proposed regulations section 1 163(j) 6(j)

26 CFR § 1.163(j)-6 - Application of the section 163(j) limitation to partnerships and subchapter S corporations.

(a) Overview. If a deduction for business interest expense of a partnership or an S corporation is subject to the section 163(j) limitation , section 163(j)(4) provides that the section 163(j) limitation applies at the partnership or S corporation level and any deduction for business interest expense is taken into account in determining the nonseparately stated taxable income or loss of the partnership or S corporation . Once a partnership or an S corporation determines its business interest expense , business interest income , ATI, and floor plan financing interest expense , the partnership or S corporation calculates its section 163(j) limitation by applying the rules of § 1.163(j) –2(b) and this section. Paragraph (b) of this section provides definitions used in this section. Paragraph (c) of this section provides rules regarding the character of a partnership 's deductible business interest expense and excess business interest expense . Paragraph (d) of this section provides rules regarding the calculation of a partnership 's ATI and floor plan financing interest expense . Paragraph (e) of this section provides rules regarding a partner 's ATI and business interest income . Paragraph (f) of this section provides an eleven-step computation necessary for properly allocating a partnership 's deductible business interest expense and section 163(j) excess items to its partners. Paragraph (g) of this section applies carryforward rules at the partner level if a partnership has excess business interest expense . Paragraph (h) of this section provides basis adjustment rules, and paragraph (k) of this section provides rules regarding investment items of a partnership . Paragraph (l) of this section provides rules regarding S corporations . Paragraph (m) of this section provides rules for partnerships and S corporations not subject to section 163(j). Paragraph (o) of this section provides examples illustrating the rules of this section.

(b) Definitions. In addition to the definitions contained in § 1.163(j) –1, the following definitions apply for purposes of this section.

(1) Section 163(j) items. The term section 163(j) items means the partnership or S corporation 's business interest expense , business interest income , and items comprising ATI.

(2) Partner basis items. The term partner basis items means any items of income , gain, loss , or deduction resulting from either an adjustment to the basis of partnership property used in a non-excepted trade or business made pursuant to section 743(b) or the operation of section 704(c)(1)(C)(i) with respect to such property . Partner basis items also include section 743(b) basis adjustments used to increase or decrease a partner 's share of partnership gain or loss on the sale of partnership property used in a non-excepted trade or business (as described in § 1.743 –1(j)(3)(i)) and amounts resulting from the operation of section 704(c)(1)(C)(i) used to decrease a partner 's share of partnership gain or increase a partner 's share of partnership loss on the sale of such property .

(3) Remedial items. The term remedial items means any allocation to a partner of remedial items of income , gain, loss , or deduction pursuant to section 704(c) and § 1.704 –3(d).

(4) Excess business interest income. The term excess business interest income means the amount by which a partnership 's or S corporation 's business interest income exceeds its business interest expense in a taxable year .

(5) Deductible business interest expense. The term deductible business interest expense means the amount of a partnership 's or S corporation 's business interest expense that is deductible under section 163(j) in the current taxable year following the application of the limitation contained in § 1.163(j) –2(b).

(6) Section 163(j) excess items. The term section 163(j) excess items means the partnership 's excess business interest expense , excess taxable income , and excess business interest income .

(7) Non-excepted assets. The term non-excepted assets means assets from a non-excepted trade or business .

(8) Excepted assets. The term excepted assets means assets from an excepted trade or business .

(c) Business interest income and business interest expense of a partnership —

(1) Modification of business interest income for partnerships. The business interest income of a partnership generally is determined in accordance with § 1.163(j) –1(b)(4). However, to the extent that interest income of a partnership that is properly allocable to trades or businesses that are per se non-passive activities is allocated to partners that do not materially participate (within the meaning of section 469), as described in § 1.469 –1T(e)(6) and subject to section 163(d)(5)(A)(ii), such interest income shall not be considered business interest income for purposes of determining the section 163(j) limitation of a partnership pursuant to § 1.163(j) –2(b). A per se non-passive activity is an activity that is not treated as a passive activity for purposes of section 469 regardless of whether the owners of the activity materially participate in the activity .

(2) Modification of business interest expense for partnerships. The business interest expense of a partnership generally is determined in accordance with § 1.163(j) –1(b)(3). However, to the extent that interest expense of a partnership that is properly allocable to trades or businesses that are per se non-passive activities is allocated to partners that do not materially participate (within the meaning of section 469), as described in § 1.469 –1T(e)(6) and subject to section 163(d)(5)(A)(ii), such interest expense shall not be considered business interest expense for purposes of determining the section 163(j) limitation of a partnership pursuant to § 1.163(j) –2(b).

(3) Transition rule. With respect to a partner in a partnership engaged in a trade or business described in § 1.469 –1T(e)(6) and subject to section 163(d)(5)(A)(ii), if such partner had been allocated EBIE from the partnership with respect to the trade or business described in § 1.469 –1T(e)(6) and subject to section 163(d)(5)(A)(ii) in any prior taxable year in which the partner did not materially participate, such partner may treat such excess business interest expense not previously treated as paid or accrued under § 1.163(j) –6(g)(2) as paid or accrued by the partner in the first taxable year ending on or after the effective date of the final regulations and not subject to further limitation under section 163(j) or 163(d).

(4) Character of business interest expense. If a partnership has deductible business interest expense , such deductible business interest expense is not subject to any additional application of section 163(j) at the partner -level because it is taken into account in determining the nonseparately stated taxable income or loss of the partnership . However, for all other purposes of the Code, deductible business interest expense and excess business interest expense retain their character as business interest expense at the partner -level. For example , for purposes of section 469, such business interest expense retains its character as either passive or non-passive in the hands of the partner . Additionally, for purposes of section 469, deductible business interest expense and excess business interest expense from a partnership remain interest derived from a trade or business in the hands of a partner even if the partner does not materially participate in the partnership 's trade or business activity . For additional rules regarding the interaction between sections 465, 469, and 163(j), see § 1.163(j) –3.

(d) Adjusted taxable income of a partnership —(1) Tentative taxable income of a partnership. For purposes of computing a partnership 's ATI under § 1.163(j) –1(b)(1), the tentative taxable income of a partnership is the partnership 's taxable income determined under section 703(a), but computed without regard to the application of the section 163(j) limitation .

(2) Section 734(b), partner basis items, and remedial items. A partnership takes into account items resulting from adjustments made to the basis of its property pursuant to section 734(b) for purposes of calculating its ATI pursuant to § 1.163(j) –1(b)(1). However, partner basis items and remedial items are not taken into account in determining a partnership 's ATI under § 1.163(j) –1(b)(1). Instead, partner basis items and remedial items are taken into account by the partner in determining the partner 's ATI pursuant to § 1.163(j) –1(b)(1). See Example 6 in paragraph (o)(6) of this section.

(3) Section 743(b) adjustments and publicly traded partnerships. Solely for purposes of § 1.163(j) –6, a publicly traded partnership , as defined in § 1.7704 –1, shall treat the amount of any section 743(b) adjustment of a purchaser of a partnership unit that relates to a remedial item that the purchaser inherits from the seller as an offset to the related section 704(c) remedial item . For this purpose, § 1.163(j) –6(e)(2)(ii) applies. See Example 25 in paragraph (o)(25) of this section.

(4) Modification of adjusted taxable income for partnerships. The adjusted taxable income of a partnership generally is determined in accordance with § 1.163(j) –1(b)(1). However, to the extent that the items comprising the adjusted taxable income of a partnership that are properly allocable to trades or businesses that are per se non-passive activities are allocated to partners that do not materially participate (within the meaning of section 469), as described in section 163(d)(5)(A)(ii), such partnership items shall not be considered adjusted taxable income for purposes of determining the section 163(j) limitation of a partnership pursuant to § 1.163(j) –2(b).

(5) Election to use 2019 adjusted taxable income for taxable years beginning in 2020. In the case of any taxable year beginning in 2020, a partnership may elect to apply this section by substituting its adjusted taxable income for the last taxable year beginning in 2019 for the adjusted taxable income for such taxable year (post-election ATI or 2019 ATI). See § 1.163(j) –2(b)(4) for the time and manner of making or revoking this election . An electing partnership determines each partner 's allocable ATI (as defined in paragraph (f)(2)(ii) of this section) by using the partnership 's 2019 section 704 income , gain, loss , and deduction as though such amounts were recognized by the partnership in 2020. See Example 34 in paragraph (o)(34) of this section.

(e) Adjusted taxable income and business interest income of partners —(1) Modification of adjusted taxable income for partners. The ATI of a partner in a partnership generally is determined in accordance with § 1.163(j) –1(b)(1), without regard to such partner 's distributive share of any items of income , gain, deduction, or loss of such partnership , except as provided for in paragraph (m) of this section, and is increased by such partner 's distributive share of such partnership 's excess taxable income determined under paragraph (f) of this section. For rules regarding corporate partners, see § 1.163(j)–4(b)(3).

(2) Partner basis items and remedial items. Partner basis items and remedial items are taken into account as items derived directly by the partner in determining the partner 's ATI for purposes of the partner 's section 163(j) limitation . If a partner is allocated remedial items, such partner 's ATI is increased or decreased by the amount of such items. Additionally, to the extent a partner is allocated partner basis items, such partner 's ATI is increased or decreased by the amount of such items. See Example 6 in paragraph (o)(6) of this section.

(3) Disposition of partnership interests. If a partner recognizes gain or loss upon the disposition of interests in a partnership , and the partnership in which the interest is being disposed owns only non-excepted trade or business assets, the gain or loss on the disposition of the partnership interest is included in the partner 's ATI. See § 1.163(j) –10(b)(4)(ii) for dispositions of interests in partnerships that own—

(i) Non-excepted assets and excepted assets; or

(ii) Investment assets; or

(iii) Both.

(4) Double counting of business interest income and floor plan financing interest expense prohibited. For purposes of calculating a partner 's section 163(j) limitation , the partner does not include—

(i) Business interest income from a partnership that is subject to section 163(j), except to the extent the partner is allocated excess business interest income from that partnership pursuant to paragraph (f)(2) of this section; and

(ii) The partner 's allocable share of the partnership 's floor plan financing interest expense , because such floor plan financing interest expense already has been taken into account by the partnership in determining its nonseparately stated taxable income or loss for purposes of section 163(j).

(5) Partner basis items, remedial items, and publicly traded partnerships. Solely for purposes of § 1.163(j) –6, a publicly traded partnership , as defined in § 1.7704 –1, shall either allocate gain that would otherwise be allocated under section 704(c) based on a partner 's section 704(b) sharing ratios, or, for purposes of allocating cost recovery deductions under section 704(c), determine a partner 's remedial items, as defined in § 1.163(j) –6(b)(3), based on an allocation of the partnership 's asset basis (inside basis) items among its partners in proportion to their share of corresponding section 704(b) items (rather than applying the traditional method, described in § 1.704 –3(b)). See Example 24 in paragraph (o)(24) of this section.

(f) Allocation and determination of section 163(j) excess items made in the same manner as nonseparately stated taxable income or loss of the partnership —(1) Overview —(i) In general. The purpose of this paragraph is to provide guidance regarding how a partnership must allocate its deductible business interest expense and section 163(j) excess items, if any, among its partners. For purposes of section 163(j)(4) and this section, allocations and determinations of deductible business interest expense and section 163(j) excess items are considered made in the same manner as the nonseparately stated taxable income or loss of the partnership if, and only if, such allocations and determinations are made in accordance with the eleven-step computation set forth in paragraphs (f)(2)(i) through (xi) of this section. A partnership first determines its section 163(j) limitation , total amount of deductible business interest expense , and section 163(j) excess items under paragraph (f)(2)(i) of this section. The partnership then applies paragraphs (f)(2)(ii) through (xi) of this section, in that order, to determine how those items of the partnership are allocated among its partners. At the conclusion of the eleven-step computation set forth in paragraphs (f)(2)(i) through (xi) of this section, the total amount of deductible business interest expense and section 163(j) excess items allocated to each partner will equal the partnership 's total amount of deductible business interest expense and section 163(j) excess items.

(ii) Relevance solely for purposes of section 163(j). No rule set forth in paragraph (f)(2) of this section prohibits a partnership from making an allocation to a partner of any item of partnership income , gain, loss , or deduction that is otherwise permitted under section 704 and the regulations under section 704 of the Code. Accordingly, any calculations in paragraphs (f)(2)(i) through (xi) of this section are solely for the purpose of determining each partner 's deductible business interest expense and section 163(j) excess items and do not otherwise affect any other provision under the Code, such as section 704(b). Additionally, floor plan financing interest expense is not allocated in accordance with paragraph (f)(2) of this section. Instead, floor plan financing interest expense of a partnership is allocated to its partners under section 704(b) and is taken into account as a nonseparately stated item of loss for purposes of section 163(j).

(iii) Exception applicable to publicly traded partnerships. Publicly traded partnerships , as defined in § 1.7704 –1, do not apply the rules in paragraph (f)(2) of this section to determine a partner 's share of section 163(j) excess items. Rather, publicly traded partnerships determine a partner 's share of section 163(j) excess items by applying the same percentage used to determine the partner 's share of the corresponding section 704(b) items that comprise ATI.

(2) Steps for allocating deductible business interest expense and section 163(j) excess items —(i) Partnership-level calculation required by section 163(j)(4)(A). First, a partnership must determine its section 163(j) limitation pursuant to § 1.163(j) –2(b). This calculation determines a partnership 's total amounts of excess business interest income , excess taxable income , excess business interest expense (that is, the partnership 's section 163(j) excess items), and deductible business interest expense under section 163(j) for a taxable year .

(ii) Determination of each partner's relevant section 163(j) items. Second, a partnership must determine each partner 's allocable share of each section 163(j) item under section 704(b) and the regulations under section 704 of the Code, including any allocations under section 704(c), other than remedial items . Only section 163(j) items that were actually taken into account in the partnership 's section 163(j) calculation under paragraph (f)(2)(i) of this section are taken into account for purposes of this paragraph (f)(2)(ii). Partner basis items, allocations of investment income and expense, remedial items, and amounts determined for the partner under § 1.163–8T are not taken into account for purposes of this paragraph (f)(2)(ii). For purposes of paragraphs (f)(2)(ii) through (xi) of this section, the term allocable ATI means a partner 's distributive share of the partnership 's ATI (that is, a partner 's distributive share of gross income and gain items comprising ATI less such partner 's distributive share of gross loss and deduction items comprising ATI), the term allocable business interest income means a partner 's distributive share of the partnership 's business interest income , and the term allocable business interest expense means a partner 's distributive share of the partnership 's business interest expense that is not floor plan financing interest expense . If the partnership determines that each partner has a pro rata share of allocable ATI, allocable business interest income , and allocable business interest expense , then the partnership may bypass paragraphs (f)(2)(iii) through (xi) of this section and allocate its section 163(j) excess items in the same proportion. See Example 1 through Example 16 in paragraphs (o)(1) through (16), respectively. This pro-rata exception does not result in allocations of section 163(j) excess items that vary from the array of allocations of section 163(j) excess items that would have resulted had paragraphs (f)(2)(iii) through (xi) been applied.

(iii) Partner-level comparison of business interest income and business interest expense. Third, a partnership must compare each partner 's allocable business interest income to such partner 's allocable business interest expense . Paragraphs (f)(2)(iii) through (v) of this section determine how a partnership must allocate its excess business interest income among its partners , as well as the amount of each partner 's allocable business interest expense that is not deductible business interest expense after taking the partnership 's business interest income into account . To the extent a partner 's allocable business interest income exceeds its allocable business interest expense , the partner has an allocable business interest income excess. The aggregate of all the partners' allocable business interest income excess amounts is the total allocable business interest income excess. To the extent a partner 's allocable business interest expense exceeds its allocable business interest income , the partner has an allocable business interest income deficit. The aggregate of all the partners' allocable business interest income deficit amounts is the total allocable business interest income deficit. These amounts are required to perform calculations in paragraphs (f)(2)(iv) and (v) of this section, which appropriately reallocate allocable business interest income excess to partners with allocable business interest income deficits in order to reconcile the partner -level calculation under paragraph (f)(2)(iii) of this section with the partnership -level result under paragraph (f)(2)(i) of this section.

(iv) Matching partnership and aggregate partner excess business interest income. Fourth, a partnership must determine each partner 's final allocable business interest income excess. A partner 's final allocable business interest income excess is determined by reducing, but not below zero, such partner 's allocable business interest income excess (if any) by the partner 's step four adjustment amount . A partner 's step four adjustment amount is the product of the total allocable business interest income deficit and the ratio of such partner 's allocable business interest income excess to the total allocable business interest income excess. The rules of this paragraph (f)(2)(iv) ensure that, following the application of paragraph (f)(2)(xi) of this section, the aggregate of all the partners' allocations of excess business interest income equals the total amount of the partnership 's excess business interest income as determined in paragraph (f)(2)(i) of this section.

(v) Remaining business interest expense determination. Fifth, a partnership must determine each partner 's remaining business interest expense . A partner 's remaining business interest expense is determined by reducing, but not below zero, such partner 's allocable business interest income deficit (if any) by such partner 's step five adjustment amount . A partner 's step five adjustment amount is the product of the total allocable business interest income excess and the ratio of such partner 's allocable business interest income deficit to the total allocable business interest income deficit . Generally, a partner 's remaining business interest expense is a partner 's allocable business interest income deficit adjusted to reflect a reallocation of allocable business interest income excess from other partners . Determining a partner 's remaining business interest expense is necessary to perform an ATI calculation that begins in paragraph (f)(2)(vii) of this section.

(vi) Determination of final allocable ATI. Sixth, a partnership must determine each partner 's final allocable ATI. Paragraphs (f)(2)(vi) through (x) of this section determine how a partnership must allocate its excess taxable income and excess business interest expense among its partners.

(A) Positive allocable ATI. To the extent a partner 's income and gain items comprising its allocable ATI exceed its deduction and loss items comprising its allocable ATI, the partner has positive allocable ATI. The aggregate of all the partners' positive allocable ATI amounts is the total positive allocable ATI.

(B) Negative allocable ATI. To the extent a partner 's deduction and loss items comprising its allocable ATI exceed its income and gain items comprising its allocable ATI, the partner has negative allocable ATI. The aggregate of all the partners' negative allocable ATI amounts is the total negative allocable ATI.

(C) Final allocable ATI. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Any partner with a positive allocable ATI of $0 has a final allocable ATI of $0. The final allocable ATI of any partner with a positive allocable ATI greater than $0 is such partner 's positive allocable ATI reduced, but not below zero, by the partner 's step six adjustment amount . A partner 's step six adjustment amount is the product of the total negative allocable ATI and the ratio of such partner 's positive allocable ATI to the total positive allocable ATI. The total of the partners' final allocable ATI amounts must equal the partnership 's ATI amount used to compute its section 163(j) limitation pursuant to § 1.163(j) –2(b).

