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An Overlooked Tax Benefit for Construction Firms: Business Interest Limitation Changes
The Tax Cuts and Jobs Act (TCJA) of 2017 was generally a taxpayer-friendly legislation for the business community. However, there were several provisions in that Act that were implemented as revenue raisers to partially offset the cost of those tax breaks. One of those revenue raising provisions was the business interest expense limitation. This limitation can potentially impact construction companies of all entity types. The recently passed Coronavirus Aid, Relief and Economic Security (CARES) Act modified and increased the existing 30% business interest limitation to 50% for the years beginning with 2019 and 2020. For partnerships, this will not apply to years beginning with 2019, but only for 2020.
The excess interest not deducted for any year is carried forward indefinitely and can potentially be deducted in a subsequent year if the construction company has sufficient taxable income.
There are several exemptions from the business interest limitation. The Small Business Taxpayer Exception exempts construction companies with average gross receipts of less than $26 million* for the three preceding tax years. You may have to “aggregate” the revenue of related businesses when measuring against the $26 million limit.
A second exemption, often overlooked by construction firms, allows qualifying real property trades or businesses to simply elect out of these limitations and deduct all of their interest expense. Many construction companies don’t realize that “construction” can fit into this category, allowing them to elect out as well, and deduct all of their interest expense. The potential downside to making the election is that it requires the electing taxpayer to depreciate all their real property using the less favorable, longer lives, of the Alternative Depreciation System (ADS). Since most construction companies do not own much real property or the property is held in a separate company, this “downside” may not be significant when compared with the potential limitations on their interest expense deduction. The business would be required to apply the ADS rules to both newly-acquired and previously-existing real property.
Every tax deduction is helpful in these challenging times. Construction companies affected by the business interest limitations must weigh the benefit of making the election and getting the immediate interest deduction against the cost of the longer depreciation lives for the assets. The decision should not be made based on the one year tax effect, as the election is irrevocable. Instead, affected companies should make a decision based on an analysis of the long term tax ramifications. Of course the decision process should always involve consultation with a professional tax adviser. Please contact Paul Gevertzman at [email protected] or your Anchin Relationship Partner for further information.
Disclaimer: Please note this is based on the information that is currently available and is subject to change.
*The Small Business Taxpayer Exception was indexed for inflation. For 2019, the gross receipts threshold is $26 million.