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Did you Know: Interest Expense Limitations

Did you know the Tax Cuts and Jobs Act (TCJA) could limit the amount of interest a business is able to deduct for tax years beginning after 2017?  The business interest deduction limit doesn’t apply to small businesses – defined as those whose average annual gross receipts for the preceding three years is $25 million or less.  Keep in mind though that related businesses must aggregate their gross receipts for purposes of this test, to avoid companies splitting into smaller entities to avoid the limit.  If your business is subject to the limitation, then your interest expense can’t exceed the sum of:

  1. your business interest income
  2. your floor plan financing interest, and;
  3. 30% of your adjusted taxable income.

Adjusted taxable income is taxable income, computed without regard to:

  • Nonbusiness income, gain, deduction, or loss
  • Business interest income or expense
  • Net operating loss deductions
  • For tax years beginning before 2022 – depreciation, amortization, or depletion

Keep in mind that applicability must be determined on a year by year basis, as businesses can fluctuate under or above the $25 million limit.  Disallowed interest expense may be carried forward indefinitely.

If your business is subject to the interest expense limitation, and you have a real property business (defined as development, construction, reconstruction, acquisition, conversion, rental, operation, management, lending and brokerage businesses) – you can elect not to apply the limits.  The downside of this irrevocable election is that you must depreciate certain business property under the alternative depreciation system (ADS).  This means longer recovery periods and lower depreciation deductions.

To determine whether making the election makes sense for your business, you need to weigh the benefits of unrestricted business interest deductions against the cost of lower depreciation.

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