Qualified Residential Living Facilities Granted Safe Harbor Election for IRC Section 163(j) Deductions by IRS

The IRS recently released Revenue Procedure 2021-9, creating a safe harbor allowing taxpayers that manage or operate qualified residential living facilities to be treated as a real property trade or business (RPTB) exclusively for purposes of qualifying as an electing RPTB under section 163(j)(7)(B) of the Internal Revenue Code (IRC). This revenue procedure will apply to taxable years beginning after December 31, 2017.

On December 22, 2017, the Tax Cuts and Jobs Act was passed, amending IRC Section 163(j) to limit the business interest expense deduction of taxpayers to the sum of: (1) business interest income for the taxable year, (2) 30% of adjusted taxable income (50% for any tax year beginning in 2019 or 2020 under the CARES Act), and (3) floor plan financing interest expense. With the exception of certain small businesses meeting the gross-receipts test in IRC Section 448(c), and certain trades or businesses listed in IRC Section 163(j)(7), the 163(j) interest expense limitation applies to taxable years beginning after December 31, 2017. One of the trades or businesses exempt from the interest limitation rules is an electing RPTB.

An RPTB is any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. If electing to be treated as an RPTB, the taxpayer must depreciate its nonresidential real property, residential rental property, and qualified improvement property, using the alternative depreciation system (ADS). The ADS system will usually result in a lower amount of depreciation deductions each year. Generally, the RPTB election is a one-time irrevocable election applying to the taxable year the election is made and all subsequent years, until the taxpayer ceases to engage in the electing trade or business.

Under Revenue Procedure 2021-9, a safe harbor is made available to treat a trade or business managing or operating residential living facilities as an electing RPTB, if the residential living facility:

1. Consists of multiple rental dwelling units within one or more buildings or structures that generally serve as primary residences on a permanent or semi- permanent basis to individual customers or patients;
2. Provides supplemental assistive, nursing, or other routine medical services; and
3. Has an average period of customer or patient use of individual rental dwelling units of 30 days or more.

The above testing for the safe harbor is done on an annual basis. Thus, if the taxpayer fails to meet the safe harbor, the taxpayer is deemed to have ceased to be an electing RPTB under the safe harbor. Unless the taxpayer would be considered a RPTB without the safe harbor, the taxpayer would then become subject to the 163(j) interest limitation rules.

01/15/2021