Section 163(j) Election: Who Qualifies and How It Works

A Section 163(j) election lets a qualifying real property or farming business opt out of the business interest expense limitation and deduct all its interest in the current year, in exchange for mandatory use of the Alternative Depreciation System (ADS) on specified assets going forward. The election is made by attaching a short statement to a timely filed return, and once made it is irrevocable without IRS consent. For 2026, the math behind the decision has shifted: the One, Big, Beautiful Bill Act restored the depreciation, amortization, and depletion add-back to adjusted taxable income, so many capital-intensive businesses that were squeezed by the limitation during 2022 through 2024 may no longer need to elect out at all.

What the Election Does and Why 2026 Is Different

Section 163(j) caps a company’s deductible business interest expense at the sum of its interest income, 30% of its adjusted taxable income (ATI), and any floor plan financing interest.¹ Interest above the cap is disallowed in the current year and carries forward indefinitely. Making the election removes the cap entirely for the electing trade or business.

The pivotal change for 2026 is on the ATI side of the formula. The OBBBA restored the add-back of depreciation, amortization, and depletion to ATI for tax years beginning after December 31, 2024.¹ During 2022 through 2024, those deductions could not be added back, which shrank ATI and tightened the 30% cap for capital-intensive businesses. ATI is now once again calculated on roughly an EBITDA basis. Businesses that were running up against the limitation in prior years should rerun the numbers before assuming they still need to elect out.

Who Qualifies

Two categories of business can elect out: a real property trade or business and a farming business.¹ A real property trade or business covers developing, constructing, acquiring, renting, operating, or managing real property, which reaches most participants in commercial and residential real estate, including property managers and brokerages.

One boundary worth checking first: the election only matters if your business is actually subject to the limitation. A business that qualifies as an exempt small business under the Section 448(c) gross receipts test is not limited at all. For 2025, the threshold is $31 million in average annual gross receipts over the prior three tax years.² For 2026, the inflation-adjusted threshold rises to $32 million. All related entities under common control must aggregate their receipts for this test, so splitting operations across multiple LLCs will not drop a combined business below the threshold.¹

The Depreciation Cost

The price of unlimited interest deductions is a permanent change to how you depreciate certain assets. An electing real property trade or business must use ADS for all nonresidential real property, residential rental property, and qualified improvement property (QIP).³

Longer Recovery Periods

ADS stretches depreciation out compared to the General Depreciation System. Nonresidential real property moves from 39 years under GDS to 40 years under ADS, and residential rental property goes from 27.5 years to 30 years.³ Those differences are modest. The bigger impact typically falls on QIP, which drops from a 15-year GDS recovery period to a significantly longer ADS period. Annual deductions shrink and taxable income rises in the near term.

Loss of Bonus Depreciation

The OBBBA permanently restored 100% bonus depreciation for qualified property acquired after January 19, 2025.⁴ Assets required to be depreciated under ADS do not qualify for bonus depreciation. Making the election locks you out of 100% first-year expensing on nonresidential real property, residential rental property, and QIP going forward. That trade-off is heavier now than it was during 2023 (80% bonus) or 2024 (60% bonus), because every qualifying asset you place in service after electing gives up a full first-year write-off.

Prospective Only

The ADS requirement applies only to property placed in service in the election year and later. Assets already in service continue on whatever depreciation method you originally used. But the requirement binds every qualifying asset you acquire from the election year onward, making it a long-term constraint on tax planning.

Special Rules for Farming Businesses

A farming business can make the same election, but the depreciation trade works on a different basis. An electing farming business must use ADS for any asset with a recovery period of 10 years or more.¹ That reaches single-purpose agricultural structures, fruit and nut trees and vines, and farm buildings. Shorter-lived equipment such as tractors and harvest machinery (typically 5- or 7-year property) stays on GDS and remains eligible for bonus depreciation.

Operations with heavy investment in structures and orchards should model the ADS cost carefully. Losing 100% first-year expensing on those long-lived assets can add up quickly.