(vii) Partner-level comparison of 30 percent of adjusted taxable income and remaining business interest expense. Seventh, a partnership must compare each partner 's ATI capacity to such partner 's remaining business interest expense as determined under paragraph (f)(2)(v) of this section. A partner 's ATI capacity is the amount that is 30 percent of such partner 's final allocable ATI as determined under paragraph (f)(2)(vi) of this section. A partner 's final allocable ATI is grossed down to 30 percent prior to being compared to its remaining business interest expense in this calculation to parallel the partnership 's adjustment to its ATI under section 163(j)(1)(B). To the extent a partner 's ATI capacity exceeds its remaining business interest expense , the partner has an ATI capacity excess. The aggregate of all the partners' ATI capacity excess amounts is the total ATI capacity excess. To the extent a partner 's remaining business interest expense exceeds its ATI capacity, the partner has an ATI capacity deficit. The aggregate of all the partners' ATI capacity deficit amounts is the total ATI capacity deficit. These amounts (which may be subject to adjustment under paragraph (f)(2)(viii) of this section) are required to perform calculations in paragraphs (f)(2)(ix) and (x) of this section, which appropriately reallocate ATI capacity excess to partners with ATI capacity deficits in order to reconcile the partner -level calculation under paragraph (f)(2)(vii) of this section with the partnership -level result under paragraph (f)(2)(i) of this section.

(viii) Partner priority right to ATI capacity excess determination.

(A) Eighth, the partnership must determine whether it is required to make any adjustments described in this paragraph (f)(2)(viii) and, if it is, make such adjustments . The rules of this paragraph (f)(2)(viii) are necessary to account for adjustments made to a partner 's allocable ATI in paragraph (f)(2)(vi) of this section to ensure that the partners who had a negative allocable ATI do not inappropriately benefit under the rules of paragraphs (f)(2)(ix) through (xi) of this section to the detriment of the partners who had positive allocable ATI. The partnership must perform the calculations and make the necessary adjustments described under paragraphs (f)(2)(viii)(B) and (C) or paragraph (f)(2)(viii)(D) of this section if, and only if, there is—

(1) An excess business interest expense amount greater than $0 under paragraph (f)(2)(i) of this section;

(2) A total negative allocable ATI amount greater than $0 under paragraph (f)(2)(vi) of this section; and

(3) A total ATI capacity excess amount greater than $0 under paragraph (f)(2)(vii) of this section.

(B) A partnership must determine each partner 's priority amount and usable priority amount . A partner 's priority amount is 30 percent of the amount by which a partner 's positive allocable ATI under paragraph (f)(2)(vi)(A) of this section exceeds such partner 's final allocable ATI under paragraph (f)(2)(vi)(C) of this section. However, only partners with an ATI capacity deficit as determined under paragraph (f)(2)(vii) of this section can have a priority amount greater than $0. The aggregate of all the partners' priority amounts is the total priority amount. A partner 's usable priority amount is the lesser of such partner 's priority amount or such partner 's ATI capacity deficit as determined under paragraph (f)(2)(vii) of this section. The aggregate of all the partners' usable priority amounts is the total usable priority amount. If the total ATI capacity excess amount , as determined under paragraph (f)(2)(vii) of this section, is greater than or equal to the total usable priority amount , then the partnership must perform the adjustments described in paragraph (f)(2)(viii)(C) of this section. If the total usable priority amount is greater than the total ATI capacity excess amount , as determined under paragraph (f)(2)(vii) of this section, then the partnership must perform the adjustments described in paragraph (f)(2)(viii)(D) of this section.

(C) For purposes of paragraph (f)(2)(ix) of this section, each partner 's final ATI capacity excess amount is $0. For purposes of paragraph (f)(2)(x) of this section, the following terms have the following meanings for each partner:

(1) Each partner 's ATI capacity deficit is such partner 's ATI capacity deficit as determined under paragraph (f)(2)(vii) of this section, reduced by such partner 's usable priority amount .

(2) The total ATI capacity deficit is the total ATI capacity deficit as determined under paragraph (f)(2)(vii) of this section, reduced by the total usable priority amount .

(3) The total ATI capacity excess is the total ATI capacity excess as determined under paragraph (f)(2)(vii) of this section, reduced by the total usable priority amount .

(D) Any partner with a priority amount greater than $0 is a priority partner. Any partner that is not a priority partner is a non-priority partner. For purposes of paragraph (f)(2)(ix) of this section, each partner 's final ATI capacity excess amount is $0. For purposes of paragraph (f)(2)(x) of this section, each non-priority partner 's final ATI capacity deficit amount is such partner 's ATI capacity deficit as determined under paragraph (f)(2)(vii) of this section. For purposes of paragraph (f)(2)(x) of this section, the following terms have the following meanings for priority partners.

(1) Each priority partner must determine its step eight excess share. A partner 's step eight excess share is the product of the total ATI capacity excess as determined under paragraph (f)(2)(vii) of this section and the ratio of the partner 's priority amount to the total priority amount .

(2) To the extent a priority partner 's step eight excess share exceeds its ATI capacity deficit as determined under paragraph (f)(2)(vii) of this section, such excess amount is the priority partner 's ATI capacity excess for purposes of paragraph (f)(2)(x) of this section. The total ATI capacity excess is the aggregate of the priority partners' ATI capacity excess amounts as determined under this paragraph (f)(2)(viii)(D)( 2 ).

(3) To the extent a priority partner 's ATI capacity deficit as determined under paragraph (f)(2)(vii) of this section exceeds its step eight excess share, such excess amount is the priority partner 's ATI capacity deficit for purposes of paragraph (f)(2)(x) of this section. The total ATI capacity deficit is the aggregate of the priority partners' ATI capacity deficit amounts as determined under this paragraph (f)(2)(viii)(D)( 3 ).

(ix) Matching partnership and aggregate partner excess taxable income. Ninth, a partnership must determine each partner 's final ATI capacity excess. A partner 's final ATI capacity excess amount is determined by reducing, but not below zero, such partner 's ATI capacity excess (if any) by the partner 's step nine adjustment amount . A partner 's step nine adjustment amount is the product of the total ATI capacity deficit and the ratio of such partner 's ATI capacity excess to the total ATI capacity excess. The rules of this paragraph (f)(2)(ix) ensure that, following the application of paragraph (f)(2)(xi) of this section, the aggregate of all the partners' allocations of excess taxable income equals the total amount of the partnership 's excess taxable income as determined in paragraph (f)(2)(i) of this section.

(x) Matching partnership and aggregate partner excess business interest expense. Tenth, a partnership must determine each partner 's final ATI capacity deficit . A partner 's final ATI capacity deficit amount is determined by reducing, but not below zero, such partner 's ATI capacity deficit (if any) by the partner 's step ten adjustment amount . A partner 's step ten adjustment amount is the product of the total ATI capacity excess and the ratio of such partner 's ATI capacity deficit to the total ATI capacity deficit . Generally, a partner 's final ATI capacity deficit is a partner 's ATI capacity deficit adjusted to reflect a reallocation of ATI capacity excess from other partners. The rules of this paragraph (f)(2)(x) ensure that, following the application of paragraph (f)(2)(xi) of this section, the aggregate of all the partners' allocations of excess business interest expense equals the total amount of the partnership 's excess business interest expense as determined in paragraph (f)(2)(i) of this section.

(xi) Final section 163(j) excess item and deductible business interest expense allocation. Eleventh, a partnership must allocate section 163(j) excess items and deductible business interest expense to its partners. Excess business interest income calculated under paragraph (f)(2)(i) of this section, if any, is allocated dollar for dollar by the partnership to its partners with final allocable business interest income excess amounts. Excess business interest expense calculated under paragraph (f)(2)(i) of this section, if any, is allocated dollar for dollar to partners with final ATI capacity deficit amounts. After grossing up each partner 's final ATI capacity excess amount by ten-thirds, excess taxable income calculated under paragraph (f)(2)(i) of this section, if any, is allocated dollar for dollar to partners with final ATI capacity excess amounts. A partner 's allocable business interest expense is deductible business interest expense to the extent it exceeds such partner 's share of excess business interest expense . See Example 17 through Example 21 in paragraphs (o)(17) through (21) of this section, respectively.

(g) Carryforwards —(1) In general. The amount of any business interest expense not allowed as a deduction to a partnership by reason of § 1.163(j) –2(b) and paragraph (f)(2) of this section for any taxable year is—

(i) Not treated as business interest expense of the partnership in the succeeding taxable year ; and

(ii) Subject to paragraph (g)(2) of this section, treated as excess business interest expense , which is allocated to each partner pursuant to paragraph (f)(2) of this section.

(2) Treatment of excess business interest expense allocated to partners. If a partner is allocated excess business interest expense from a partnership under paragraph (f)(2) of this section for any taxable year and the excess business interest expense is treated as such under paragraph (h)(2) of this section—

(i) Solely for purposes of section 163(j), such excess business interest expense is treated as business interest expense paid or accrued by the partner in the next succeeding taxable year in which the partner is allocated excess taxable income or excess business interest income from such partnership , but only to the extent of such excess taxable income or excess business interest income ; and

(ii) Any portion of such excess business interest expense remaining after the application of paragraph (g)(2)(i) of this section is excess business interest expense that is subject to the limitations of paragraph (g)(2)(i) of this section in succeeding taxable years , unless paragraph (m)(3) of this section applies. See Example 1 through Example 16 in paragraphs (o)(1) through (16) of this section, respectively.

(3) Excess taxable income and excess business interest income ordering rule. In the event a partner has excess business interest expense from a prior taxable year and is allocated excess taxable income or excess business interest income from the same partnership in a succeeding taxable year , the partner must treat, for purposes of section 163(j), the excess business interest expense as business interest expense paid or accrued by the partner in an amount equal to the partner 's share of the partnership 's excess taxable income or excess business interest income in such succeeding taxable year . See Example 2 through Example 16 in paragraphs (o)(2) through (16) of this section, respectively.

(4) Special rule for taxable years beginning in 2019 and 2020. In the case of any excess business interest expense of a partnership for any taxable year beginning in 2019 that is allocated to a partner under paragraph (f)(2) of this section, 50 percent of such excess business interest expense (§ 1.163(j)–6(g)(4) business interest expense) is treated as business interest expense that, notwithstanding paragraph (g)(2) of this section, is paid or accrued by the partner in the partner 's first taxable year beginning in 2020. Additionally, § 1.163(j)–6(g)(4) business interest expense is not subject to the section 163(j) limitation at the level of the partner . For purposes of paragraph (h)(1) of this section, any § 1.163(j)–6(g)(4) business interest expense is, similar to deductible business interest expense , taken into account before any excess business interest expense . This paragraph applies after paragraph (n) of this section. If a partner disposes of a partnership interest in the partnership 's 2019 or 2020 taxable year , § 1.163(j)–6(g)(4) business interest expense is deductible by the partner (except to the extent that the business interest expense is negative section 163(j) expense as defined in § 1.163(j)–6(h)(1) immediately prior to the disposition) and thus does not result in a basis increase under paragraph (h)(3) of this section. See Example 35 and Example 36 in paragraphs (o)(35) and (o)(36), respectively, of this section. A partner may elect to not have this provision apply with respect to each partnership interest held by the partner on an interest by interest basis. The rules and procedures regarding the time and manner of making, or revoking, such an election are provided in Revenue Procedure 2020–22, 2020–18 I.R.B. 745, and may be further modified through other guidance (see §§ 601.601(d) and 601.602 of this chapter).

(h) Basis adjustments —(1) Section 704(d) ordering. Deductible business interest expense and excess business interest expense are subject to section 704(d). If a partner is subject to a limitation on loss under section 704(d) and a partner is allocated losses from a partnership in a taxable year , § 1.704 –1(d)(2) requires that the limitation on losses under section 704(d) be apportioned amongst these losses based on the character of each loss (each grouping of losses based on character being a section 704(d) loss class ). If there are multiple section 704(d) loss classes in a given year , § 1.704 –1(d)(2) requires the partner to apportion the limitation on losses under section 704(d) to each section 704(d) loss class proportionately. For purposes of applying this proportionate rule, any deductible business interest expense and business interest expense of an exempt entity (whether allocated to the partner in the current taxable year or suspended under section 704(d) in a prior taxable year), any excess business interest expense allocated to the partner in the current taxable year , and any excess business interest expense from a prior taxable year that was suspended under section 704(d) (negative section 163(j) expense) shall comprise the same section 704(d) loss class. Once the partner determines the amount of limitation on losses apportioned to this section 704(d) loss class, any deductible business interest expense is taken into account before any excess business interest expense or negative section 163(j) expense. See Example 7 in paragraph (o)(7) of this section.

(2) Excess business interest expense basis adjustments. The adjusted basis of a partner in a partnership interest is reduced, but not below zero, by the amount of excess business interest expense allocated to the partner pursuant to paragraph (f)(2) of this section. Negative section 163(j) expense is not treated as excess business interest expense in any subsequent year until such negative section 163(j) expense is no longer suspended under section 704(d). Therefore, negative section 163(j) expense does not affect, and is not affected by, any allocation of excess taxable income to the partner . Accordingly, any excess taxable income allocated to a partner from a partnership while the partner still has negative section 163(j) expense will be included in the partner 's ATI. However, once the negative section 163(j) expense is no longer suspended under section 704(d), it becomes excess business interest expense , which is subject to the general rules in paragraph (g) of this section. See Example 8 in paragraph (o)(8) of this section.

(3) Partner basis adjustment upon disposition of partnership interest. If a partner (transferor) disposes of an interest in a partnership , the adjusted basis of the partnership interest being disposed of (transferred interest) is increased immediately before the disposition by the amount of the excess (if any) of the amount of the basis reduction under paragraph (h)(2) of this section over the portion of any excess business interest expense allocated to the transferor under paragraph (f)(2) of this section which has previously been treated under paragraph (g) of this section as business interest expense paid or accrued by the transferor, multiplied by the ratio of the fair market value of the transferred interest to the total fair market value of the transferor's partnership interest immediately prior to the disposition . Therefore, the adjusted basis of the transferred interest is not increased immediately before the disposition by any allocation of excess business interest expense from the partnership that did not reduce the transferor's adjusted basis in its partnership interest pursuant to paragraph (h) of this section prior to the disposition , or by any excess business interest expense that was treated under paragraph (g) of this section as business interest expense paid or accrued by the transferor prior to the disposition . If the transferor disposes of all of its partnership interest , no deduction under section 163(j) is allowed to the transferor or transferee under chapter 1 of subtitle A of the Code for any excess business interest expense or negative section 163(j) expense. If the transferor disposes of a portion of its partnership interest , no deduction under section 163(j) is allowed to the transferor or transferee under chapter 1 of subtitle A of the Code for the amount of excess business interest expense proportionate to the transferred interest . The amount of excess business interest expense proportionate to the partnership interest retained by the transferor shall remain as excess business interest expense of the transferor until such time as such excess business interest expense is treated as business interest expense paid or accrued by the transferor pursuant to paragraph (g) of this section. Further, if the transferor disposes of a portion of its partnership interest , any negative section 163(j) expense shall remain negative section 163(j) expense of the transferor partner until such negative section 163(j) expense is no longer suspended under section 704(d). For purposes of this paragraph, a disposition includes a distribution of money or other property by the partnership to a partner in complete liquidation of its interest in the partnership . Further, solely for purposes of this section, each partner is considered to have disposed of its partnership interest if the partnership terminates under section 708(b)(1). See Example 9 and Example 10 in paragraphs (o)(9) and (o)(10) of this section, respectively.

(i) –(j) [Reserved]

(k) Investment items and certain other items. Any item of a partnership 's income , gain, deduction, or loss that is investment interest income or expense pursuant to § 1.163 –8T, and any other tax item of a partnership that is neither properly allocable to a trade or business of the partnership nor described in section 163(d), is allocated to each partner in accordance with section 704(b) and the regulations under section 704 of the Code, and the effect of such allocation for purposes of section 163 is determined at the partner -level. See § 1.163(j) –4(b)(3), section 163(d), and § 1.163 –8T.

(l) S corporations —(1) In general—(i) Corporate level limitation. In the case of any S corporation , the section 163(j) limitation is applied at the S corporation level, and any deduction allowed for business interest expense is taken into account in determining the nonseparately stated taxable income or loss of the S corporation . An S corporation determines its section 163(j) limitation in the same manner as set forth in § 1.163(j) –2(b). Allocations of excess taxable income and excess business interest income are made in accordance with the shareholders' pro rata interests in the S corporation pursuant to section 1366(a)(1) after determining the S corporation 's section 163(j) limitation pursuant to § 1.163(j) –2(b). See Example 22 and Example 23 in paragraphs (o)(22) and (23) of this section, respectively.

(ii) Short taxable periods. For rules on applying the section 163(j) limitation where an S corporation has a two short taxable periods or where its taxable year consists of two separate taxable years see §§ 1.1362 –3(c), 1.1368–1(g), and 1.1377–1(b).

(2) Character of deductible business interest expense. If an S corporation has deductible business interest expense , such deductible business interest expense is not subject to any additional application of section 163(j) at the shareholder-level because such deductible business interest expense is taken into account in determining the nonseparately stated taxable income or loss of the S corporation . However, for all other purposes of the Code, deductible business interest expense retains its character as business interest expense at the shareholder-level. For example , for purposes of section 469, such deductible business interest expense retains its character as either passive or non-passive in the hands of the shareholder. Additionally, for purposes of section 469, deductible business interest expense from an S corporation remains interest derived from a trade or business in the hands of a shareholder even if the shareholder does not materially participate in the S corporation 's trade or business activity . For additional rules regarding the interaction between sections 465, 469, and 163(j), see § 1.163(j) –3.

(3) Adjusted taxable income of an S corporation. The ATI of an S corporation generally is determined in accordance with § 1.163(j) –1(b)(1). For purposes of computing the S corporation 's ATI, the tentative taxable income of the S corporation is determined under section 1363(b) and includes—

(i) Any item described in section 1363(b)(1); and

(ii) Any item described in § 1.163(j) –1(b)(1), to the extent such item is consistent with subchapter S of the Code.

(4) Adjusted taxable income and business interest income of S corporation shareholders —(i) Adjusted taxable income of S corporation shareholders. The ATI of an S corporation shareholder is determined in accordance with § 1.163(j) –1(b)(1) without regard to such shareholder's distributive share of any items of income , gain, deduction, or loss of such S corporation , except as provided in paragraph (m) , and is increased by such shareholder's distributive share of such S corporation 's excess taxable income .

(ii) Disposition of S corporation stock. If a shareholder of an S corporation recognizes gain or loss upon the disposition of stock of the S corporation , and the corporation the stock of which is being disposed of only owns non-excepted trade or business assets, the gain or loss on the disposition of the stock is included in the shareholder's ATI. See § 1.163(j) –10(b)(4)(ii) for dispositions of stock of S corporations that own—

(A) Non-excepted assets and excepted assets; or

(B) Investment assets; or

(iii) Double counting of business interest income and floor plan financing interest expense prohibited. For purposes of calculating an S corporation shareholder's section 163(j) limitation , the shareholder does not include—

(A) Business interest income from an S corporation that is subject to section 163(j), except to the extent the shareholder is allocated excess business interest income from that S corporation pursuant to paragraph (l)(1) of this section; and

(B) The shareholder's share of the S corporation 's floor plan financing interest expense , because such floor plan financing interest expense already has been taken into account by the S corporation in determining its nonseparately stated taxable income or loss for purposes of section 163(j).

