New Law Limits Deduction for Business Interest Expense

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Starting in 2018, the Tax Cuts and Jobs Act limits the amount of business interest expense that a company may deduct from its taxable income. The interest deduction is generally limited to 30 percent of the business's adjusted taxable income. This limitation is imposed on corporations, partnerships (including LLCs taxed as partnerships), and sole proprietorships, but it does not apply to businesses that averaged under $25 million of revenue over the prior three years.

 

For those businesses to which the limit applies, business interest deduction is limited to the total of the following three items:

  1. Business interest income,
  2. 30 percent of adjusted taxable income, plus
  3. Floor plan financing (this is specific to auto retailers). 

Real estate businesses may elect to deduct the full business interest expense if they accept moderately longer depreciable lives for certain new property. The election is available to a real estate firm in rental, operation, management, leasing, development, construction, acquisition, conversion, or brokerage. A company that makes this election must use a 40-year life to depreciate new commercial real estate property, 30 years for residential rental property, and 20 years for qualified improvement property (the normal lives for these assets are 39 years, 27.5 years, and 15 years respectively). Existing properties will continue with their original schedule.

 

Any disallowed interest expense may be carried forward to subsequent years, subject to the same limitation in those years. For a passthrough entity such as a partnership, LLC, or S corp, the taxable income limitation is determined at the business level, but any disallowed interest is passed through to the partner or shareholder. It may be used in a subsequent year only against any share of income from that entity not used for that year's interest expense.

 

If you have any questions on how the deduction for interest expense will affect your tax liability, please contact your LMC professional.


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