When you take out a loan to expand a commercial property or upgrade farm equipment, you expect to deduct those financing costs on your tax return. However, a federal rule known as Section 163(j) caps the amount of interest expense a business can deduct in a single year. To avoid this limitation, many heavily capitalized companies originally opted out of the restriction, accepting slower depreciation schedules for their property and equipment as a necessary trade-off.
While business decisions are based on the tax rules in effect at the time, changes in tax law can alter those long-term financial calculations. Here’s a breakdown of how Section 163(j) functions, the mechanics of the election, and how these recent updates affect your tax planning.
How Does the Section 163(j) Interest Deduction Limit Work?
Section 163(j) of the Internal Revenue Code places a cap on how much business interest expense a company can deduct in a single tax year. According to the IRS, your annual deduction cannot exceed the sum of your business interest income, 30% of adjusted taxable income, calculated by adding back depreciation, amortization, and depletion to taxable income, and floor plan financing interest expense. This figure is referred to as ATI. Any interest expense that exceeds this annual limitation is carried forward for use in future tax years.
Who does this apply to?
The Section 163(j) limitation applies to all taxpayers with business interest expense, with a few key exceptions. You are generally exempt from the rule if your business is a:
- Small business that can meet the gross receipts test for the current tax year.
- Company with average annual gross receipts of $25 million or less over the previous three years, a threshold that the IRS adjusts annually for inflation.
If your corporate or partnership operation carries substantial debt or operates above that gross receipts threshold, Section 163(j) is a factor you must account for in your annual filing.
What Does a 163(j) Election Mean?
Certain types of businesses can opt out of the interest deduction cap entirely by electing to be an excepted trade or business. Real estate businesses and farming operations are the most common candidates for this choice, which allows you to deduct your business interest expense in full for the year it is incurred. However, this choice comes with a specific trade-off. If you elect out as a real property trade or business, your assets must be depreciated using the alternative depreciation system (ADS) and lose eligibility for bonus depreciation. Farming businesses face similar property restrictions, particularly on assets with recovery periods of 10 years or more.
What Regulatory Changes Apply to the Section 163(j) Election?
The One Big Beautiful Bill Act altered how adjusted taxable income (ATI) is calculated for certain tax years, in some cases allowing depreciation, amortization, and depletion to be added back to taxable income when calculating ATI. This produces a higher ATI figure, which in turn raises the cap on deductible business interest expense for businesses still subject to the limitation.
Here’s why this also matters for those who previously elected out:
- Past trade-offs have changed: Many real estate and farming operations originally elected out to avoid the interest cap, accepting slower depreciation as the cost.
- Depreciation benefits have shifted: With bonus depreciation restored to 100% under current law, companies that maintained an opt-out stance may now be forgoing a depreciation benefit that was previously unavailable.
- The IRS provided withdrawal guidance: The IRS released Rev. Proc. 2026-17, establishing a formal pathway for eligible farming and real estate operations to withdraw those prior elections.
Whether the updated calculation or the withdrawal option is relevant to your business depends on your specific circumstances, and a CPA can help you work through that analysis.
Is It Time to Review Your 163(j) Election?
Withdrawing a prior election requires a business to file amended tax returns for the original election year as well as all subsequent impacted years. Partnerships and S corporations must also issue amended K-1s to their owners, who then must amend their individual returns. Because this process demands a careful review across multiple filing years, decisions should be made with thorough analysis.
Before moving forward, here are a few questions to review with your tax advisor:
- How much bonus depreciation did the business give up by making the original election?
- Does that depreciation figure outweigh the interest deductions that were preserved over time?
- Does your business hold assets such as qualified improvement property, agricultural structures, or long-lived farm equipment for which accelerated depreciation changes the math?
- What does the complete financial picture look like when accounting for any income adjustments resulting from amended returns?
Businesses that frequently complete tenant improvements, along with capital-intensive farming, ranching, and horticultural operations, are often the strongest candidates for this multi-year tax review.
How Can MBE CPAs Help You with Section 163(j)?
Determining whether to maintain or withdraw a Section 163(j) election requires a close look at both your interest expenses and your depreciation history. The specialists at MBE CPAs can help you analyze how these overlapping calculations apply to your historical filings and future tax positioning. Reach out to our team to start your review.