(5) Carryforwards. The amount of any business interest expense not allowed as a deduction for any taxable year by reason of the limitation contained in § 1.163(j) –2(b) is carried forward in the succeeding taxable year as a disallowed business interest expense carryforward under the rules set forth in § 1.163(j) –2(c) (whether to an S corporation taxable year or a C corporation taxable year). For purposes of applying section 163(j), S corporations are subject to the same ordering rules as a C corporation that is not a member of a consolidated group . See § 1.163(j) –5(b)(2).

(6) Basis adjustments and disallowed business interest expense carryforwards. An S corporation shareholder's adjusted basis in its S corporation stock is reduced, but not below zero, when a disallowed business interest expense carryforward becomes deductible under section 163(j).

(7) Accumulated adjustment accounts. The accumulated adjustment account of an S corporation is adjusted to take into account business interest expense in the year in which the S corporation treats such business interest expense as deductible under the section 163(j) limitation . See section 1368(e)(1).

(8) Termination of qualified subchapter S subsidiary election. If a corporation 's qualified subchapter S subsidiary election terminates and any disallowed business interest expense carryforward is attributable to the activities of the qualified subchapter S subsidiary at the time of termination , such disallowed business interest expense carryforward remains with the parent S corporation , and no portion of these items is allocable to the former qualified subchapter S subsidiary .

(9) Investment items. Any item of an S corporation 's income , gain, deduction, or loss that is investment interest income or expense pursuant to § 1.163 –8T is allocated to each shareholder in accordance with the shareholders' pro rata interests in the S corporation pursuant to section 1366(a)(1). See section 163(d) and § 1.163 –8T.

(10) Application of section 382. In the event of an ownership change , within the meaning of section 382(g), the S corporation 's business interest expense is subject to section 382. Therefore, the allocation of the S corporation 's business interest expense between the pre-change period (as defined in § 1.382 –6(g)(2)) and the post-change period (as defined in § 1.382 –6(g)(3)), and the determination of the amount that is deducted and carried forward, is determined pursuant to § 1.382 –6. If the date of the ownership change is also the date of a qualifying disposition (as defined in § 1.1368 –1(g)(2)) or the date for a termination of shareholder interest (as defined in § 1.1377 –1(b)(4)), then—

(i) The rules of this paragraph govern the S corporation 's business interest expense ;

(ii) The S corporation must make an election under § 1.382 –6(b) with respect to such date if it also makes an election under § 1.1368 –1(g)(2) or a shareholder termination election to apply normal tax accounting rules, as applicable, with respect to such date; and

(iii) The S corporation may not make an election under § 1.382 –6(b) with respect to such date if it does not make an election under § 1.1368 –1(g)(2) or a termination election under § 1.1377 –1(b)(1), as applicable, with respect to such date.

(m) Partnerships and S corporations not subject to section 163(j) —(1) Exempt partnerships and S corporations. If the small business exemption in § 1.163(j) –2(d) applies to a partnership or an S corporation in a taxable year (exempt entity), the general rule in § 1.163(j) –2 and this section does not apply to limit the deduction for business interest expense of the exempt entity in that taxable year . Additionally, if a partner or S corporation shareholder is allocated business interest expense from an exempt entity , such business interest expense is not subject to the section 163(j) limitation at the partner 's or S corporation shareholder's level. However, see paragraph (h)(1) of this section. Further, a partner or S corporation shareholder of an exempt entity includes its share of non-excepted trade or business items of income , gain, loss , and deduction (including business interest expense and business interest income) of such exempt entity when calculating its ATI. However, if a partner 's or S corporation shareholder's allocations of non-excepted trade or business items of loss and deduction from an exempt entity exceed its allocations of non-excepted trade or business items of income and gain from such exempt entity (net loss allocation), then such net loss allocation will not reduce a partner 's or S corporation shareholder's ATI. See Example 11 and Example 12 in paragraphs (o)(11) and (12) of this section, respectively.

(2) Partnerships and S corporations engaged in excepted trades or businesses. To the extent a partnership or an S corporation is engaged in an excepted trade or business , the general rule in § 1.163(j) –2 and this section does not apply to limit the deduction for business interest expense that is allocable to such excepted trade or business . If a partner or S corporation shareholder is allocated any section 163(j) item that is allocable to an excepted trade or business of the partnership or S corporation (excepted 163(j) items ), such excepted 163(j) items are excluded from the partner 's or shareholder's section 163(j) deduction calculation . See § 1.163(j) –10(c) (regarding the allocation of items between excepted and non-excepted trades or businesses). See also Example 13 in paragraph (o)(13) of this section.

(3) Treatment of excess business interest expense from partnerships that are exempt entities in a succeeding taxable year. If a partner is allocated excess business interest expense from a partnership and, in a succeeding taxable year , such partnership is an exempt entity , then the partner shall treat any of its excess business interest expense that was previously allocated from such partnership as business interest expense paid or accrued by the partner in such succeeding taxable year , which is potentially subject to limitation at the partner level under section 163(j). However, if a partner is allocated excess business interest expense from a partnership and, in a succeeding taxable year , such partnership engages in excepted trades or businesses, then the partner shall not treat any of its excess business interest expense that was previously allocated from such partnership as business interest expense paid or accrued by the partner in such succeeding taxable year by reason of the partnership engaging in excepted trades or businesses. See Example 14 through Example 16 in paragraphs (o)(14) through (o)(16) of this section, respectively. For rules regarding the treatment of excess business interest expense from a partnership that terminates under section 708(b)(1), see paragraph (h)(3) of this section.

(4) S corporations with disallowed business interest expense carryforwards prior to becoming exempt entities. If an S corporation has a disallowed business interest expense carryforward for a taxable year and, in a succeeding taxable year , such S corporation is an exempt entity , then such disallowed business interest expense carryforward—

(i) Continues to be carried forward at the S corporation level;

(ii) Is no longer subject to the section 163(j) limitation ; and

(iii) Is taken into account in determining the nonseparately stated taxable income or loss of the S corporation .

(n) Treatment of self-charged lending transactions between partnerships and partners. In the case of a lending transaction between a partner (lending partner) and partnership (borrowing partnership) in which the lending partner owns a direct interest (self-charged lending transaction), any business interest expense of the borrowing partnership attributable to the self-charged lending transaction is business interest expense of the borrowing partnership for purposes of this section. If in a given taxable year the lending partner is allocated excess business interest expense from the borrowing partnership and has interest income attributable to the self-charged lending transaction (interest income), the lending partner is deemed to receive an allocation of excess business interest income from the borrowing partnership in such taxable year . The amount of the lending partner 's deemed allocation of excess business interest income is the lesser of such lending partner 's allocation of excess business interest expense from the borrowing partnership in such taxable year or the interest income attributable to the self-charged lending transaction in such taxable year . To prevent the double counting of business interest income , the lending partner includes interest income that was treated as excess business interest income pursuant to this paragraph (n) only once when calculating its own section 163(j) limitation . To the extent an amount of interest income received by a lending partner is attributable to a self-charged lending transaction , and is deemed to be an allocation of excess business interest income from the borrowing partnership pursuant to this paragraph (n), such an amount of interest income will not be treated as investment income for purposes of section 163(d). In cases where the lending partner is not a C corporation , to the extent that any interest income exceeds the lending partner 's allocation of excess business interest expense from the borrowing partnership for the taxable year , and such interest income otherwise would be properly treated as investment income of the lending partner for purposes of section 163(d) for that year , such excess amount of interest income will continue to be treated as investment income of the lending partner for that year for purposes of section 163(d). See Example 26 in paragraph (o)(26) of this section.

(o) Examples. The examples in this paragraph illustrate the provisions of section 163(j) as applied to partnerships and subchapter S corporations . For purposes of these examples , unless stated otherwise, each partnership and S corporation is subject to the provisions of section 163(j), is only engaged in non-excepted trades or businesses, was created or organized in the United States , and uses the calendar year for its annual accounting period. Unless stated otherwise, all partners and shareholders are subject to the provisions of section 163(j), are not subject to a limitation under section 704(d) or 1366(d), have no tax items other than those listed in the example , are U.S. citizens, and use the calendar year for their annual accounting period. The phrase “section 163(j) limit” shall equal the maximum potential deduction allowed under section 163(j)(1). Unless stated otherwise, business interest expense means business interest expense that is not floor plan financing interest expense . With respect to partnerships , all allocations are in accordance with section 704(b) and the regulations in this part under section 704 of the Code.

(1) Example 1 —(i) Facts. X and Y are equal partners in partnership PRS. In Year 1, PRS has $100 of ATI and $40 of business interest expense . PRS allocates the items comprising its $100 of ATI $50 to X and $50 to Y. PRS allocates its $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 1, PRS's section 163(j) limit is 30 percent of its ATI, or $30 ($100 × 30 percent). Thus, PRS has $30 of deductible business interest expense and $10 of excess business interest expense . Such $30 of deductible business interest expense is includable in PRS's nonseparately stated income or loss , and is not subject to further limitation under section 163(j) at the partners' level.

(iii) Partner-level allocations. Pursuant to § 1.163(j) –6(f)(2), X and Y are each allocated $15 of deductible business interest expense and $5 of excess business interest expense . At the end of Year 1, X and Y each have $5 of excess business interest expense from PRS, which is not treated as paid or accrued by the partner until such partner is allocated excess taxable income or excess business interest income from PRS in a succeeding taxable year . Pursuant to § 1.163(j) –6(e)(1), X and Y, in computing their limit under section 163(j), do not increase any of their section 163(j) items by any of PRS's section 163(j) items . X and Y each increase their outside basis in PRS by $30 ($50−$20).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $100 of ATI and $20 of business interest expense from its sole proprietorship. X's section 163(j) limit is $30 ($100 × 30 percent). Thus, X's $20 of business interest expense is deductible business interest expense . Y, in computing its limit under section 163(j), has $20 of business interest expense from its sole proprietorship. Y's section 163(j) limit is $0 ($0 × 30 percent). Thus, Y's $20 of business interest expense is not allowed as a deduction and is treated as business interest expense paid or accrued by Y in Year 2.

(2) Example 2 —(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $200 of ATI, $0 of business interest income , and $30 of business interest expense . PRS allocates the items comprising its $200 of ATI $100 to X and $100 to Y. PRS allocates its $30 of business interest expense $15 to X and $15 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $60 ($200 × 30 percent). Thus, PRS has $100 of excess taxable income , $30 of deductible business interest expense , and $0 of excess business interest expense . Such $30 of deductible business interest expense is includable in PRS's nonseparately stated income or loss , and is not subject to further limitation under section 163(j) at the partners' level.

(iii) Partner-level allocations. Pursuant to § 1.163(j) –6(f)(2), X and Y are each allocated $50 of excess taxable income , $15 of deductible business interest expense , and $0 of excess business interest expense . As a result , X and Y each increase their ATI by $50. Because X and Y are each allocated $50 of excess taxable income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner , X and Y each treat $5 of excess business interest expense (the carryforward from Year 1) as paid or accrued in Year 2. X and Y each increase their outside basis in PRS by $85 ($100−$15).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $150 of ATI ($100 from its sole proprietorship, plus $50 excess taxable income) and $25 of business interest expense ($20 from its sole proprietorship, plus $5 excess business interest expense treated as paid or accrued in Year 2). X's section 163(j) limit is $45 ($150 × 30 percent). Thus, X's $25 of business interest expense is deductible business interest expense . At the end of Year 2, X has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2). Y, in computing its limit under section 163(j), has $50 of ATI ($0 from its sole proprietorship, plus $50 excess taxable income) and $45 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $5 excess business interest expense treated as paid or accrued in Year 2). Y's section 163(j) limit is $15 ($50 × 30 percent). Thus, $15 of Y's business interest expense is deductible business interest expense . The $30 of Y's business interest expense not allowed as a deduction ($45 business interest expense , less $15 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2).

(3) Example 3 —(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $0 of ATI, $60 of business interest income , and $40 of business interest expense . PRS allocates its $60 of business interest income $30 to X and $30 to Y. PRS allocates its $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $60 (($0 × 30 percent) + $60). Thus, PRS has $20 of excess business interest income , $0 of excess taxable income , $40 of deductible business interest expense , and $0 of excess business interest expense . Such $40 of deductible business interest expense is includable in PRS's nonseparately stated income or loss , and is not subject to further limitation under section 163(j) at the partners' level.

(iii) Partner-level allocations. Pursuant to § 1.163(j) –6(f)(2), X and Y are each allocated $10 of excess business interest income , and $20 of deductible business interest expense . As a result , X and Y each increase their business interest income by $10. Because X and Y are each allocated $10 of excess business interest income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner , X and Y each treat $5 of excess business interest expense (the carryforward from Year 1) as paid or accrued in Year 2. X and Y each increase their outside basis in PRS by $10 ($30−$20).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $100 of ATI (from its sole proprietorship), $10 of business interest income (from the allocation of $10 of excess business interest income from PRS), and $25 of business interest expense ($20 from its sole proprietorship, plus $5 excess business interest expense treated as paid or accrued in Year 2). X's section 163(j) limit is $40 (($100 × 30 percent) + $10). Thus, X's $25 of business interest expense is deductible business interest expense . At the end of Year 2, X has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2). Y, in computing its limit under section 163(j), has $0 of ATI (from its sole proprietorship), $10 of business interest income , and $45 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $5 excess business interest expense treated as paid or accrued in Year 2). Y's section 163(j) limit is $10 (($0 × 30 percent) + $10). Thus, $10 of Y's business interest expense is deductible business interest expense . The $35 of Y's business interest expense not allowed as a deduction ($45 business interest expense , less $10 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2).

(4) Example 4 —(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $100 of ATI, $60 of business interest income , and $40 of business interest expense . PRS allocates the items comprising its $100 of ATI $50 to X and $50 to Y. PRS allocates its $60 of business interest income $30 to X and $30 to Y. PRS allocates its $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $90 (($100 × 30 percent)) + $60). Thus, PRS has $20 of excess business interest income , $100 of excess taxable income , $40 of deductible business interest expense , and $0 of excess business interest expense . Such $40 of deductible business interest expense is includable in PRS's nonseparately stated income or loss , and is not subject to further limitation under section 163(j) at the partners' level.

(iii) Partner-level allocations. Pursuant to § 1.163(j) –6(f)(2), X and Y are each allocated $10 of excess business interest income , $50 of excess taxable income , and $20 of deductible business interest expense . As a result , X and Y each increase their business interest income by $10 and ATI by $50. Because X and Y are each allocated $10 of excess business interest income and $50 of excess taxable income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner , X and Y each treat $5 of excess business interest expense (the carryforward from Year 1) as paid or accrued in Year 2. X and Y each increase their outside basis in PRS by $60 ($80−$20).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $150 of ATI ($100 from its sole proprietorship, plus $50 excess taxable income), $10 of business interest income , and $25 of business interest expense ($20 from its sole proprietorship, plus $5 excess business interest expense treated as paid or accrued in Year 2). X's section 163(j) limit is $55 (($150 × 30 percent) + $10). Thus, $25 of X's business interest expense is deductible business interest expense . At the end of Year 2, X has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2). Y, in computing its limit under section 163(j), has $50 of ATI ($0 from its sole proprietorship, plus $50 excess taxable income), $10 of business interest income , and $45 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $5 excess business interest expense treated as paid or accrued in Year 2). Y's section 163(j) limit is $25 (($50 × 30 percent) + $10). Thus, $25 of Y's business interest expense is deductible business interest expense . Y's $20 of business interest expense not allowed as a deduction ($45 business interest expense , less $25 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess business interest expense from PRS ($5 from Year 1, less $5 treated as paid or accrued in Year 2).

(5) Example 5 —(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section. In Year 2, PRS has $100 of ATI, $11.20 of business interest income , and $40 of business interest expense . PRS allocates the items comprising its $100 of ATI $50 to X and $50 to Y. PRS allocates its $11.20 of business interest income $5.60 to X and $5.60 to Y. PRS allocates its $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $41.20 (($100 × 30 percent) + $11.20). Thus, PRS has $0 of excess business interest income , $4 of excess taxable income , and $40 of deductible business interest expense . Such $40 of deductible business interest expense is includable in PRS's nonseparately stated income or loss , and is not subject to further limitation under section 163(j) at the partners' level.

(iii) Partner-level allocations. Pursuant to § 1.163(j) –6(f)(2), X and Y are each allocated $2 of excess taxable income , $20 of deductible business interest expense , and $0 of excess business interest expense . As a result , X and Y each increase their ATI by $2. Because X and Y are each allocated $2 of excess taxable income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner , X and Y each treat $2 of excess business interest expense (a portion of the carryforward from Year 1) as paid or accrued in Year 2. X and Y each increase their outside basis in PRS by $35.60 ($55.60−$20).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $102 of ATI ($100 from its sole proprietorship, plus $2 excess taxable income), $0 of business interest income , and $22 of business interest expense ($20 from its sole proprietorship, plus $2 excess business interest expense treated as paid or accrued). X's section 163(j) limit is $30.60 ($102 × 30 percent). Thus, X's $22 of business interest expense is deductible business interest expense . At the end of Year 2, X has $3 of excess business interest expense from PRS ($5 from Year 1, less $2 treated as paid or accrued in Year 2). Y, in computing its limit under section 163(j), has $2 of ATI ($0 from its sole proprietorship, plus $2 excess taxable income), $0 of business interest income , and $42 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $2 excess business interest expense treated as paid or accrued in Year 2). Y's section 163(j) limit is $0.60 ($2 × 30 percent). Thus, $0.60 of Y's business interest expense is deductible business interest expense . Y's $41.40 of business interest expense not allowed as a deduction ($42 business interest expense , less $0.60 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $3 of excess business interest expense from PRS ($5 from Year 1, less $2 treated as paid or accrued in Year 2).

(6) Example 6 —(i) Facts. In Year 1, X, Y, and Z formed partnership PRS. Upon formation, X and Y each contributed $100, and Z contributed non-excepted and non-depreciable trade or business property with a basis of $0 and fair market value of $100 (Blackacre). PRS allocates all items pro rata between its partners. Immediately after the formation of PRS, Z sold all of its interest in PRS to A for $100 (assume the interest sale is respected for U.S. Federal income tax purposes). In connection with the interest transfer , PRS made a valid election under section 754. Therefore, after the interest sale, A had a $100 positive section 743(b) adjustment in Blackacre. In Year 1, PRS had $0 of ATI, $15 of business interest expense , and $0 of business interest income . Pursuant to § 1.163(j) –6(f)(2), PRS allocated each of the partners $5 of excess business interest expense . In Year 2, PRS sells Blackacre for $100 which generated $100 of ATI. The sale of Blackacre was PRS's only item of income in Year 2. In accordance with section 704(c), PRS allocates all $100 of gain resulting from the sale of Blackacre to A. Additionally, PRS has $15 of business interest expense , all of which it allocates to X. A has $50 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30 percent of its ATI, or $30 ($100 × 30 percent). Thus, PRS has $15 of deductible business interest expense and $50 of excess taxable income . Such $15 of deductible business interest expense is includable in PRS's nonseparately stated income or loss , and is not subject to further limitation under section 163(j) at X's level.

