A Section 163(j) election lets a qualifying real property trade or business or farming business opt out of the business interest expense limitation and deduct all of its interest in the current year, in exchange for a permanent switch to the Alternative Depreciation System on specified assets. The election is made by attaching a statement to a timely filed return, it is irrevocable without IRS consent, and for tax years beginning in 2026 the underlying math has shifted in ways that make the decision less obvious than it was a year ago.
What Changed for 2026
Section 163(j) caps a business’s annual interest deduction at the sum of its interest income, 30% of adjusted taxable income (ATI), and any floor plan financing interest. Interest above the cap is disallowed for the current year and carries forward indefinitely.1Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
Two changes drive the 2026 analysis. First, the One, Big, Beautiful Bill Act (OBBBA) restored the add-back of depreciation, amortization, and depletion to ATI for tax years beginning after December 31, 2024.1Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense From 2022 through 2024, those items could not be added back, which shrank ATI and tightened the cap on capital-heavy businesses. ATI is now calculated on roughly an EBITDA basis again, so many businesses that were bumping against the limitation in those years may find they have enough headroom under the 30% cap without electing at all.
Second, OBBBA permanently restored 100% bonus depreciation for qualified property acquired after January 19, 2025.2Internal Revenue Service. Notice 2026-11, Interim Guidance on Additional First Year Depreciation Deduction Because ADS-required property does not qualify for bonus depreciation, the price of electing out is now higher than it was during the 2023 and 2024 phasedown years, when bonus was already stepping down to 80% and 60%.
Who Qualifies
Two categories of business can make the election: a real property trade or business and a farming business.1Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense A real property trade or business covers developing, constructing, acquiring, renting, operating, or managing real property, which reaches most participants in commercial and residential real estate, including property managers and brokerages.
The election only matters if the business is actually subject to the limitation in the first place. Businesses that meet the Section 448(c) small business gross receipts test are exempt from 163(j) entirely. The threshold was $31 million in average annual gross receipts over the prior three years for 20253Internal Revenue Service. Revenue Procedure 2024-40 and rises to $32 million for 2026. If your three-year average is below that number, you have nothing to elect out of.
One trap: related entities under common control must aggregate their receipts. A holding company cannot split operations across five LLCs and treat each separately.1Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
The Depreciation Price
An electing real property trade or business must use ADS for all nonresidential real property, residential rental property, and qualified improvement property (QIP).4Internal Revenue Service. Publication 946 (2025), How To Depreciate Property The impact comes from two places.
Longer Recovery Periods
Nonresidential real property moves from a 39-year life under the General Depreciation System to 40 years under ADS. Residential rental goes from 27.5 to 30 years.4Internal Revenue Service. Publication 946 (2025), How To Depreciate Property Those differences are modest. QIP takes the harder hit, moving from a 15-year GDS period to a significantly longer ADS period. Annual deductions shrink and get spread over more years, raising near-term taxable income.
Loss of Bonus Depreciation
Assets required to be depreciated under ADS do not qualify for 100% bonus depreciation. Electing out permanently gives up first-year expensing on nonresidential real property, residential rental property, and QIP acquired from the election year forward. With 100% bonus depreciation now permanent, that is a much larger giveback than it was during the phasedown.
Prospective Only
The ADS requirement applies to property placed in service in the election year and afterward. Assets already in service continue on their original method. But the requirement is mandatory on every qualifying asset acquired from the election year onward, for as long as the business exists.
Farming Businesses
An electing farming business must use ADS for any asset with a recovery period of 10 years or more.1Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense That reaches single-purpose agricultural structures, fruit and nut trees and vines, and farm buildings. Shorter-lived equipment like tractors and harvest machinery, typically 5-year or 7-year property, stays on GDS and remains eligible for bonus depreciation. Farms with heavy investment in orchards and structures should model the ADS cost carefully before electing.
Partnerships and S Corporations
The limitation is applied at the entity level for both partnerships and S corporations, but disallowed interest is handled very differently.
Partnerships
A partnership runs the 163(j) calculation on its own numbers. Allowed interest flows through as part of ordinary income or loss. Disallowed interest is allocated to partners as excess business interest expense (EBIE), and the carryforward sits at the partner level, not the partnership level.1Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
A partner can deduct carried EBIE only when the same partnership later allocates excess taxable income or excess business interest income. The deduction is tied to that specific partnership. And when EBIE finally converts to deductible interest, it still has to clear the partner’s own 163(j) limitation if one applies.
When a partnership makes the election, it binds the whole partnership. Partners cannot individually opt in or out, and Form 1065 must reflect the election status.
S Corporations
An S corporation applies the limitation at the entity level and keeps the disallowed carryforward at the entity level. It is not pushed out to shareholders.1Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense That simplifies shareholder tracking but means the disallowed interest is usable only when the S corporation itself generates enough ATI or interest income later.
How to Make the Election
There is no dedicated IRS form. You attach a statement to a timely filed federal return, including extensions. The statement must be titled “Section 1.163(j)-9 Election” and include, for each electing trade or business:5eCFR. 26 CFR 1.163(j)-9 – Elections for Excepted Trades or Businesses
- Taxpayer name, address, and EIN or SSN.
- A description sufficient to show the business qualifies, including the principal business activity code.
- A statement that the taxpayer is electing under Section 163(j)(7)(B) for a real property trade or business, or Section 163(j)(7)(C) for a farming business.
Partnerships attach the statement to Form 1065, C corporations to Form 1120, and S corporations to Form 1120-S. A single entity running multiple qualifying trades or businesses can elect for each one independently. A corporation with both a real estate operation and a manufacturing division can elect only for the real estate side, and the ADS requirement then reaches only the assets in that elected activity.
Timing
Make the election for the first tax year the business is actually subject to 163(j). Missing that window does not bar you permanently, but it forces you to request late election relief from the IRS, which adds uncertainty and cost.
Irrevocability
The election is irrevocable without IRS consent.5eCFR. 26 CFR 1.163(j)-9 – Elections for Excepted Trades or Businesses Once filed, you are locked into full interest deductibility and mandatory ADS on every future qualifying asset. Revocation requires going through an IRS consent process that is not routinely granted. Treat it as permanent.
When the Election Actually Makes Sense
The restored ATI formula means fewer businesses will need the election in 2026 than in the three years prior. Before running the numbers, weigh these factors:
- Leverage against earnings. A highly leveraged business whose interest expense exceeds 30% of ATI benefits most. If the EBITDA-based ATI now gives you enough headroom, you may not need the election at all.
- Capital expenditure plans. Businesses with heavy upcoming property acquisitions or improvements pay a steeper price, because every new qualifying asset goes on ADS and loses 100% bonus. Low-capex, high-debt businesses get the better deal.
- Existing carryforwards. A large stock of disallowed business interest from prior years does not disappear when you elect. Model whether those carryforwards will be absorbed naturally as ATI grows under the restored formula.
- Entity structure. Partners saddled with EBIE they cannot use because the partnership does not generate excess taxable income may find that an entity-level election is the cleaner fix.
The irrevocability is what should slow you down the most. A business that elects out in a high-leverage year and later pays down its debt can spend decades stuck with ADS depreciation on new buildings and improvements long after the interest limitation would have stopped binding. Run a multi-year model that accounts for projected debt levels, capital spending, and the restored ATI formula before committing. Getting the decision wrong in one direction costs you a few years of carryforwards. Getting it wrong the other way costs you decades of reduced depreciation on every building and improvement you buy.