Business Interest Deduction Limitation: Should You Opt-Out? – Seth Gilson, Partner, CPA

Our winter newsletter addressed interest deduction limitations under the Tax Cuts and Jobs Act of 2017, Section 163(j). In general, the new section limits the deduction of business interest expense to the sum of the following:

1. Business interest income, plus
2. 30% of the adjusted taxable income, plus
3. Floor plan financing interest

Your cooperative most likely will only be concerned with items 1 and 2 above. In addition, the new tax law provides an option for “specified agricultural and horticultural cooperatives” to opt-out of this limitation. The opt-option is irrevocable.

The election comes with a requirement that will restrict a cooperative’s choice on depreciating certain assets. Under Section 168 (g)(1)(G), “property with a recovery period of 10 years or more…held by an electing farming business” must depreciate all assets held using the alternative depreciation system (ADS). This method tends to depreciate assets slower and uses the straight-line method.

The IRS clarified the meaning of “all assets held”, when it released Rev. Proc. 2019-08. In Section 4.02 of this revenue procedure, the IRS defined these assets to consist of “existing property” and “newly acquired property.” Taxpayers will not re-calculate depreciation on the “existing property,” rather the remaining depreciable basis will begin to depreciate under the ADS method in the year of election. In addition, under this election the use of bonus depreciation is not available.

In general, the limitation on interest deduction does not appear to be a pressing concern for most cooperatives today. If the law stands as it is, this general rule could change beginning with tax year 2022, when changes to the calculation to derive limitation amounts occur.

Hopefully, your cooperative’s management team and board have been thinking about this topic. We encourage you to work through some possible scenarios before your fiscal year-end.