(iii) Partner-level allocations. Pursuant to § 1.163(j) –6(f)(2), X is allocated $15 of deductible business interest expense and X's outside basis in PRS is reduced by $15. A is allocated $50 of excess taxable income and, as a result , A increases its ATI by $50. Because A is allocated $50 of excess taxable income , and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to a partner , A treats $5 of excess business interest expense (the carryforward from Year 1) as paid or accrued in Year 2. PRS's $100 of gain allocated to A in Year 2 is fully reduced by A's $100 section 743(b) adjustment. Therefore, at the end of Year 2, there is no change to A's outside basis in PRS.

(iv) Partner-level. A, in computing its limit under section 163(j), has $0 of ATI ($50 from its sole proprietorship, plus $50 excess taxable income , less $100 ATI reduction as a result of A's section 743(b) adjustment under § 1.163(j) –6(e)(2)) and $25 of business interest expense ($20 from its sole proprietorship, plus $5 excess business interest expense treated as paid or accrued in Year 2). A's section 163(j) limit is $0 ($0 × 30 percent). Thus, all $25 of A's business interest expense is not allowed as a deduction and is treated as business interest expense paid or accrued by A in Year 3.

(7) Example 7 —(i) Facts. X and Y are equal partners in partnership PRS. At the beginning of Year 1, X and Y each have an outside basis in PRS of $5. In Year 1, PRS has $0 of ATI, $20 of business interest income , and $40 of business interest expense . PRS allocates its $20 of business interest income $10 to X and $10 to Y. PRS allocates $40 of business interest expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 1, PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $20 (($0 × 30 percent) + $20). Thus, PRS has $0 of excess business interest income , $0 of excess taxable income , $20 of deductible business interest expense , and $20 of excess business interest expense . Such $20 of deductible business interest expense is includable in nonseparately stated income or loss of PRS, and not subject to further limitation under section 163(j) by the partners.

(iii) Partner-level allocations. Pursuant to § 1.163(j) –6(f)(2), X and Y are each allocated $10 of deductible business interest expense and $10 of excess business interest expense . After adjusting each partner 's respective basis for business interest income under section 705(a)(1)(A), pursuant to § 1.163(j) –6(h)(1), X and Y each take their $10 of deductible business interest expense into account when reducing their outside basis in PRS before taking the $10 of excess business interest expense into account . Following each partner 's reduction in outside basis due to the $10 of deductible business interest expense , each partner has $5 of outside basis remaining in PRS. Pursuant to § 1.163(j) –6(h)(2), each partner has $5 of excess business interest expense and $5 of negative section 163(j) expense. In sum, at the end of Year 1, X and Y each have $5 of excess business interest expense from PRS which reduces each partner 's outside basis to $0 (and is not treated as paid or accrued by the partners until such partner is allocated excess taxable income or excess business interest income from PRS in a succeeding taxable year), and $5 of negative section 163(j) expense (which is suspended under section 704(d) and not treated as excess business interest expense of the partners until such time as the negative section 163(j) expense is no longer subject to a limitation under section 704(d)).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $100 of ATI (from its sole proprietorship) and $20 of business interest expense (from its sole proprietorship). X's section 163(j) limit is $30 ($100 × 30 percent). Thus, $20 of X's business interest expense is deductible business interest expense . Y, in computing its limit under section 163(j), has $20 of business interest expense (from its sole proprietorship). Y's section 163(j) limit is $0 ($0 × 30 percent). Thus, $20 of Y's business interest expense is not allowed as a deduction in Year 1, and is treated as business interest expense paid or accrued by Y in Year 2.

(8) Example 8 —(i) Facts. The facts are the same as in Example 7 in paragraph (o)(7)(i) of this section. In Year 2, PRS has $20 of gross income that is taken into account in determining PRS's ATI (in other words, properly allocable to a trade or business), $30 of gross deductions from an investment activity , and $0 of business interest expense . PRS allocates the items comprising its $20 of ATI $10 to X and $10 to Y. PRS allocates the items comprising its $30 of gross deductions $15 to X and $15 to Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $6 ($20 × 30 percent). Because PRS has no business interest expense , all $20 of its ATI is excess taxable income .

(iii) Partner-level allocations. Pursuant to § 1.163(j) –6(f)(2), X and Y are each allocated $10 of excess taxable income . Because X and Y are each allocated $10 of excess taxable income from PRS, X and Y each increase their ATI by $10. Pursuant to § 1.704 –(1)(d)(2), each partner 's limitation on losses under section 704(d) must be allocated to its distributive share of each such loss . Thus, each partner reduces its adjusted basis of $10 (attributable to the allocation of items comprising PRS's ATI in Year 2) by $7.50 of gross deductions from Year 2 ($10 × ($15 of total gross deductions from Year 2/$20 of total losses disallowed)), and $2.50 of excess business interest expense that was carried over as negative section 163(j) expense from Year 1 ($10 × ($5 of negative section 163(j) expense treated as excess business interest expense solely for the purposes of section 704(d)/$20 of total losses disallowed)). Following the application of section 704(d), each partner has $7.50 of excess business interest expense from PRS ($5 excess business interest expense from Year 1, plus $2.50 of excess business interest expense that was formerly negative section 163(j) expense carried over from Year 1). Excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess taxable income and excess business interest income are allocated from such partnership to the partner . As a result , X and Y each treat $7.50 of excess business interest expense as paid or accrued in Year 2.

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $110 of ATI ($100 from its sole proprietorship, plus $10 excess taxable income) and $27.50 of business interest expense ($20 from its sole proprietorship, plus $7.50 excess business interest expense treated as paid or accrued in Year 2). X's section 163(j) limit is $33 ($110 × 30 percent). Thus, $27.50 of X's business interest expense is deductible business interest expense . At the end of Year 2, X has $0 of excess business interest expense from PRS ($5 from Year 1, plus $2.50 treated as excess business interest expense in Year 2, less $7.50 treated as paid or accrued in Year 2), and $2.50 of negative section 163(j) expense from PRS. Y, in computing its limit under section 163(j), has $10 of ATI ($0 from its sole proprietorship, plus $10 excess taxable income) and $47.50 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $7.50 excess business interest expense treated as paid or accrued in Year 2). Y's section 163(j) limit is $3 ($10 × 30 percent). Thus, $3 of Y's business interest expense is deductible business interest expense . The $44.50 of Y's business interest expense not allowed as a deduction ($47.50 business interest expense , less $3 section 163(j) limit) is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess business interest expense from PRS ($5 from Year 1, plus $2.50 treated as excess business interest expense in Year 2, less $7.50 treated as paid or accrued in Year 2), and $2.50 of negative section 163(j) expense from PRS.

(9) Example 9 —(i) Facts. X and Y are equal partners in partnership PRS, and are not members of a consolidated group . At the beginning of Year 1, X and Y each have $120 of outside basis in PRS. Neither X nor Y's share of partnership liabilities exceeds the adjusted basis of its entire interest . In Year 1, X is allocated $20 of excess business interest expense , which reduces its outside basis from $120 to $100. In Year 2, X sells 80 percent of its interest in PRS to Z for $160. Immediately prior to the sale, X's entire PRS interest had a fair market value of $200 and the transferred portion of the interest had a fair market value of $160.

(ii) Basis adjustment. Immediately before the sale to Z, X increases its basis in the portion of the interest sold by 80 percent of the amount of the excess of the amount of the basis reduction under paragraph (h)(2) of this section ($20) over the portion of any excess business interest expense allocated the partner under paragraph (f)(2) of this section that has previously been treated under paragraph (g) of this section as business interest expense paid or accrued by X ($0). Therefore, X's basis in the portion of its interest sold is $96 (($100 × 80%) + ($20 × 80%)), and X's gain is $64 ($160−$96). Following the sale, X has $20 of outside basis in its remaining partnership interest and $4 of excess business interest expense .

(10) Example 10 —(i) Facts. X and Y are equal partners in partnership PRS, and are not members of a consolidated group . At the beginning of Year 1, X and Y each have an outside basis in PRS of $10. Neither X nor Y's share of partnership liabilities exceeds the adjusted basis of its entire interest . In Year 1, X is allocated $8 of excess business interest expense and $12 of loss from PRS. As a result , X has $4 of excess business interest expense , $4 of negative section 163(j) expense, $6 of allowable loss , $6 of loss suspended under section 704(d), and $0 of outside basis in PRS at the end of Year 1. In Year 2, X sells 50 percent of its interest in PRS to Z for $20. Immediately prior to the sale, X's entire partnership interest had a fair market value of $40 and the transferred portion of the interest had a fair market value of $20.

(ii) Basis adjustment. Immediately before the sale to Z, X increases its basis in the portion of the interest sold by 50 percent of the amount of the excess of the amount of the basis reduction under paragraph (h)(2) of this section ($4) over the portion of any excess business interest expense allocated the partner under paragraph (f)(2) of this section that has previously been treated under paragraph (g) of this section as business interest expense paid or accrued by X ($0). Therefore, X's basis in the portion of its interest sold is $2 (($0 × 50%) + $2), and X's gain is $18 ($20−$2). Following the sale, X has $0 of outside basis in its remaining partnership interest , $2 of excess business interest expense , $4 of negative section 163(j) expense, and $6 of loss suspended under section 704(d).

(11) Example 11 —(i) Facts. X (a corporation), Y (an individual), and Z (an individual) are equal partners in partnership PRS. X, Y, and Z are subject to section 163(j). PRS is not subject to section 163(j) under section 163(j)(3). In 2021, PRS has $150 of trade or business income (not taking into account business interest income or business interest expense), $30 of business interest income , and $45 of business interest expense . PRS also has $75 of investment income and $60 of investment interest expense . PRS allocates its items of income , gain, loss , and deduction equally among its partners. X, Y, and Z each have $10 of business interest expense from their respective businesses.

(ii) Partnership-level. PRS is not subject to section 163(j) by reason of section 163(j)(3). As a result , none of PRS's $45 of business interest expense is subject to the section 163(j) limitation .

(iii) Partner-level allocations. Because PRS is not subject to section 163(j) by reason of section 163(j)(3), PRS's $45 of business interest expense does not retain its character as business interest expense for purposes of section 163(j). As a result , such business interest expense is not subject to the section 163(j) limitation at the level of either the partnership or partner . Additionally, pursuant to § 1.163(j) –6(m)(1), each partner includes its share of non-excepted trade or business items of income , gain, loss , and deduction (including business interest expense and business interest income) of PRS when calculating its ATI. As a result , each partner increases its ATI by $45 (one third of $150 + $30−$45). Also, X increases its ATI by an additional $25 because its items of investment income and loss from PRS are recharacterized as non-excepted trade or business income and loss at its level pursuant to §§ 1.163(j) –4(b)(3)(i) and 1.163(j)–10(b)(6). Further, X increases its business interest expense by its $20 allocation of investment interest expense from PRS pursuant to §§ 1.163(j) –4(b)(3)(i) and 1.163(j)–10(b)(6).

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $70 of ATI and $30 of business interest expense . X's section 163(j) limit is $21 ($70 × 30 percent). Thus, X has $21 of deductible business interest expense . X's $9 of business interest expense not allowed as a deduction is treated as business interest expense paid or accrued by X in 2020. Y and Z, in computing their respective limits under section 163(j), each have $45 of ATI and $10 of business interest expense . Y and Z each have a section 163(j) limit of $13.50 ($45−30 percent). Thus, Y and Z each have $10 of deductible business interest expense .

(12) Example 12 —(i) Facts. The facts are the same as in Example 11 in paragraph (o)(11)(i) of this section, except PRS has $200 of depreciation deductions in addition to its other items of income , gain, loss , and deduction.

(ii) Partnership-level. Same analysis as Example 11 in paragraph (o)(11)(ii) of this section.

(iii) Partner-level allocations. Because PRS is not subject to section 163(j) by reason of section 163(j)(3), PRS's $45 of business interest expense does not retain its character as business interest expense for purposes of section 163(j). As a result , such business interest expense is not subject to the section 163(j) limitation at the level of either the partnership or partner . Additionally, pursuant to § 1.163(j) –6(m)(1), each partner includes its share of non-excepted trade or business items of income , gain, loss , and deduction (including business interest expense and business interest income) of PRS when calculating its ATI; however, a net loss allocation of trade or business items from an exempt entity does not reduce a partner 's ATI. Because each of the partners has a net loss allocation of trade or business items from PRS, none of the partners adjust their ATI for the trade or business items of PRS. X, the corporate partner , increases its ATI by $25 because its items of investment income and loss from PRS are recharacterized as trade or business income and loss at its level pursuant to §§ 1.163(j) –4(b)(3)(i) and 1.163(j)–10(b)(6). Further, X increases its business interest expense by its $20 allocation of investment interest expense from PRS pursuant to §§ 1.163(j) –4(b)(3)(i) and 1.163(j)–10(b)(6).

(iv) Partner-level computations. In computing its limit under section 163(j), each partner has $0 of ATI and $10 of business interest expense . Each partner 's section 163(j) limit is $0 ($0 × 30 percent). Thus, each partner 's $10 of business interest expense is not allowed as a deduction and is treated as business interest expense paid or accrued by the partner in 2020. X, in computing its limit under section 163(j), has $25 of ATI and $30 of business interest expense . X's section 163(j) limit is $7.50 ($25 × 30 percent). Thus, X has $7.50 of deductible business interest expense . X's $22.50 of business interest expense not allowed as a deduction is treated as business interest expense paid or accrued by X in 2020. Y and Z, in computing their respective limits under section 163(j), each have $0 of ATI and $10 of business interest expense . Thus, Y and Z each have $10 of business interest expense not allowed as a deduction that is treated as business interest expense paid or accrued in 2020.

(13) Example 13 —(i) Facts. X, Y, and Z are equal partners in partnership PRS. X, Y, and Z are each individuals subject to section 163(j). PRS is not subject to section 163(j) under section 163(j)(3). PRS has one excepted and one non-excepted trade or business . In Year 1, PRS has $200 of income and $10 of business interest expense from its excepted trade or business , and $60 of business interest income and $30 of business interest expense from its non-excepted trade or business . PRS allocates its items of income , gain, loss , and deduction equally among its partners. X, Y, and Z each have $10 of business interest expense from their respective businesses.

(ii) Partnership-level. PRS is not subject to section 163(j) by reason of section 163(j)(3). As a result , none of PRS's business interest expense is subject to the section 163(j) limitation .

(iii) Partner-level allocations. Because PRS's business interest expense is not subject to the section 163(j) limitation , such business interest expense is not subject to the section 163(j) limitation at the level of either the partnership or partner . Additionally, pursuant to § 1.163(j) –6(m)(1), each partner includes its share of non-excepted trade or business items of income , gain, loss , and deduction (including business interest expense and business interest income) of PRS when calculating its ATI. Therefore, each partner increases its ATI by $10 (each partner 's share of $20 of non-excepted income less each partner 's share of $10 of non-excepted loss).

(iv) Partner-level computations. In computing its limit under section 163(j), each partner has $10 of ATI and $10 of business interest expense . Each partner 's section 163(j) limit is $3 ($10 × 30 percent). Thus, each partner has $3 of deductible business interest expense . Each partner has $7 of business interest expense not allowed as a deduction that is treated as business interest expense paid or accrued by the partner in Year 2.

(14) Example 14 —(i) Facts. The facts are the same as in Example 5 in paragraph (o)(5)(i) of this section, except in Year 2 Y is not subject to section 163(j) under section 163(j)(3).

(ii) Partnership-level. Same analysis as Example 5 in paragraph (o)(5)(ii) of this section.

(iii) Partner-level allocations. Same analysis as Example 5 in paragraph (o)(5)(iii) of this section.

(iv) Partner-level computations. For X, same analysis as Example 5 in paragraph (o)(5)(iv) of this section. Y is not subject to section 163(j) under section 163(j)(3). Thus, all $42 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1, plus $2 excess business interest expense treated as paid or accrued in Year 2) is not subject to limitation under § 1.163(j)–2(d). At the end of Year 2, Y has $3 of excess business interest expense from PRS ($5 from Year 1, less $2 treated as paid or accrued in Year 2).

(15) Example 15 —(i) Facts. The facts are the same as in Example 5 in paragraph (o)(5)(i) of this section, except in Year 2 PRS and Y become not subject to section 163(j) by reason of section 163(j)(3).

(ii) Partnership-level. In Year 2, PRS is not subject to section 163(j) by reason of section 163(j)(3). As a result , none of PRS's $40 of business interest expense is subject to the section 163(j) limitation at the level of either the partnership or partner .

(iii) Partner-level allocations. Because PRS is not subject to section 163(j) by reason of section 163(j)(3), PRS's $40 of business interest expense does not retain its character as business interest expense for purposes of section 163(j). As a result , such business interest expense is not subject to the section 163(j) limitation at the level of either the partnership or partner . Additionally, pursuant to § 1.163(j) –6(m)(1), each partner includes its share of non-excepted trade or business items of income , gain, loss , and deduction (including business interest expense and business interest income) of PRS when calculating its ATI. As a result , X and Y each increase their ATI by $35.60. Further, because PRS is not subject to section 163(j) by reason of section 163(j)(3), the excess business interest expense from Year 1 is treated as paid or accrued by the partners pursuant to § 1.163(j) –6(m)(3). As a result , X and Y each treat their $5 of excess business interest expense from Year 1 as paid or accrued in Year 2, and increase their business interest expense by $5.

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $135.60 of ATI ($100 from its sole proprietorship, plus $35.60 ATI from PRS) and $25 of business interest expense ($20 from its sole proprietorship, plus $5 of excess business interest expense treated as paid or accrued in Year 2). X's section 163(j) limit is $40.68 ($135.60 × 30 percent). Thus, $25 of X's business interest expense is deductible business interest expense . Y is not subject to section 163(j) under section 163(j)(3). As a result , Y's business interest expense is not subject to the section 163(j) limitation . Thus, all $45 of Y's business interest expense ($20 from its sole proprietorship, plus $20 disallowed from year 1, plus $5 of excess business interest expense treated as paid or accrued in Year 2) is not subject to the section 163(j) limitation .

(16) Example 16 —(i) Facts. The facts are the same as in Example 1 in paragraph (o)(1)(i) of this section, except that PRS's only trade or business is a real property trade or business for which PRS does not make the election provided for in section 163(j)(7)(B). In Year 2, when PRS's only trade or business is still its real property trade or business , PRS makes the election provided for in section 163(j)(7)(B). Further, in Year 2, PRS has $100 of income and $40 of business interest expense . PRS allocates its items of income , gain, deduction, and loss equally between X and Y. X has $100 of ATI and $20 of business interest expense from its sole proprietorship. Y has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) Partnership-level. In Year 2, PRS is not subject to section 163(j) because its only trade or business is an excepted trade or business . As a result , none of PRS's $40 of business interest expense is subject to the section 163(j) limitation at the level of either the partnership or partner .