How to Make the Election

The election is made by attaching a statement to a timely filed federal tax return, including extensions. There is no special IRS form. The statement must be titled “Section 1.163(j)-9 Election” and must include the following for each trade or business electing out:⁵

Taxpayer name, address, and EIN or SSN.
A description sufficient to show the business qualifies, including the principal business activity code.
A statement that the taxpayer is electing under Section 163(j)(7)(B) for a real property trade or business, or Section 163(j)(7)(C) for a farming business.

A partnership attaches the statement to Form 1065, a C corporation to Form 1120, and an S corporation to Form 1120-S. If a single entity runs multiple qualifying trades or businesses, each one can be elected independently. A corporation operating both a real estate activity and a manufacturing division can elect only for the real estate side, with ADS applying only to the elected trade’s assets.

Timing

Make the election for the first tax year in which the business is subject to the 163(j) limitation. Missing that window does not permanently foreclose the election, but it forces you into IRS late-election relief, which adds uncertainty and cost.

Irrevocability

The election is irrevocable without IRS consent.⁵ Once filed, the business is locked into full interest deductibility and mandatory ADS depreciation for every subsequent year. Revocation requires an IRS consent process that is not routinely granted. Treat it as permanent.

Partnership and S Corporation Consequences

The 163(j) limitation applies at the entity level for both partnerships and S corporations, but what happens to disallowed interest afterward is very different.

Partnerships

A partnership calculates its own 163(j) limit, deducts the allowed interest at the partnership level, and allocates any disallowed amount to partners as excess business interest expense (EBIE).¹ EBIE carries forward at the partner level. A partner can only deduct that EBIE when the same partnership later allocates excess taxable income or excess business interest income to that partner, which ties the deduction to the specific partnership that generated it. Once EBIE converts to deductible interest, it must still clear the partner’s own 163(j) limit if one applies.

When a partnership elects out, the election binds the entire partnership. Partners cannot individually opt in or out, and the ADS requirement flows through to partnership assets.

S Corporations

S corporations also apply the limitation at the entity level, but disallowed interest stays and carries forward at the S corporation level rather than being pushed out to shareholders.¹ Tracking is simpler for shareholders, but the deduction can only come back when the S corporation itself generates enough ATI or interest income in a later year.

When the Election Still Makes Sense

With the EBITDA-based ATI formula restored, fewer businesses need to elect out than did during 2022 through 2024. A few factors should drive the decision:

Leverage relative to earnings. A highly leveraged business whose interest expense still exceeds 30% of ATI under the restored formula gets the most from the election. If the new ATI calculation gives you room under the cap, you may not need to elect at all.
Capital expenditure plans. Businesses planning major property acquisitions or improvements pay a steeper price, because every new qualifying asset goes on ADS and loses 100% bonus depreciation. Low-capex, high-debt businesses come out ahead.
Existing disallowed carryforwards. If you already carry a large stock of disallowed interest from prior years, electing lets you deduct current-year interest freely, but the old carryforwards remain subject to the limit in the year they arose. Project whether a growing ATI will absorb them without the election.
Entity structure. Partners facing persistent EBIE allocations they cannot use because they lack excess taxable income from that partnership may find a partnership-level election cleaner.

Irrevocability is the factor that should slow you down most. A business that elects in a high-leverage year and later pays down its debt can spend decades on ADS depreciation long after the interest limitation would have stopped binding. Run a multi-year model that reflects projected debt, planned capital spending, and the restored ATI formula before committing. Getting the decision wrong in one direction costs a few years of carryforwards; getting it wrong in the other costs decades of reduced depreciation on every building and improvement you buy.

1
Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
2
Internal Revenue Service. Revenue Procedure 2024-40
3
Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
4
Internal Revenue Service. Notice 2026-11, Interim Guidance on Additional First Year Depreciation Deduction
5
eCFR. 26 CFR 1.163(j)-9 – Elections for Excepted Trades or Businesses