(h)(2).

45

Prop. reg. section 1.163(j)-6(h)(3).

46Section 163(j)(4)(A)(ii)(I) and prop. reg. section 1.163(j)-6(e)(4).

47

See the TCJA blue book, supra note 29, at 175-176.

48

Id.

49Section 163(j)(5). Section 163(d) generally limits the deduction for investment interest expense in a tax year to net investment income from the same tax year. This rule applies to any taxpayer "other than a corporation." See section 163(d)(1).

50

See prop. reg. section 1.163(j)-4(b)(1), which is consistent with the legislative history of section 163(j). See, e.g., H.R. Rep. 115-466, at 386 n.688 (2017).

51

See prop. reg. section 1.163(j)-6(j). On the other hand, a partnership that is engaging in a trade or business -- for example, a hedge fund whose activity in trading securities is regular, continuous, and substantial -- would be subject to the section 163(j) BIE limitation, and not the section 163(d) investment interest expense limitation, at the partnership level.

52

This example ignores the fact that before the TCJA, section 163(j) generally limited interest deductions for amounts paid to related foreign parties.

53

Depending on the facts, it may be more tax efficient for the blocker's foreign owner to hold the interest in the partnership directly if the investment is generating passive income and the foreign owner is eligible for reduced withholding tax for such income under the applicable income tax treaty.

54See section 163(j)(7)(A)(ii). Other businesses that may elect to be an excepted business include farming businesses. See section 163(j)(7)(A)(iii).

55

See section 163(j)(7)(B).

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of businesses that qualify as RPTOBs.56 Both definitions refer to the "day-to-day operations of a trade or business" involving real estate (emphasis added). The preamble to the proposed section 163(j) regulations, citing the legislative history of section 469(c)(7)(C), states that taxpayers engaged in trades or businesses that are not directly or substantially involved in the creation, acquisition, or management of rental real estate will generally not be treated as engaging in a RPTOB for this purpose.57

The RPTOB election, once made, is irrevocable and applies only to a taxpayer's eligible trade or business for which the election is made.58 Although this is generally a taxpayer favorable option, an eligible taxpayer must carefully think through the ramifications of making an election. For example, a taxpayer should consider each of the following issues when evaluating whether it should make the election to be an excepted business and, if so, when to make that election. As will become apparent after considering the following issues, the days of doing a back-of-theenvelope calculation of the limitation regarding a blocker's interest deductions are officially over.

A. Prior Years' Interest Expense Carryforwards

A blocker's election to be an excepted business potentially affects the deductibility of its prioryear interest expense carryforwards. Any disallowed interest carryforward from the preTCJA section 163(j) rules (that is, disallowed disqualified interest59) is generally carried forward to the blocker's first tax year beginning after 2017 and is subject to the section 163(j) rules, except to the extent it is properly allocable to an excepted business (for example, an electing RPTOB).60 Under the proposed section 163(j) regulations, disallowed disqualified interest carryforwards allocable to a RPTOB are lost effective the tax year the blocker elects to be an excepted business.

56

See prop. reg. section 1.469-9(b)(2)(ii). 57Preamble to REG-106089-18.

58

Prop. reg. section 1.163(j)-9(b)(1) and (2). 59See prop. reg. section 1.163(j)-1(b)(10).

60

Prop. reg. section 1.163(j)-11(b)(1).

TAX PRACTICE

Similarly, any disallowed BIE carryforwards from post-2017 tax years (disallowed BIE carryforwards61) allocable to a non-excepted business RPTOB are not re-allocated to such RPTOB after it elects to be an excepted business. Instead, the RPTOB's disallowed BIE carryforwards "continue to be treated as allocable to a non-excepted trade or business" regardless of whether or not such a non-excepted trade or business actually exists.62 Thus, a blocker with only an electing RPTOB (that is, no non-excepted trades or businesses) would lose the ability to deduct any disallowed BIE carryforwards, whereas one with both an electing RPTOB and a non-excepted trade or business may be able to use the disallowed BIE carryforwards, but only to the extent that they are properly allocable to the nonexcepted trade or business.63

Thus, a blocker with disallowed disqualified interest carryforwards or disallowed BIE carryforwards allocable to a RPTOB will need to determine whether the benefit of electing to be treated as an excepted business, and therefore not being subject to the section 163(j) rules going forward, outweighs the cost of losing the benefit of deducting its interest expense carryforward amounts from prior years. Further, if the blocker determines it should so elect, it should also consider whether the election should be made in 2018 or in a later tax year.

B. Depreciation and NOL Deductions

An electing blocker is required to use the alternative depreciation system (ADS) of section 168(g), rather than modified accelerated cost recovery systems of section 168(a) for real properties and "qualified improvement properties."64 This requirement applies to tax years beginning after 2017 without regard to

61See prop. reg. section 1.163(j)-1(b)(9).

62

Prop. reg. section 1.163(j)-10(c)(4).

63

Id. 64See section 4.02 of Rev. Proc. 2019-8, 2019-3 IRB, and section 168(g)(1)(F). The definitions of residential rental property, nonresidential real property, and qualified improvement property are in section 168(e)(2)(A), (B), and (6), respectively (any of the foregoing section 168(g)(8) property). The definition of qualified improvement property, added by the TCJA, is "any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service." See section 13204(a)(4)(B)(i) of the TCJA.

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