(iii) Partner-level allocations. Because PRS is not subject to section 163(j), PRS's $40 of business interest expense does not retain its character as business interest expense for purposes of section 163(j). As a result , such business interest expense is not subject to the section 163(j) limitation at the partners' level. Pursuant to § 1.163(j) –6(m)(1), the partners do not include their respective $50 shares of income from PRS when calculating their own ATI because such $50 is excepted trade or business income .

(iv) Partner-level computations. X, in computing its limit under section 163(j), has $100 of ATI ($100 from its sole proprietorship) and $20 of business interest expense ($20 from its sole proprietorship). X's section 163(j) limit is $30 ($100 × 30 percent). Thus, $20 of X's business interest expense is deductible business interest expense . At the end of Year 2, X has $5 of excess business interest expense from PRS ($5 from Year 1). Y, in computing its limit under section 163(j), has $0 of ATI and $40 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from Year 1). Y's section 163(j) limit is $0. Thus, Y's $40 of business interest expense not allowed as a deduction is treated as business interest expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $5 of excess business interest expense from PRS ($5 from Year 1).

(17) Example 17: Facts. A (an individual) and B (a corporation) own all of the interests in partnership PRS. At the beginning of Year 1, A and B each have $100 section 704(b) capital account and $100 of basis in PRS. In Year 1, PRS has $100 of ATI, $10 of investment interest income , $20 of business interest income (BII), $60 of business interest expense (BIE), and $10 of floor plan financing interest expense . PRS's ATI consists of $100 of gross income and $0 of gross deductions . PRS allocates its items comprising ATI $100 to A and $0 to B. PRS allocates its business interest income $10 to A and $10 to B. PRS allocates its business interest expense $30 to A and $30 to B. PRS allocates all $10 of its investment interest income and all $10 of its floor plan financing interest expense to B. A has ATI from a sole proprietorship, unrelated to PRS, in the amount of $300.

(i) First, PRS determines its limitation pursuant to § 1.163(j) –2. PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $50 (($100 × 30 percent) + $20). Thus, PRS has $0 of excess business interest income (EBII), $0 of excess taxable income , $50 of deductible business interest expense , and $10 of excess business interest expense . PRS takes its $10 of floor plan financing into account in determining its nonseparately stated taxable income or loss .

(ii) Second, PRS determines each partner 's allocable share of section 163(j) items used in its own section 163(j) calculation . B's $10 of investment interest income is not included in B's allocable business interest income amount because the $10 of investment interest income was not taken into account in PRS's section 163(j) calculation . B's $10 of floor plan financing interest expense is not included in B's allocable business interest expense . The $300 of ATI from A's sole proprietorship is not included in A's allocable ATI amount because the $300 was not taken into account in PRS's section 163(j) calculation .

Table 1 to Paragraph ( o )(17)( ii )

(iii) Third, PRS compares each partner 's allocable business interest income to such partner 's allocable business interest expense . Because each partner 's allocable business interest expense exceeds its allocable business interest income by $20 ($30−$10), each partner has an allocable business interest income deficit of $20. Thus, the total allocable business interest income deficit is $40 ($20 + $20). No partner has allocable business interest income excess because no partner has allocable business interest income in excess of its allocable business interest expense . Thus, the total allocable business interest income excess is $0.

Table 2 to Paragraph ( o )(17)( iii )

(iv) Fourth, PRS determines each partner 's final allocable business interest income excess. Because no partner had any allocable business interest income excess, each partner has final allocable business interest income excess of $0.

(v) Fifth, PRS determines each partner 's remaining business interest expense . PRS determines A's remaining business interest expense by reducing, but not below $0, A's allocable business interest income deficit ($20) by the product of the total allocable business interest income excess ($0) and the ratio of A's allocable business interest income deficit to the total business interest income deficit ($20/$40). Therefore, A's allocable business interest income deficit of $20 is reduced by $0 ($0 × 50 percent). As a result , A's remaining business interest expense is $20. PRS determines B's remaining business interest expense by reducing, but not below $0, B's allocable business interest income deficit ($20) by the product of the total allocable business interest income excess ($0) and the ratio of B's allocable business interest income deficit to the total business interest income deficit ($20/$40). Therefore, B's allocable business interest income deficit of $20 is reduced by $0 ($0 × 50 percent). As a result , B's remaining business interest expense is $20.

Table 3 to Paragraph ( o )(17)( v )

(vi) Sixth, PRS determines each partner 's final allocable ATI. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, B has a positive allocable ATI of $0. Because A's allocable ATI is comprised of $100 of income and gain and $0 of deduction and loss , A has positive allocable ATI of $100. Thus, the total positive allocable ATI is $100 ($100 + $0). PRS determines A's final allocable ATI by reducing, but not below $0, A's positive allocable ATI ($100) by the product of total negative allocable ATI ($0) and the ratio of A's positive allocable ATI to the total positive allocable ATI ($100/$100). Therefore, A's positive allocable ATI is reduced by $0 ($0 × 100 percent). As a result , A's final allocable ATI is $100. Because B has a positive allocable ATI of $0, B's final allocable ATI is $0.

Table 4 to Paragraph ( o )(17)( vi )

Table 5 to Paragraph ( o )(17)( vi )

(vii) Seventh, PRS compares each partner 's ATI capacity (ATIC) amount to such partner 's remaining business interest expense . A's ATIC amount is $30 ($100 × 30 percent) and B's ATIC amount is $0 ($0 × 30 percent). Because A's ATIC amount exceeds its remaining business interest expense by $10 ($30−$20), A has an ATIC excess of $10. B does not have any ATIC excess. Thus, the total ATIC excess is $10 ($10 + $0). A does not have any ATIC deficit . Because B's remaining business interest expense exceeds its ATIC amount by $20 ($20−$0), B has an ATIC deficit of $20. Thus, the total ATIC deficit is $20 ($0 + $20).

Table 6 to Paragraph ( o )(17)( vii )

(A) Eighth, PRS must perform the calculations and make the necessary adjustments described under paragraph (f)(2)(viii) of this section if, and only if, PRS has—

(1) An excess business interest expense greater than $0 under paragraph (f)(2)(i) of this section;

(2) A total negative allocable ATI greater than $0 under paragraph (f)(2)(vi) of this section; and

(3) A total ATIC excess amount greater than $0 under paragraph (f)(2)(vii) of this section.

(B) Because PRS does not meet all three requirements in paragraph (o)(17)(viii)(A) of this section, PRS does not perform the calculations or adjustments described in paragraph (f)(2)(viii) of this section. In sum, the correct amounts to be used in paragraphs (o)(17)(ix) and (x) of this section are as follows.

Table 7 to Paragraph ( o )(17)( viii )(B)

(ix) Ninth, PRS determines each partner 's final ATIC excess amount . Because A has an ATIC excess, PRS must determine A's final ATIC excess amount . A's final ATIC excess amount is A's ATIC excess ($10), reduced, but not below $0, by the product of the total ATIC deficit ($20) and the ratio of A's ATIC excess to the total ATIC excess ($10/$10). Therefore, A has $0 of final ATIC excess ($10−($20 × 100 percent)).

Table 8 to Paragraph ( o )(17)( ix )

(x) Tenth, PRS determines each partner 's final ATIC deficit amount . Because B has an ATIC deficit , PRS must determine B's final ATIC deficit amount . B's final ATIC deficit amount is B's ATIC deficit ($20), reduced, but not below $0, by the product of the total ATIC excess ($10) and the ratio of B's ATIC deficit to the total ATIC deficit ($20/$20). Therefore, B has $10 of final ATIC deficit ($20−($10 × 100 percent)).

Table 9 to Paragraph ( o )(17)( x )

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $10 of excess business interest expense . PRS allocates the excess business interest expense dollar for dollar to the partners with final ATIC deficits amounts. Thus, PRS allocates all $10 of its excess business interest expense to B. A partner 's allocable business interest expense is deductible business interest expense to the extent it exceeds such partner 's share of excess business interest expense . Therefore, A has deductible business interest expense of $30 ($30−$0) and B has deductible business interest expense of $20 ($30−$10). As a result of its allocations from PRS, A increases its section 704(b) capital account and basis in PRS by $80 to $180. As a result of its allocations from PRS, B decreases its capital account and basis in PRS by $20 to $80.

Table 10 to Paragraph ( o )(17)( xi )

(18) Example 18: Facts. A, B, and C own all of the interests in partnership PRS. In Year 1, PRS has $150 of ATI, $10 of business interest income , and $40 of business interest expense . PRS's ATI consists of $200 of gross income and $50 of gross deductions . PRS allocates its items comprising ATI ($50) to A, $200 to B, and $0 to C. PRS allocates its business interest income $0 to A, $0 to B, and $10 to C. PRS allocates its business interest expense $30 to A, $10 to B, and $0 to C.

(i) First, PRS determines its limitation pursuant to § 1.163(j) –2. PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $55 (($150 × 30 percent) + $10). Thus, PRS has $0 of excess business interest income , $50 of excess taxable income , $40 of deductible business interest expense , and $0 of excess business interest expense .

(ii) Second, PRS determines each partner 's allocable share of section 163(j) items used in its own section 163(j) calculation .

Table 11 to Paragraph ( o )(18)( ii )

(iii) Third, PRS compares each partner 's allocable business interest income to such partner 's allocable business interest expense . Because A's allocable business interest expense exceeds its allocable business interest income by $30 ($30−$0), A has an allocable business interest income deficit of $30. Because B's allocable business interest expense exceeds its allocable business interest income by $10 ($10−$0), B has an allocable business interest income deficit of $10. C does not have any allocable business interest income deficit . Thus, the total allocable business interest income deficit is $40 ($30 + $10 + $0). A and B do not have any allocable business interest income excess. Because C's allocable business interest income exceeds its allocable business interest expense by $10 ($10−$0), C has an allocable business interest income excess of $10. Thus, the total allocable business interest income excess is $10 ($0 + $0 + $10).

Table 12 to Paragraph ( o )(18)( iii )

(iv) Fourth, PRS determines each partner 's final allocable business interest income excess. Because A and B do not have any allocable business interest income excess, each partner has final allocable business interest income excess of $0. PRS determines C's final allocable business interest income excess by reducing, but not below $0, C's allocable business interest income excess ($10) by the product of the total allocable business interest income deficit ($40) and the ratio of C's allocable business interest income excess to the total allocable business interest income excess ($10/$10). Therefore, C's allocable business interest income excess of $10 is reduced by $10 ($40 × 100 percent). As a result , C's allocable business interest income excess is $0.

Table 13 to Paragraph ( o )(18)( iv )

(v) Fifth, PRS determines each partner 's remaining business interest expense . PRS determines A's remaining business interest expense by reducing, but not below $0, A's allocable business interest income deficit ($30) by the product of the total allocable business interest income excess ($10) and the ratio of A's allocable business interest income deficit to the total business interest income deficit ($30/$40). Therefore, A's allocable business interest income deficit of $30 is reduced by $7.50 ($10 × 75 percent). As a result , A's remaining business interest expense is $22.50. PRS determines B's remaining business interest expense by reducing, but not below $0, B's allocable business interest income deficit ($10) by the product of the total allocable business interest income excess ($10) and the ratio of B's allocable business interest income deficit to the total business interest income deficit ($10/$40). Therefore, B's allocable business interest income deficit of $10 is reduced by $2.50 ($10 × 25 percent). As a result , B's remaining business interest expense is $7.50. Because C does not have any allocable business interest income deficit , C's remaining business interest expense is $0.

Table 14 to Paragraph ( o )(18)( v )

(vi) Sixth, PRS determines each partner 's final allocable ATI. Because A's allocable ATI is comprised of $50 of items of deduction and loss and $0 of income and gain, A has negative allocable ATI of $50. A is the only partner with negative allocable ATI. Thus, the total negative allocable ATI amount is $50. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, A and C have a positive allocable ATI of $0. Because B's allocable ATI is comprised of $200 of items of income and gain and $0 of deduction and loss , B has positive allocable ATI of $200. Thus, the total positive allocable ATI is $200 ($0 + $200 + $0). PRS determines B's final allocable ATI by reducing, but not below $0, B's positive allocable ATI ($200) by the product of total negative allocable ATI ($50) and the ratio of B's positive allocable ATI to the total positive allocable ATI ($200/$200). Therefore, B's positive allocable ATI is reduced by $50 ($50 × 100 percent). As a result , B's final allocable ATI is $150.

Table 15 to Paragraph ( o )(18)( vi )

Table 16 to Paragraph ( o )(18)( vi )

(vii) Seventh, PRS compares each partner 's ATI capacity (ATIC) amount to such partner 's remaining business interest expense . A's ATIC amount is $0 ($0 × 30 percent), B's ATIC amount is $45 ($150 × 30 percent), and C's ATIC amount is $0 ($0 × 30 percent). A does not have any ATIC excess. Because B's ATIC amount exceeds its remaining business interest expense by $37.50 ($45−$7.50), B has an ATIC excess amount of $37.50. C does not have any ATIC excess. Thus, the total ATIC excess amount is $37.50 ($0 + $37.50 + $0). Because A's remaining business interest expense exceeds its ATIC amount by $22.50 ($22.50−$0), A has an ATIC deficit of $22.50. B and C do not have any ATIC deficit . Thus, the total ATIC deficit is $22.50 ($22.50 + $0 + $0).

Table 17 to Paragraph ( o )(18)( vii )

(B) Because PRS does not meet all three requirements in paragraph (o)(18)(viii)(A) of this section, PRS does not perform the calculations or adjustments described in paragraph (f)(2)(viii) of this section. In sum, the correct amounts to be used in paragraphs (o)(18)(ix) and (x) of this section are as follows.

Table 18 to Paragraph ( o )(18)( viii )(B)

(ix) Ninth, PRS determines each partner 's final ATIC excess amount . Because B has ATIC excess, PRS must determine B's final ATIC excess amount . B's final ATIC excess amount is B's ATIC excess ($37.50), reduced, but not below $0, by the product of the total ATIC deficit ($22.50) and the ratio of B's ATIC excess to the total ATIC excess ($37.50/$37.50). Therefore, B has $15 of final ATIC excess ($37.50−($22.50 × 100 percent)).

Table 19 to Paragraph ( o )(18)( ix )

(x) Tenth, PRS determines each partner 's final ATIC deficit amount . Because A has an ATIC deficit , PRS must determine A's final ATIC deficit amount . A's final ATIC deficit amount is A's ATIC deficit ($22.50), reduced, but not below $0, by the product of the total ATIC excess ($37.50) and the ratio of A's ATIC deficit to the total ATIC deficit ($22.50/$22.50). Therefore, A has $0 of final ATIC deficit ($22.50−($37.50 × 100 percent)).

Table 20 to Paragraph ( o )(18)( x )

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $50 of excess taxable income and $40 of deductible business interest expense . After grossing up each partner 's final ATIC excess amounts by ten-thirds, excess taxable income is allocated dollar for dollar to partners with final ATIC excess amounts. Thus, PRS allocates its excess taxable income $50 to B. A partner 's allocable business interest expense is deductible business interest expense to the extent it exceeds such partner 's share of excess business interest expense . Therefore, A has deductible business interest expense of $30 ($30−$0), B has deductible business interest expense of $10 ($10−$0), and C has deductible business interest expense of $0 ($0−$0).

Table 21 to Paragraph ( o )(18)( xi )

(19) Example 19: Facts. A, B, and C own all of the interests in partnership PRS. In Year 1, PRS has $100 of ATI, $0 of business interest income , and $50 of business interest expense . PRS's ATI consists of $200 of gross income and $100 of gross deductions . PRS allocates its items comprising ATI $100 to A, $100 to B, and ($100) to C. PRS allocates its business interest expense $0 to A, $25 to B, and $25 to C.

(i) First, PRS determines its limitation pursuant to § 1.163(j) –2. PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $30 ($100 × 30 percent). Thus, PRS has $30 of deductible business interest expense and $20 of excess business interest expense .

Table 22 to Paragraph ( o )(19)( ii )

(iii) Third, PRS compares each partner 's allocable business interest income to such partner 's allocable business interest expense . No partner has allocable business interest income . Consequently, each partner 's allocable business interest income deficit is equal to such partner 's allocable business interest expense . Thus, A's allocable business interest income deficit is $0, B's allocable business interest income deficit is $25, and C's allocable business interest income deficit is $25. The total allocable business interest income deficit is $50 ($0 + $25 + $25). No partner has allocable business interest income excess because no partner has allocable business interest income in excess of its allocable business interest expense . Thus, the total allocable business interest income excess is $0.

Table 23 to Paragraph ( o )(19)( iii )

(v) Fifth, PRS determines each partner 's remaining business interest expense . Because no partner has any allocable business interest income excess, each partner 's remaining business interest expense equals its allocable business interest income deficit . Thus, A's remaining business interest expense is $0, B's remaining business interest expense is $25, and C's remaining business interest expense is $25.

Table 24 to Paragraph ( o )(19)( v )

(vi) Sixth, PRS determines each partner 's final allocable ATI. Because C's allocable ATI is comprised of $100 of items of deduction and loss and $0 of income and gain, C has negative allocable ATI of $100. C is the only partner with negative allocable ATI. Thus, the total negative allocable ATI amount is $100. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, C has a positive allocable ATI of $0. Because A's allocable ATI is comprised of $100 of items of income and gain and $0 of deduction and loss , A has positive allocable ATI of $100. Because B's allocable ATI is comprised of $100 of items of income and gain and $0 of deduction and loss , B has positive allocable ATI of $100. Thus, the total positive allocable ATI is $200 ($100 + $100 + $0). PRS determines A's final allocable ATI by reducing, but not below $0, A's positive allocable ATI ($100) by the product of total negative allocable ATI ($100) and the ratio of A's positive allocable ATI to the total positive allocable ATI ($100/$200). Therefore, A's positive allocable ATI is reduced by $50 ($100 × 50 percent). As a result , A's final allocable ATI is $50. PRS determines B's final allocable ATI by reducing, but not below $0, B's positive allocable ATI ($100) by the product of total negative allocable ATI ($100) and the ratio of B's positive allocable ATI to the total positive allocable ATI ($100/$200). Therefore, B's positive allocable ATI is reduced by $50 ($100 × 50 percent). As a result , B's final allocable ATI is $50. Because C has a positive allocable ATI of $0, C's final allocable ATI is $0.

Table 25 to Paragraph ( o )(19)( vi )

Table 26 to Paragraph ( o )(19)( vi )

(vii) Seventh, PRS compares each partner 's ATI capacity (ATIC) amount to such partner 's remaining business interest expense . A's ATIC amount is $15 ($50 × 30 percent), B's ATIC amount is $15 ($50 × 30 percent), and C's ATIC amount is $0 ($0 × 30 percent). Because A's ATIC amount exceeds its remaining business interest expense by $15 ($15−$0), A has an ATIC excess of $15. B and C do not have any ATIC excess. Thus, the total ATIC excess is $15 ($15 + $0 + $0). A does not have any ATIC deficit . Because B's remaining business interest expense exceeds its ATIC amount by $10 ($25−$15), B has an ATIC deficit of $10. Because C's remaining business interest expense exceeds its ATIC amount by $25 ($25−$0), C has an ATIC deficit of $25. Thus, the total ATIC deficit is $35 ($0 + $10 + $25).

Table 27 to Paragraph ( o )(19)( vii )

(3) A total ATIC excess greater than $0 under paragraph (f)(2)(vii) of this section. Because PRS satisfies each of these three requirements , PRS must perform the calculations and make the necessary adjustments described under paragraphs (f)(2)(viii)(B) and (C) or (D) of this section.

(B) PRS must determine each partner 's priority amount and usable priority amount . Only partners with an ATIC deficit under paragraph (f)(2)(vii) of this section can have a priority amount greater than $0. Thus, only partners B and C can have a priority amount greater than $0. PRS determines a partner 's priority amount as 30 percent of the amount by which such partner 's allocable positive ATI exceeds its final allocable ATI. Therefore, A's priority amount is $0, B's priority amount is $15 (($100−$50) × 30 percent), and C's priority amount is $0 (($0−$0) × 30 percent). Thus, the total priority amount is $15 ($0 + $15 + $0). Next, PRS must determine each partner 's usable priority amount . Each partner 's usable priority amount is the lesser of such partner 's priority amount or ATIC deficit . Thus, A has a usable priority amount of $0, B has a usable priority amount of $10, and C has a usable priority amount of $0. As a result , the total usable priority amount is $10 ($0 + $10 + $0). Because the total ATIC excess under paragraph (f)(2)(vii) of this section ($15) is greater than the total usable priority amount ($10), PRS must perform the adjustments described in paragraph (f)(2)(viii)(C) of this section.

Table 28 to Paragraph ( o )(19)( viii )(B)

Table 29 to Paragraph ( o )(19)( viii )(B)

(C) For purposes of paragraph (f)(2)(ix) of this section, each partner 's final ATIC excess is $0. For purposes of paragraph (f)(2)(x) of this section, the following terms have the following meanings. Each partner 's ATIC deficit is such partner 's ATIC deficit as determined pursuant to paragraph (f)(2)(vii) of this section reduced by such partner 's usable priority amount . Thus, A's ATIC deficit is $0 ($0−$0), B's ATIC deficit is $0 ($10−$10), and C's ATIC deficit is $25 ($25−$0). The total ATIC deficit is the total ATIC deficit determined pursuant to paragraph (f)(2)(vii) ($35) reduced by the total usable priority amount ($10). Thus, the total ATIC deficit is $25 ($35−$10). The total ATIC excess is the total ATIC excess determined pursuant to paragraph (f)(2)(vii) of this section ($15) reduced by the total usable priority amount ($10). Thus, the total ATIC excess is $5 ($15−$5).

Table 30 to Paragraph ( o )(19)( viii )(C)

(1) In light of the fact that the total ATIC excess was greater than the total usable priority amount under paragraph (f)(2)(viii)(B) of this section, paragraph (f)(2)(viii)(D) of this section does not apply.

(2) In sum, the correct amounts to be used in paragraphs (o)(19)(ix) and (x) of this section are as follows.

Table 31 to Paragraph ( o )(19)( viii )(D)(2)

(ix) Ninth, PRS determines each partner 's final ATIC excess amount . Pursuant to paragraph (f)(2)(viii)(C) of this section, each partner 's final ATIC excess amount is $0.

(x) Tenth, PRS determines each partner 's final ATIC deficit amount . Because C has an ATIC deficit , PRS must determine C's final ATIC deficit amount . C's final ATIC deficit amount is C's ATIC deficit ($25), reduced, but not below $0, by the product of the total ATIC excess ($5) and the ratio of C's ATIC deficit to the total ATIC deficit ($25/$25). Therefore, C has $20 of final ATIC deficit ($25−($5 × 100 percent)).

Table 32 to Paragraph ( o )(19)( x )

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $20 of excess business interest expense . PRS allocates the excess business interest expense dollar for dollar to the partners with final ATIC deficits. Thus, PRS allocates its excess business interest expense $20 to C. A partner 's allocable business interest expense is deductible business interest expense to the extent it exceeds such partner 's share of excess business interest expense . Therefore, A has deductible business interest expense of $0 ($0−$0), B has deductible business interest expense of $25 ($25−$0), and C has deductible business interest expense of $5 ($25−$20).

Table 33 to Paragraph ( o )(19)( xi )

(20) Example 20: Facts. A, B, C, and D own all of the interests in partnership PRS. In Year 1, PRS has $200 of ATI, $0 of business interest income , and $140 of business interest expense . PRS's ATI consists of $600 of gross income and $400 of gross deductions . PRS allocates its items comprising ATI $100 to A, $100 to B, $400 to C, and ($400) to D. PRS allocates its business interest expense $0 to A, $40 to B, $60 to C, and $40 to D.

(i) First, PRS determines its limitation pursuant to § 1.163(j) –2. PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $60 ($200 × 30 percent). Thus, PRS has $60 of deductible business interest expense and $80 of excess business interest expense .

Table 34 to Paragraph ( o )(20)( ii )

(iii) Third, PRS compares each partner 's allocable business interest income to such partner 's allocable business interest expense . No partner has allocable business interest income . Consequently, each partner 's allocable business interest income deficit is equal to such partner 's allocable business interest expense . Thus, A's allocable business interest income deficit is $0, B's allocable business interest income deficit is $40, C's allocable business interest income deficit is $60, and D's allocable business interest income deficit is $40. The total allocable business interest income deficit is $140 ($0 + $40 + $60 + $40). No partner has allocable business interest income excess because no partner has allocable business interest income in excess of its allocable business interest expense . Thus, the total allocable business interest income excess is $0.

Table 35 to Paragraph ( o )(20)( iii )

(iv) Fourth, PRS determines each partner 's final allocable business interest income excess. Because no partner has any allocable business interest income excess, each partner has final allocable business interest income excess of $0.

(v) Fifth, PRS determines each partner 's remaining business interest expense . Because no partner has any allocable business interest income excess, each partner 's remaining business interest expense equals its allocable business interest income deficit . Thus, A's remaining business interest expense is $0, B's remaining business interest expense is $40, C's remaining business interest expense is $60, and D's remaining business interest expense is $40.

Table 36 to Paragraph ( o )(20)( v )

(vi) Sixth, PRS determines each partner 's final allocable ATI. Because D's allocable ATI is comprised of $400 of items of deduction and loss and $0 of income and gain, D has negative allocable ATI of $400. D is the only partner with negative allocable ATI. Thus, the total negative allocable ATI amount is $400. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, D has a positive allocable ATI of $0. PRS determines A's final allocable ATI by reducing, but not below $0, A's positive allocable ATI ($100) by the product of total negative allocable ATI ($400) and the ratio of A's positive allocable ATI to the total positive allocable ATI ($100/$600). Therefore, A's positive allocable ATI is reduced by $66.67 ($400 × 16.67 percent). As a result , A's final allocable ATI is $33.33. PRS determines B's final allocable ATI by reducing, but not below $0, B's positive allocable ATI ($100) by the product of total negative allocable ATI ($400) and the ratio of B's positive allocable ATI to the total positive allocable ATI ($100/$600). Therefore, B's positive allocable ATI is reduced by $66.67 ($400 × 16.67 percent). As a result , B's final allocable ATI is $33.33. PRS determines C's final allocable ATI by reducing, but not below $0, C's positive allocable ATI ($400) by the product of total negative allocable ATI ($400) and the ratio of C's positive allocable ATI to the total positive allocable ATI ($400/$600). Therefore, C's positive allocable ATI is reduced by $266.67 ($400 × 66.67 percent). As a result , C's final allocable ATI is $133.33. Because D has a positive allocable ATI of $0, D's final allocable ATI is $0.

Table 37 to Paragraph ( o )(20)( vi )

Table 38 to Paragraph ( o )(20)( vi )

(vii) Seventh, PRS compares each partner 's ATI capacity (ATIC) amount to such partner 's remaining business interest expense . A's ATIC amount is $10 ($33.33 × 30 percent), B's ATIC amount is $10 ($33.33 × 30 percent), C's ATIC amount is $40 ($133.33 × 30 percent), and D's ATIC amount is $0 ($0 × 30 percent). Because A's ATIC amount exceeds its remaining business interest expense by $10 ($10−$0), A has an ATIC excess of $10. B, C, and D do not have any ATIC excess. Thus, the total ATIC excess is $10 ($10 + $0 + $0 + $0). A does not have any ATIC deficit . Because B's remaining business interest expense exceeds its ATIC amount by $30 ($40−$10), B has an ATIC deficit of $30. Because C's remaining business interest expense exceeds its ATIC amount by $20 ($60−$40), C has an ATIC deficit of $20. Because D's remaining business interest expense exceeds its ATIC amount by $40 ($40−$0), D has an ATIC deficit of $40. Thus, the total ATIC deficit is $90 ($0 + $30 + $20 + $40).

Table 39 to Paragraph ( o )(20)( vii )

(A) Eighth, PRS must perform the calculations and make the necessary adjustments described under paragraph (f)(2)(viii) of this section if, and only if, PRS has (1) an excess business interest expense greater than $0 under paragraph (f)(2)(i) of this section, (2) a total negative allocable ATI greater than $0 under paragraph (f)(2)(vi) of this section, and (3) a total ATIC excess amount greater than $0 under paragraph (f)(2)(vii) of this section. Because PRS satisfies each of these three requirements , PRS must perform the calculations and make the necessary adjustments described under paragraphs (f)(2)(viii)(B) and (C) or paragraph (f)(2)(viii)(D) of this section.

(B) PRS must determine each partner 's priority amount and usable priority amount . Only partners with an ATIC deficit under paragraph (f)(2)(vii) of this section can have a priority amount greater than $0. Thus, only partners B, C, and D can have a priority amount greater than $0. PRS determines a partner 's priority amount as 30 percent of the amount by which such partner 's allocable positive ATI exceeds its final allocable ATI. Therefore, B's priority amount is $20 (($100−$33.33) × 30 percent), C's priority amount is $80 (($400−$133.33) × 30 percent), and D's priority amount is $0 (($0−$0) × 30 percent). Thus, the total priority amount is $100 ($0 + $20 + $80 + $0). Next, PRS must determine each partner 's usable priority amount . Each partner 's usable priority amount is the lesser of such partner 's priority amount or ATIC deficit . Thus, A has a usable priority amount of $0, B has a usable priority amount of $20, C has a usable priority amount of $20, and D has a usable priority amount of $0. As a result , the total usable priority amount is $40 ($0 + $20 + $20 + $0). Because the total usable priority amount ($40) is greater than the total ATIC excess under paragraph (f)(2)(vii) of this section ($10), PRS must perform the adjustments described in paragraph (f)(2)(viii)(D) of this section.

Table 40 to Paragraph ( o )(20)( viii )(B)

Table 41 to Paragraph ( o )(20)( viii )(B)

(C) In light of the fact that the total usable priority amount is greater than the total ATIC excess under paragraph (f)(2)(viii)(B) of this section, paragraph (f)(2)(viii)(C) of this section does not apply.

(D) ( 1 ) Because B and C are the only partners with priority amounts greater than $0, B and C are priority partners , while A and D are non-priority partners . For purposes of paragraph (f)(2)(ix) of this section, each partner 's final ATIC excess amount is $0. For purposes of paragraph (f)(2)(x) of this section, each non-priority partner 's final ATIC deficit amount is such partner 's ATIC deficit determined pursuant to paragraph (f)(2)(vii) of this section. Therefore, A has a final ATIC deficit of $0 and D has a final ATIC deficit of $40. Additionally, for purposes of paragraph (f)(2)(x) of this section, PRS must determine each priority partner 's step eight excess share. A priority partner 's step eight excess share is the product of the total ATIC excess and the ratio of the partner 's priority amount to the total priority amount . Thus, B's step eight excess share is $2 ($10 × ($20/$100)) and C's step eight excess share is $8 ($10 × ($80/$100)). To the extent a priority partner 's step eight excess share exceeds its ATIC deficit , the excess will be the partner 's ATIC excess for purposes of paragraph (f)(2)(x) of this section. Thus, B and C each have an ATIC excess of $0, resulting in a total ATIC excess is $0. To the extent a priority partner 's ATIC deficit exceeds its step eight excess share, the excess will be the partner 's ATIC deficit for purposes of paragraph (f)(2)(x) of this section. Because B's ATIC deficit ($30) exceeds its step eight excess share ($2), B's ATIC deficit for purposes of paragraph (f)(2)(x) of this section is $28 ($30−$2). Because C's ATIC deficit ($20) exceeds its step eight excess share ($8), C's ATIC deficit for purposes of paragraph (f)(2)(x) of this section is $12 ($20−$8). Thus, the total ATIC deficit is $40 ($28 + $12).

Table 42 to Paragraph ( o )(20)( viii )(D)( 1 )

Table 43 to Paragraph ( o )(20)( viii )(D)( 1 )

(2) In sum, the correct amounts to be used in paragraphs (o)(20)(ix) and (x) of this section are as follows.

Table 44 to Paragraph ( o )(20)( viii )(D)(2)

(ix) Ninth, PRS determines each partner 's final ATIC excess amount . Pursuant to paragraph (f)(2)(viii)(D) of this section, each priority and non-priority partner 's final ATIC excess amount is $0.

(x) Tenth, PRS determines each partner 's final ATIC deficit amount . Because B has an ATIC deficit , PRS must determine B's final ATIC deficit amount . B's final ATIC deficit amount is B's ATIC deficit ($28), reduced, but not below $0, by the product of the total ATIC excess ($0) and the ratio of B's ATIC deficit to the total ATIC deficit ($28/$40). Therefore, B has $28 of final ATIC deficit ($28−($0 × 70 percent)). Because C has an ATIC deficit , PRS must determine C's final ATIC deficit amount . C's final ATIC deficit amount is C's ATIC deficit ($12), reduced, but not below $0, by the product of the total ATIC excess ($0) and the ratio of C's ATIC deficit to the total ATIC deficit ($12/$40). Therefore, C has $12 of final ATIC deficit ($12−($0 × 30 percent)). Pursuant to paragraph (f)(2)(viii)(D) of this section, D's final ATIC deficit amount is $40.

Table 45 to Paragraph ( o )(20)( x )

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $80 of excess business interest expense . PRS allocates the excess business interest expense dollar for dollar to the partners with final ATIC deficits. Thus, PRS allocates its excess business interest expense $28 to B, $12 to C, and $40 to D. A partner 's allocable business interest expense is deductible business interest expense to the extent it exceeds such partner 's share of excess business interest expense . Therefore, A has deductible business interest expense of $0 ($0−$0), B has deductible business interest expense of $12 ($40−$28), C has deductible business interest expense of $48 ($60−$12), and D has deductible business interest expense of $0 ($40−$40).

Table 46 to Paragraph ( o )(20)( xi )

(21) Example 21: Facts. A, B, C, and D own all of the interests in partnership PRS. In Year 1, PRS has $200 of ATI, $0 of business interest income , and $150 of business interest expense . PRS's ATI consists of $500 of gross income and $300 of gross deductions . PRS allocates its items comprising ATI $50 to A, $50 to B, $400 to C, and ($300) to D. PRS allocates its business interest expense $0 to A, $50 to B, $50 to C, and $50 to D.

(i) First, PRS determines its limitation pursuant to § 1.163(j) –2. PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $60 ($200 × 30 percent). Thus, PRS has $60 of deductible business interest expense , and $90 of excess business interest expense .

Table 47 to Paragraph ( o )(21)( ii )

(iii) Third, PRS compares each partner 's allocable business interest income to such partner 's allocable business interest expense . No partner has allocable business interest income . Consequently, each partner 's allocable business interest income deficit is equal to such partner 's allocable business interest expense . Thus, A's allocable business interest income deficit is $0, B's allocable business interest income deficit is $50, C's allocable business interest income deficit is $50, and D's allocable business interest income deficit is $50. The total allocable business interest income deficit is $150 ($0 + $50 + $50 + $50). No partner has allocable business interest income excess because no partner has allocable business interest income in excess of its allocable business interest expense . Thus, the total allocable business interest income excess is $0.

Table 48 to Paragraph ( o )(21)( iii )

(v) Fifth, PRS determines each partner 's remaining business interest expense . Because no partner has any allocable business interest income excess, each partner 's remaining business interest expense equals its allocable business interest income deficit . Thus, A's remaining business interest expense is $0, B's remaining business interest expense is $50, C's remaining business interest expense is $50, and D's remaining business interest expense is $50.

Table 49 to Paragraph ( o )(21)( v )

(vi) Sixth, PRS determines each partner 's final allocable ATI. Because D's allocable ATI is comprised of $300 of items of deduction and loss and $0 of income and gain, D has negative allocable ATI of $300. D is the only partner with negative allocable ATI. Thus, the total negative allocable ATI amount is $300. Any partner with a negative allocable ATI, or an allocable ATI of $0, has a positive allocable ATI of $0. Therefore, D has a positive allocable ATI of $0. PRS determines A's final allocable ATI by reducing, but not below $0, A's positive allocable ATI ($50) by the product of total negative allocable ATI ($300) and the ratio of A's positive allocable ATI to the total positive allocable ATI ($50/$500). Therefore, A's positive allocable ATI is reduced by $30 ($300 × 10 percent). As a result , A's final allocable ATI is $20. PRS determines B's final allocable ATI by reducing, but not below $0, B's positive allocable ATI ($50) by the product of total negative allocable ATI ($300) and the ratio of B's positive allocable ATI to the total positive allocable ATI ($50/$500). Therefore, B's positive allocable ATI is reduced by $30 ($300 × 10 percent). As a result , B's final allocable ATI is $20. PRS determines C's final allocable ATI by reducing, but not below $0, C's positive allocable ATI ($400) by the product of total negative allocable ATI ($300) and the ratio of C's positive allocable ATI to the total positive allocable ATI ($400/$500). Therefore, C's positive allocable ATI is reduced by $240 ($300 × 80 percent). As a result , C's final allocable ATI is $160. Because D has a positive allocable ATI of $0, D's final allocable ATI is $0.

Table 50 to Paragraph ( o )(21)( vi )

Table 51 to Paragraph ( o )(21)( vi )

(vii) Seventh, PRS compares each partner 's ATI capacity (ATIC) amount to such partner 's remaining business interest expense . A's ATIC amount is $6 ($20 × 30 percent), B's ATIC amount is $6 ($20 × 30 percent), C's ATIC amount is $48 ($160 × 30 percent), and D's ATIC amount is $0 ($0 × 30 percent). Because A's ATIC amount exceeds its remaining business interest expense by $6 ($6−$0), A has an ATIC excess of $6. B, C, and D do not have any ATIC excess. Thus, the total ATIC excess amount is $6 ($6 + $0 + $0 + $0). A does not have any ATIC deficit . Because B's remaining business interest expense exceeds its ATIC amount by $44 ($50−$6), B has an ATIC deficit of $44. Because C's remaining business interest expense exceeds its ATIC amount by $2 ($50−$48), C has an ATIC deficit of $2. Because D's remaining business interest expense exceeds its ATIC amount by $50 ($50−$0), D has an ATIC deficit of $50. Thus, the total ATIC deficit is $96 ($0 + $44 + $2 + $50).

Table 52 to Paragraph ( o )(21)( vii )

(3) A total ATIC excess amount greater than $0 under paragraph (f)(2)(vii) of this section. Because PRS satisfies each of these three requirements , PRS must perform the calculations and make the necessary adjustments described under paragraph (f)(2)(viii) of this section.

(B) PRS must determine each partner 's priority amount and usable priority amount . Only partners with an ATIC deficit under paragraph (f)(2)(vii) of this section of this section can have a priority amount greater than $0. Thus, only partners B, C, and D can have a priority amount greater than $0. PRS determines a partner 's priority amount as 30 percent of the amount by which such partner 's allocable positive ATI exceeds its final allocable ATI. Therefore, B's priority amount is $9 (($50−$20) × 30 percent), C's priority amount is $72 (($400−$160) × 30 percent), and D's priority amount is $0 (($0−$0) × 30 percent). Thus, the total priority amount is $81 ($0 + $9 + $72 + $0). Next, PRS must determine each partner 's usable priority amount . Each partner 's usable priority amount is the lesser of such partner 's priority amount or ATIC deficit . Thus, B has a usable priority amount of $9, C has a usable priority amount of $2, and D has a usable priority amount of $0. As a result , the total usable priority amount is $11 ($0 + $9 + $2 + $0). Because the total usable priority amount ($11) is greater than the total ATIC excess ($6) under paragraph (f)(2)(vii) of this section, PRS must perform the adjustments described in paragraph (f)(2)(viii)(D) of this section.

Table 53 to Paragraph ( o )(21)( viii )(B)

Table 54 to Paragraph ( o )(21)( viii )(B)

(D) ( 1 ) Because B and C are the only partners with priority amounts greater than $0, B and C are priority partners , while A and D are non-priority partners . For purposes of paragraph (f)(2)(ix) of this section, each partner 's final ATIC excess amount is $0. For purposes of paragraph (f)(2)(x) of this section, each non-priority partner 's final ATIC deficit amount is such partner 's ATIC deficit determined pursuant to paragraph (f)(2)(vii) of this section. Therefore, A has a final ATIC deficit of $0 and D has a final ATIC deficit of $50. Additionally, for purposes of paragraph (f)(2)(x) of this section, PRS must determine each priority partner 's step eight excess share. A priority partner 's step eight excess share is the product of the total ATIC excess and the ratio of the partner 's priority amount to the total priority amount . Thus, B's step eight excess share is $0.67 ($6 × ($9/$81)) and C's step eight excess share is $5.33 ($6 × ($72/$81)). To the extent a priority partner 's step eight excess share exceeds its ATIC deficit , the excess will be the partner 's ATIC excess for purposes of paragraph (f)(2)(x) of this section. B's step eight excess share does not exceed its ATIC deficit . Because C's step eight excess share ($5.33) exceeds its ATIC deficit ($2), C's ATIC excess for purposes of paragraph (f)(2)(x) of this section is $3.33 ($5.33−$2). Thus, the total ATIC excess for purposes of paragraph (f)(2)(x) of this section is $3.33 ($0 + $3.33). To the extent a priority partner 's ATIC deficit exceeds its step eight excess share, the excess will be the partner 's ATIC deficit for purposes of paragraph (f)(2)(x) of this section. Because B's ATIC deficit ($44) exceeds its step eight excess share ($0.67), B's ATIC deficit for purposes of paragraph (f)(2)(x) of this section is $43.33 ($44−$0.67). C's ATIC deficit does not exceed its step eight excess share. Thus, the total ATIC deficit for purposes of paragraph (f)(2)(x) of this section is $43.33 ($43.33 + $0).

Table 55 to Paragraph ( o )(21)( viii )(D)(1)

Table 56 to Paragraph ( o )(21)( viii )(D)(1)

(2) In sum, the correct amounts to be used in paragraphs (o)(21)(ix) and (x) of this section are as follows.

Table 57 to Paragraph ( o )(21)( viii )(D)(2)

(x) Tenth, PRS determines each partner 's final ATIC deficit amount . Because B has an ATIC deficit , PRS must determine B's final ATIC deficit amount . B's final ATIC deficit amount is B's ATIC deficit ($43.33), reduced, but not below $0, by the product of the total ATIC excess ($3.33) and the ratio of B's ATIC deficit to the total ATIC deficit ($43.33/$43.33). Therefore, B has $40 of final ATIC deficit ($43.33−($3.33 × 100 percent)). Pursuant to paragraph (f)(2)(viii)(D) of this section, D's final ATIC deficit amount is $40.

Table 58 to Paragraph ( o )(21)( x )

(xi) Eleventh, PRS allocates deductible business interest expense and section 163(j) excess items to the partners. Pursuant to paragraph (f)(2)(i) of this section, PRS has $90 of excess business interest expense . PRS allocates the excess business interest expense dollar for dollar to the partners with final ATIC deficits. Thus, PRS allocates its excess business interest expense $40 to B and $50 to D. A partner 's allocable business interest expense is deductible business interest expense to the extent it exceeds such partner 's share of excess business interest expense . Therefore, A has deductible business interest expense of $0 ($0−$0), B has deductible business interest expense of $10 ($50−$40), C has deductible business interest expense of $50 ($50−$0), and D has deductible business interest expense of $0 ($50−$50).

Table 59 to Paragraph ( o )(21)( xi )

(22) Example 22 —(i) Facts. A and B are equal shareholders in X, a subchapter S corporation . In Year 1, X has $100 of ATI and $40 of business interest expense . A has $100 of ATI and $20 of business interest expense from its sole proprietorship. B has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) S corporation-level. In Year 1, X's section 163(j) limit is 30 percent of its ATI, or $30 ($100 × 30 percent). Thus, X has $30 of deductible business interest expense and $10 of disallowed business interest expense . Such $30 of deductible business interest expense is includable in X's nonseparately stated income or loss , and is not subject to further limitation under section 163(j). X carries forward the $10 of disallowed business interest expense to Year 2 as a disallowed business interest expense carryforward under § 1.163(j) –2(c). X may not currently deduct all $40 of its business interest expense in Year 1. X only reduces its accumulated adjustments account in Year 1 by the $30 of deductible business interest expense in Year 1 under § 1.163(j) –6(l)(7).

(iii) Shareholder allocations. A and B are each allocated $35 of nonseparately stated taxable income ($50 items of income or gain, less $15 of deductible business interest expense) from X. A and B do not reduce their basis in X by the $10 of disallowed business interest expense .

(iv) Shareholder-level computations. A, in computing its limit under section 163(j), has $100 of ATI and $20 of business interest expense from its sole proprietorship. A's section 163(j) limit is $30 ($100 × 30 percent). Thus, A's $20 of business interest expense is deductible business interest expense . B, in computing its limit under section 163(j), has $20 of business interest expense from its sole proprietorship. B's section 163(j) limit is $0 ($0 × 30 percent). Thus, B's $20 of business interest expense is not allowed as a deduction and is treated as business interest expense paid or accrued by B in Year 2.

(23) Example 23 —(i) Facts. The facts are the same as in Example 22 in paragraph (o)(22)(i) of this section. In Year 2, X has $233.33 of ATI, $0 of business interest income , and $30 of business interest expense . A has $100 of ATI and $20 of business interest expense from its sole proprietorship. B has $0 of ATI and $20 of business interest expense from its sole proprietorship.

(ii) S corporation-level. In Year 2, X's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $70 ($233.33 × 30 percent). Because X's section 163(j) limit exceeds X's $40 of business interest expense ($30 from Year 2, plus the $10 disallowed business interest expense carryforwards from Year 1), X may deduct all $40 of business interest expense in Year 2. Such $40 of deductible business interest expense is includable in X's nonseparately stated income or loss , and is not subject to further limitation under section 163(j). Pursuant to § 1.163(j) –6(l)(7), X must reduce its accumulated adjustments account by $40. Additionally, X has $100 of excess taxable income under § 1.163(j) –1(b)(17).

(iii) Shareholder allocations. A and B are each allocated $96.67 of nonseparately stated taxable income ($116.67 items of income or gain, less $20 of deductible business interest expense) from X. Additionally, A and B are each allocated $50 of excess taxable income under § 1.163(j) –6(l)(4). As a result , A and B each increase their ATI by $50.

(iv) Shareholder-level computations. A, in computing its limit under section 163(j), has $150 of ATI ($100 from its sole proprietorship, plus $50 excess taxable income) and $20 of business interest expense (from its sole proprietorship). A's section 163(j) limit is $45 ($150 × 30 percent). Thus, A's $20 of business interest expense is deductible business interest expense . B, in computing its limit under section 163(j), has $50 of ATI ($0 from its sole proprietorship, plus $50 excess taxable income) and $40 of business interest expense ($20 from its sole proprietorship, plus $20 disallowed business interest expense from its sole proprietorship in Year 1). B's section 163(j) limit is $15 ($50 × 30 percent). Thus, $15 of B's business interest expense is deductible business interest expense . The $25 of B's business interest expense not allowed as a deduction ($40 business interest expense , less $15 section 163(j) limit) is treated as business interest expense paid or accrued by B in Year 3.

(24) Example 24 —(i) Facts. On January 1, 2020, L and M form LM, a publicly traded partnership (as defined in § 1.7704 –1), and agree that each will be allocated a 50 percent share of all LM items. The partnership agreement provides that LM will make allocations under section 704(c) using the remedial allocation method under § 1.704 –3(d). L contributes depreciable property with an adjusted tax basis of $4,000 and a fair market value of $10,000. The property is depreciated using the straight-line method with a 10-year recovery period and has 4 years remaining on its recovery period. M contributes $10,000 in cash , which LM uses to purchase land . Except for the depreciation deductions , LM's expenses equal its income in each year of the 10 years commencing with the year LM is formed. LM has a valid section 754 election in effect.

(ii) Section 163(j) remedial items and partner basis items. LM sells the asset contributed by L in a fully taxable transaction at a time when the adjusted basis of the property is $4,000. Under § 1.163(j) –6(e)(2)(ii), solely for purposes of § 1.163(j) –6, the tax gain of $6,000 is allocated equally between L and M ($3,000 each). To avoid shifting built-in gain to the non-contributing partner (M) in a manner consistent with the rule in section 704(c), a remedial deduction of $3,000 is allocated to M (leaving M with no net tax gain), and remedial income of $3,000 is allocated to L (leaving L with total tax gain of $6,000).

(25) Example 25 —(i) Facts. The facts are the same as Example 24 in paragraph (o)(24) of this section except the property contributed by L had an adjusted tax basis of zero. For each of the 10 years following the contribution, there would be $500 of section 704(c) remedial income allocated to L and $500 of remedial deductions allocated to M with respect to the contributed asset. A buyer of M's units would step into M's shoes with respect to the $500 of annual remedial deductions . A buyer of L's units would step into L's shoes with respect to the $500 of annual remedial income and would have an annual section 743(b) deduction of $1,000 (net $500 of deductions).

(ii) Analysis. Pursuant to § 1.163(j) –6(d)(2)(ii), solely for purposes of § 1.163(j) –6, a buyer of L's units immediately after formation of LM would offset its $500 annual section 704(c) remedial income allocation with $500 of annual section 743(b) adjustment (leaving the buyer with net $500 of section 743(b) deduction). As a result , such buyer would be in the same position as a buyer of M's units. Each buyer would have net deductions of $500 per year , which would not affect ATI before 2022.

(26) Example 26 —(i) Facts. X and Y are partners in partnership PRS. In Year 1, PRS had $200 of excess business interest expense . Pursuant to § 1.163(j) –6(f)(2), PRS allocated $100 of such excess business interest expense to each of its partners. In Year 2, X lends $10,000 to PRS and receives $1,000 of interest income for the taxable year (self-charged lending transaction). X is not in the trade or business of lending money. The $1,000 of interest expense resulting from this loan is allocable to PRS's trade or business assets. As a result , such $1,000 of interest expense is business interest expense of PRS. X and Y are each allocated $500 of such business interest expense as their distributive share of PRS's business interest expense for the taxable year . Additionally, in Year 2, PRS has $3,000 of ATI. PRS allocates the items comprising its $3,000 of ATI $0 to X and $3,000 to Y.

(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30 percent of its ATI plus its business interest income , or $900 ($3,000 × 30 percent). Thus, PRS has $900 of deductible business interest expense , $100 of excess business interest expense , $0 of excess taxable income , and $0 of excess business interest income . Pursuant to § 1.163(j) –6(f)(2), $400 of X's allocation of business interest expense is treated as deductible business interest expense , $100 of X's allocation of business interest expense is treated as excess business interest expense , and $500 of Y's allocation of business interest expense is treated as deductible business interest expense .

(iii) Lending partner. Pursuant to § 1.163(j) –6(n), X treats $100 of its $1,000 of interest income as excess business interest income allocated from PRS in Year 2. Because X is deemed to have been allocated $100 of excess business interest income from PRS, and excess business interest expense from a partnership is treated as paid or accrued by a partner to the extent excess business interest income is allocated from such partnership to a partner , X treats its $100 allocation of excess business interest expense from PRS in Year 2 as business interest expense paid or accrued in Year 2. X, in computing its limit under section 163(j), has $100 of business interest income ($100 deemed allocation of excess business interest income from PRS in Year 2) and $100 of business interest expense ($100 allocation of excess business interest expense treated as paid or accrued in Year 2). Thus, X's $100 of business interest expense is deductible business interest expense . At the end of Year 2, X has $100 of excess business interest expense from PRS ($100 from Year 1). X treats $900 of its $1,000 of interest income as investment income for purposes of section 163(d).

(27) –(33) [Reserved]

(34) Example 34 —(i) Facts. X and Y are equal partners in partnership PRS. Further, X and Y share the profits of PRS equally. In 2019, PRS had ATI of $100. Additionally, in 2019, PRS had $100 of section 704(b) income which was allocated $50 to X and $50 to Y (PRS did not have any section 704(c) income in 2019). In 2020, PRS's only items of income , gain, loss or deduction was $1 of trade or business income , which it allocated to X pursuant to section 704(c).

(ii) Partnership-level. In 2020, PRS makes the election described in § 1.163(j) –6(d)(5) to use its 2019 ATI in 2020. As a result , PRS has $100 of ATI in 2020. PRS does not have any business interest expense . Therefore, PRS has $100 of excess taxable income in 2020.

(iii) Partner-level allocations. PRS allocates its $100 of excess taxable income to X and Y pursuant to § 1.163(j) –6(f)(2). To determine each partner 's share of the $100 of excess taxable income , PRS must determine each partner 's allocable ATI (as defined in § 1.163(j) –6(f)(2)(ii)). Because PRS made the election described in § 1.163(j) –6(d)(5), PRS must determine the allocable ATI of each of its partners pursuant to paragraph (d)(5). Specifically, PRS determines each partner 's share of allocable ATI based on PRS's 2019 section 704 income , gain, loss , and deduction. PRS had $100 of section 704(b) income in 2019 which was allocated $50 to X and $50 to Y. Therefore, in 2020, X and Y are both allocated $50 of excess taxable income (50% × $100).

(35) Example 35 —(i) Facts. X, a partner in partnership PRS, was allocated $20 of excess business interest expense from PRS in 2018 and $10 of excess business interest expense from PRS in 2019. In 2020, PRS allocated $16 of excess taxable income to X.

(ii) Analysis. X treats 50 percent of its $10 of excess business interest expense allocated from PRS in 2019 as § 1.163(j) –6(g)(4) business interest expense . Thus, $5 of § 1.163(j) –6(g)(4) business interest expense is treated as paid or accrued by X in 2020 and is not subject to the section 163(j) limitation at X's level. Because X was allocated $16 of excess taxable income from PRS in 2020, X treats $16 of its $25 of excess business interest expense as business interest expense paid or accrued pursuant to § 1.163(j) –6(g)(2). X, in computing its limit under section 163(j) in 2020, has $16 of ATI (as a result of its allocation of $16 of excess taxable income from PRS), $0 of business interest income , and $16 of business interest expense ($16 of excess business interest expense treated as paid or accrued in 2020). Pursuant to § 1.163(j) –2(b)(2)(i), X's section 163(j) limit in 2020 is $8 ($16 × 50 percent). Thus, X has $8 of business interest expense that is deductible under section 163(j). The $8 of X's business interest expense not allowed as a deduction ($16 business interest expense subject to section 163(j), less $8 section 163(j) limit) is treated as business interest expense paid or accrued by X in 2021. At the end of 2020, X has $9 of excess business interest expense from PRS ($20 from 2018, plus $10 from 2019, less $5 treated as paid or accrued pursuant to § 1.163(j) –6(g)(4), less $16 treated as paid or accrued pursuant to § 1.163(j) –6(g)(2)).

(36) Example 36 —(i) Facts. X is a partner in partnership PRS. At the beginning of 2018, X's outside basis in PRS was $100. X was allocated $20 of excess business interest expense from PRS in 2018 and $10 of excess business interest expense from PRS in 2019. X sold its PRS interest in 2019 for $70.

(ii) Analysis. X treats 50 percent of its $10 of excess business interest expense allocated from PRS in 2019 as § 1.163(j) –6(g)(4) business interest expense . Thus, $5 of § 1.163(j) –6(g)(4) business interest expense is treated as paid or accrued by X in 2020 and is not subject to the section 163(j) limitation at X's level. Pursuant to paragraph (h)(3) of this section, immediately before the disposition , X increases the basis of its PRS interest from $70 to $95 (add back of $20 of EBIE from 2018 and $5 of remaining EBIE from 2019). Thus, X has a $25 section 741 loss recognized on the sale ($70−$95).

(p) Applicability dates. (1) In general. This section applies to taxable years beginning on or after November 13, 2020. However, taxpayers and their related parties , within the meaning of sections 267(b) and 707(b)(1), may choose to apply the rules of this section to a taxable year beginning after December 31, 2017, so long as the taxpayers and their related parties consistently apply the rules of the section 163(j) regulations, and, if applicable, §§ 1.263A –9, 1.263A–15, 1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–5, 1.382–6, 1.382–7, 1.383–0, 1.383–1, 1.469–9, 1.469–11, 1.704–1, 1.882–5, 1.1362–3, 1.1368–1, 1.1377–1, 1.1502–13, 1.1502–21, 1.1502–36, 1.1502–79, 1.1502–91 through 1.1502–99 (to the extent they effectuate the rules of §§ 1.382 –2, 1.382–5, 1.382–6, and 1.383–1), and 1.1504–4, to that taxable year .

(2) Paragraphs (c)(1) and (2), (d)(3) through (5), (e)(5), (f)(1)(iii), (g)(4), (n), and (o)(24) through (29), and (34) through (36). Paragraphs (c)(1) and (2), (d)(3) through (5), (e)(5), (f)(1)(iii), (g)(4), (n), and (o)(24) through (29), and (34) through (36) of this section apply to taxable years beginning on or after March 22, 2021. However, taxpayers and their related parties , within the meaning of sections 267(b) (determined without regard to section 267(c)(3)) and 707(b)(1), may choose to apply the rules in paragraphs (c)(1) and (2), (d)(3) through (5), (e)(5), (f)(1)(iii), (g)(4), (n), and (o)(24) through (29), and (34) through (36) to a taxable year beginning after December 31, 2017, and before March 22, 2021, provided that those taxpayers and their related parties consistently apply all of the rules in T.D. 9905 ( §§ 1.163(j) –0 through 1.163(j)–11, effective November 13, 2020) as modified by T.D. 9943 (effective January 13, 2021), and, if applicable, §§ 1.263A –9, 1.263A–15, 1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–5, 1.382–6, 1.382–7, 1.383–0, 1.383–1, 1.469–9, 1.469–11, 1.704–1, 1.882–5, 1.1362–3, 1.1368–1, 1.1377–1, 1.1502–13, 1.1502–21, 1.1502–36, 1.1502–79, 1.1502–91 through 1.1502–99 (to the extent they effectuate the rules of §§ 1.382 –2, 1.382–5, 1.382–6, and 1.383–1), and 1.1504–4 contained in T.D. 9905 as modified by T.D. 9943, for that taxable year and for each subsequent taxable year .

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

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Basic questions and answers about the limitation on the deduction for business interest expense

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Below are answers to some basic questions about the limitation on the deduction for business interest expense, also known as the "section 163(j) limitation." Prior to the 2017 Tax Cuts and Jobs Act (TCJA), section 163(j) of the Internal Revenue Code applied only to certain interest paid or accrued by corporations. However, the TCJA significantly changed the section 163(j) limitation. On March 27, 2020, section 163(j) was further amended by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The Treasury Department and the IRS issued final regulations under section 163(j) in September 2020 and January 2021. See Treasury Decisions 9905 and 9943.

These questions and answers address the section 163(j) limitation after amendments by the TCJA and the CARES Act.

Q1. What is the section 163(j) limitation on the deduction for business interest expense? (updated January 10, 2023)

A1. Generally, taxpayers can deduct interest expense paid or accrued in the taxable year. However, if the section 163(j) limitation applies, the amount of deductible business interest expense in a taxable year cannot exceed the sum of:

• the taxpayer's business interest income for the taxable year;
• 30% of the taxpayer's adjusted taxable income (ATI) for the taxable year; and
• the taxpayer's floor plan financing interest expense for the taxable year.

Under the CARES Act, a different percentage (50%) of ATI may apply for taxable years beginning in 2019 and 2020. See the CARES Act, discussed later, and Revenue Procedure 2020-22 PDF , for ATI elections and special rules for partnerships.

Q2. Who is subject to the section 163(j) limitation? (updated January 10, 2023)

A2. For taxable years beginning after December 31, 2017, the limitation applies to all taxpayers who have business interest expense, other than certain small businesses that meet the gross receipts test in section 448(c) ("exempt small business") (see Q/A 3-4). The limitation does not apply to certain electing trades or businesses and certain excepted trades or businesses (see Q/A 5-6).

Q3. What is the gross receipts test for purposes of the section 163(j) limitation? (updated January 10, 2023)

A3. A business generally meets the gross receipts test of section 448(c) when it is not a tax shelter (as defined in section 448(d)(3)) and has average annual gross receipts of $25 million or less in the previous three years. The $25 million gross receipts amount is adjusted annually for inflation. The inflation adjusted gross receipts amount for 2019 through 2021 is $26 million. The inflation adjusted gross receipts amount for 2022 is $27 million.

Q4. Although my average annual gross receipts for years 2018-2020 were more than $26 million, my gross receipts in 2021 decreased enough to lower my average annual gross receipts for years 2019-2021 to below $27 million. Will I be subject to the section 163(j) limitation when I file for the 2022 taxable year? (updated January 10, 2023)

A4. No. Although you are subject to the section 163(j) limitation for the 2021 taxable year, the limitation does not apply to you for the 2022 taxable year. Any business interest expense that was disallowed in 2021 due to the limitation is carried forward to 2022 and will no longer be subject to the limitation in 2022. Therefore, you do not need to compute the section 163(j) limitation for the 2022 taxable year.

Note: This answer assumes that you are operating only one trade or business that is not an electing or excepted trade or business, as discussed in Q/A 5, 6 and 7 below.

Excepted Trades or Businesses

Q5. which businesses qualify as an excepted trade or business.

A5. The following are excepted trades or businesses:

• The trade or business of providing services as an employee;
• Certain real property trades or businesses that elect to be excepted;
• Certain farming businesses that elect to be excepted; and
• Certain regulated utility trades or businesses.

Q6. How does an eligible real property trade or business or farming business elect to be an excepted trade or business? (updated January 10, 2023)

A6. A taxpayer with an eligible real property trade or business or farming business may make an election to be an excepted trade or business by following the procedures outlined in Treas. Reg. §1.163(j)-9, including the requirement to attach a statement to a timely filed federal income tax return (including any extensions) for the taxable year of election. See also Revenue Procedures 2018-59 PDF , 2020-22 PDF , and 2021-9 PDF . An exempt small business is permitted to make an election to be an excepted trade or business even though that taxpayer may already not be subject to the section 163(j) limitation. See Treas. Reg. §§1.163(j)-2(d)(1) and 1.163(j)-9(b). This provision is intended to allow taxpayers who are unsure whether they qualify as an exempt small business to make a protective election without having to apply the gross receipts test described in Q/A 3 above for the prior three taxable years. Once made, an election is generally irrevocable and binding on the trade or business for all succeeding years. See Treas. Reg. §1.163(j)-9 for certain circumstances where the election terminates. The statement making an election to be an excepted trade or business that is attached to the taxpayer's return for the taxable year of election must include the following information:

• The taxpayer's name, address, and social security number or employer identification number;
• A description of the electing trade or business, including the principal business activity code; and
• A statement that the taxpayer is making an election as a real property trade or business (under section 163(j)(7)(B) or as a farming business (under section 163(j)(7)(C)), as applicable. 

Q7. Are there any consequences I should be aware of in making an election to be an excepted trade or business? (updated January 10, 2023)

A7. Yes. If you make an election to be an excepted real property trade or business, the following assets that you hold in the electing real property trade or business must be depreciated using the alternative depreciation system (ADS) and are not eligible for a bonus depreciation deduction under section 168(k):

• Nonresidential real property;
• Residential rental property; and
• Qualified improvement property. 

If you make an election to be an electing farming business, any property with a recovery period of 10 years or more that you hold in the electing farming business must be depreciated using ADS, and such property is not eligible for a bonus depreciation deduction under section 168(k). See Revenue Procedures 2019-08 PDF , 2020-22 PDF , 2020-25 PDF , and 2021-9 PDF for more information.

Determining the Section 163(j) Limitation Amount

Q8. what is considered interest for purposes of section 163(j) (updated january 10, 2023).

A8. Treas. Reg. §1.163(j)-1(b)(22) defines the term "interest" to determine interest expense and interest income for purposes of section 163(j). In general, under Treas. Reg. §1.163(j)-1(b)(22), interest is any amount that is paid, received, or accrued as compensation for the use or forbearance of money under the terms of an instrument or contractual arrangement, including a series of transactions, that is treated as a debt instrument for purposes of section 1275(a) and Treas. Reg. §1.1275-1(d), or any amount that is treated as interest under other provisions of the Code or the regulations thereunder. Treas. Reg. §1.163(j)-1(b)(22) provides additional information on what constitutes interest for purposes of section 163(j), including anti-avoidance rules and a list of other amounts treated as interest, such as certain amounts of bond premium, factoring income, and certain dividends from regulated investment companies.

Q9. What is business interest expense? (updated January 10, 2023)

A9. Business interest expense is any interest expense that is properly allocable to a trade or business that is not an excepted trade or business. Floor plan financing interest expense is also business interest expense. See Q/A 8, above, for what is considered interest. See Q/A 15, below, if you have interest expense that is allocable to both an excepted trade or business and a non-excepted trade or business.

Q10. What is business interest income? (updated January 10, 2023)

A10. Business interest income is interest income that is includable in gross income and properly allocable to a trade or business that is not an excepted trade or business. See Q/A 8, above, for what is considered interest. See Q/A 15, below, if you have interest income that is allocable to both an excepted trade or business and a non-excepted trade or business.

Q11. How do I calculate ATI (ATI limitation)? (updated January 10, 2023)

A11. ATI is calculated by taking the taxable income for the taxable year as if section 163(j) does not limit any interest deduction, and then adding and subtracting from that amount certain amounts for the taxable year:

Additions include, but are not limited to, business interest expense; net operating loss deduction; deduction for qualified business income under section 199A; depreciation, amortization, or depletion deduction for taxable years beginning before 2022; capital loss carrybacks or carryovers; and any deduction or loss not properly allocable to a non-excepted trade or business.

Subtractions include, but are not limited to, business interest income; floor plan financing interest expense; with respect to the sale or other disposition of property (which may take place in a taxable year starting on or after January 1, 2022), the greater of the allowed or allowable depreciation, amortization or depletion of the property for taxable years beginning before 2022; and any income or gain that is not properly allocable to a non-excepted trade or business.

For taxable years beginning after January 1, 2022, deductions for depreciation, amortization, or depletion are not added back to taxable income in calculating ATI.

Certain other adjustments to ATI apply for some types of taxpayers. See Treas. Reg. §1.163(j)-1(b)(1).

Q12. How Do I Make the Election to Substitute Adjusted Taxable Income for the Last Taxable Year in 2019? (added January 10, 2023)

A12. The CARES Act allows taxpayers to elect to substitute its ATI for the last taxable year beginning in 2019 for the taxpayer's ATI in determining the taxpayer's section 163(j) limitation for any taxable year beginning in 2020, subject to modifications for short taxable years.

If this election is made, complete line 22, adjusted taxable income, on Form 8990 and leave lines 6 through 21 blank. No formal statement is required to make this election.

Please see section 6.02 of Revenue Procedure 2020-22 PDF for additional information regarding this election under new section 163(j)(10), as amended by the CARES Act.

Q13. What is floor plan financing interest expense? (updated January 10, 2023)

A13. Floor plan financing interest expense is interest paid or accrued on floor plan financing indebtedness. Floor plan financing indebtedness is indebtedness that is used to finance the acquisition of motor vehicles held for sale or lease and that is secured by the acquired inventory. For example, if you own an automobile dealership and pay interest on a loan that is secured by the dealership's office equipment, then such interest is not a floor plan financing interest expense.

Q14. What happens to business interest expense that I cannot deduct in the current year because of the section 163(j) limitation? (updated January 10, 2023)

A14. The amount of business interest expense disallowed as a deduction in the current year under section 163(j) is carried forward to the next taxable year (a "disallowed business interest expense carryforward"). Your disallowed business interest expense carryforward may be limited in the next taxable year if the section 163(j) limitation continues to apply to you. Special rules apply to partnerships and S Corporations (see Q/A 16).

Q15. If I'm engaged in both an excepted trade or business and a non-excepted trade or business, how do I determine the section 163(j) limitation? (updated January 10, 2023)

A15. Your interest expense that is properly allocable to an excepted trade or business is not subject to the section 163(j) limitation. Similarly, the amount of your items of income, gain, deduction, or loss, including interest income that is properly allocable to an excepted trade or business, is excluded in determining the section 163(j) limitation. Therefore, you should allocate tax items between excepted and non-excepted trades or businesses in order to determine the section 163(j) limitation.

Treas. Reg. §1.163(j)-10 provides special rules for allocating various tax items. You must generally compare your basis in the assets you use in your excepted trades or businesses and your basis in the assets you use in your non-excepted trades or businesses to determine what portion of interest expense and interest income to allocate to your excepted trades or businesses. In limited cases, tracing of interest expense paid on certain nonrecourse debt may be available.

Q16. How does the section 163(j) limitation apply to partnerships and S corporations? (updated January 10, 2023)

A16. The section 163(j) limitation is applied at the partnership level. As provided in Q/A 1, the amount of deductible business interest expense in a taxable year cannot exceed the sum of the partnership's business interest income, 30% of the partnership's ATI, and the partnership's floor plan financing interest expense.

Business interest expense that may be deducted upon application of the section 163(j) limitation is taken into account in determining the non-separately stated taxable income or loss of the partnership. Any business interest expense of the partnership that is disallowed upon application of the section 163(j) limitation is allocated to each partner in the same manner as the non-separately stated taxable income or loss of the partnership. This amount is called excess business interest expense (EBIE).

A partner carries forward its share of EBIE. In a succeeding taxable year, a partner may treat its EBIE as business interest expense paid or accrued by the partner to the extent the partner is allocated excess taxable income or excess business interest income from the same partnership. Excess taxable income is the amount of ATI of the partnership that was in excess of what it needed to deduct its business interest expense. Excess business interest income is the amount by which business interest income exceeded business interest expense at the partnership level. Excess taxable income is allocated to each partner in the same manner as the non-separately stated taxable income or loss of the partnership. An allocation of excess taxable income to a partner increases the partner's ATI. Similarly, an allocation of excess business interest income to a partner increases the partner's business interest income. Once EBIE is treated as business interest expense paid or accrued by the partner, such business interest expense is subject to the partner's section 163(j) limitation, if any (see Q/A 1).

S corporations apply the section 163(j) limitation at the S corporation level. Any business interest expense of the S corporation that is disallowed upon application of the section 163(j) limitation is not allocated to its shareholders, but is instead carried over at the S corporation level to its succeeding taxable years. An S corporation allocates any excess taxable income and excess business interest income to its shareholders on a pro-rata basis.

Treas. Reg. §1.163(j)-6 provides special rules and defined terms relating to the application of section 163(j) to partnerships and S corporations. Treas. Reg. §1.163(j)-6(f)(2) specifically sets out the steps for allocating deductible business interest expense and the section163(j) excess items for partnerships.

For taxable years beginning in 2020 only, a partner (unless it elects out) may treat 50% of its allocable share of a partnership's EBIE for 2019 as an interest deduction for 2020 without limitation. The remaining 50% of the partnership's EBIE for 2019 remains subject to the section 163(j) limitation applicable to the EBIE carried forward at the partner level. See Revenue Procedure 2020-22 PDF for rules for partnerships under the CARES Act. For additional discussion of CARES Act changes see Q/A 21.

Q17. How does a partner account for business interest expense when it computes its section 704(d) basis loss limitation? (added January 10, 2023)

A17. Treas. Reg. §1.163(j)-6(h) provides for a separate section 704(d) loss class for business interest expense comprised of:

• deductible business interest expense and business interest expense of an exempt entity (whether allocated to the partner in the current taxable year or suspended under section 704(d) in a prior taxable year),
• any excess business interest expense (EBIE) allocated to the partner in the current taxable year, and
• any EBIE from a prior taxable year that was suspended under section 704(d) (negative section 163(j) expense). 

After the partner determines the amount of the limitation apportioned to this section 704(d) loss class, any deductible business interest expense is taken into account before any EBIE or negative section 163(j) expense. See Example 7 in Treas. Reg. §1.163(j)-6(o)(7) for more information.

This provision is generally applicable for taxable years beginning on or after November 13, 2020. For more information, see the applicability date in Treas. Reg. §1.163(j)-6(p).

Q18. How does the section 163(j) limitation apply to a consolidated group of corporations? (updated January 10, 2023)

A18. The section 163(j) limitation applies at the consolidated return level, and a consolidated group has a single limitation. In calculating the limitation, a consolidated group's business interest expense and business interest income is, respectively, the sum of its members' business interest expense and business interest income. The consolidated group should calculate its ATI using the group's taxable income as determined under Treas. Reg. §1.1502-11 without regard to any carryforwards or disallowances under section 163(j).

Q19. Does the section 163(j) limitation apply to foreign corporations? (updated January 10, 2023)

A19. Yes, the section 163(j) limitation applies to any foreign corporation whose classification is relevant under Treas. Reg. §301.7701-3(d)(1) for a taxable year other than solely pursuant to section 881 or 882. As a result, section 163(j) applies to any foreign corporation that is a controlled foreign corporation (CFC). Generally, section 163(j) applies to a CFC in the same manner as it applies to a domestic C corporation. If a CFC is a partner in a partnership, the section 163(j) limitation applies to the partnership in the same manner as if the CFC were a domestic C corporation. Treas. Reg. §1.163(j)-7 provides rules for determining the amount of ATI and calculating the limitation for CFCs.

If a CFC group election is in effect, a single section 163(j) limitation is computed for the CFC group under rules provided in Treas. Reg. §1.163(j)-7(c). In addition, if a CFC or CFC group is eligible for a safe-harbor election, none of the CFC's or CFC group members' business interest expense is disallowed in a taxable year for which the election is made.

Section 163(j) also applies to any foreign corporation (or other foreign person) that is engaged in a U.S. trade or business. Prop. Reg. §1.163(j)-8 provides rules for determining the amount of ATI and calculating the limitation for the foreign corporation (or other foreign person). In the case of a foreign corporation engaged in a U.S. trade or business, the proposed regulations coordinate the application of section 163(j) with the rules for allocating interest expense to income effectively connected with a U.S. trade or business.

Q20. What temporary changes were made under the CARES Act? (added January 10, 2023)

A20. The CARES Act amended section 163(j) to provide benefits to taxpayers. See Q/A 16 and Q/A 21 for special rules for partnerships and its partners.

The CARES Act:

• Retroactively increases the ATI percentage for taxable years beginning in 2019 and 2020 to 50% (rather than 30%). A taxpayer can elect not to apply the 50% ATI limitation and use the 30% ATI limitation instead. The election is made by filing a return using the 30% ATI limitation instead of the 50% ATI limitation. No formal statement is required to be attached to the return. See Revenue Procedure 2020-22.
• Allows a taxpayer to elect to substitute the taxpayer's 2019 ATI for the 2020 ATI in determining the taxpayer's section 163(j) limitation for taxable years beginning in 2020. 

Q21. What temporary changes were made under the CARES Act for Partnerships and its Partners? (added January 10, 2023)

A21. The CARES Act provides special rules for partnerships and partners:

• For taxable years beginning in 2019, a partner treats 50% of its allocable share of a partnership's excess business interest expense (EBIE) for 2019 (2019 EBIE) as an interest deduction without limitation in the partner's first taxable year beginning in 2020 (50% EBIE rule). A partner may elect out of the 50% EBIE rule. The remaining 50% of such EBIE remains subject to the section 163(j) limitation rules applicable to EBIE carried forward at the partner level. 
• The 50% ATI limitation does not apply to partnerships for taxable years beginning in 2019.
• A partnership may elect to use the 30% ATI limitation instead of 50% for only taxable years beginning in 2020. No formal statement is required to be attached to the return. See Revenue Procedure 2020-22.
• A partnership may elect to substitute the partnership's 2019 ATI for the 2020 ATI in determining the partnership's section 163(j) limitation for taxable years beginning in 2020. A partnership makes this election by timely filing Form 1065, including extensions, amended Form 1065 as appropriate or administrative adjustment request. No formal statement is required to be attached to the return. See Revenue Procedure 2020-22.

Note: The CARES Act amendments discussed above only apply to taxable years beginning in 2019 and 2020 but do not apply to taxable years beginning in 2021 and later.

Q 22. How does a taxpayer make an election under the CARES Act? (added January 10, 2023)

A22. See Revenue Procedure 2020-22 PDF for more information on how to make an election.

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