The business interest expense limitation is one of the most far-reaching tax rules affecting companies of all sizes, yet many business owners still underestimate its impact. Enacted under Section 163(j) of the Internal Revenue Code as part of the Tax Cuts and Jobs Act, this rule limits the amount of interest expense a taxpayer can deduct in a given year. Whether you operate through an LLC, a corporation, or report business income on a personal return, this limitation can apply to you, and understanding how it works is essential for effective tax planning. Our tax advisory services team helps owners model the effect of this rule before debt decisions are finalized.
How the 30% interest deduction rule works
Under the business interest expense limitation, a taxpayer may generally deduct business interest expense only up to the sum of business interest income, 30% of adjusted taxable income (ATI), and floor plan financing interest. For most operating businesses, the binding component is the 30% of ATI ceiling. Any business interest expense exceeding the limit is not lost permanently. It carries forward to the following tax year, where it can be deducted subject to the same limit.
Adjusted taxable income is calculated by starting with a company’s taxable income and adding back business interest expense and, under current law, depreciation, amortization, and depletion. The treatment of depreciation and amortization has changed over time, and that history matters because it directly affects how much interest a business can deduct.
For tax years 2018 through 2021, ATI was computed on an EBITDA basis, meaning depreciation, amortization, and depletion were added back. For tax years 2022 through 2024, those deductions were no longer added back, shifting the calculation to an EBIT basis. That change lowered ATI for capital-intensive businesses and pushed more of them into the limitation. The One Big Beautiful Bill Act (OBBBA) then permanently restored the EBITDA-based computation for tax years beginning after December 31, 2024, adding depreciation, amortization, and depletion back into ATI once again.
For example, consider a business with $1 million in taxable income before interest, depreciation, and amortization, and $400,000 of depreciation and amortization. On an EBITDA basis, its ATI is $1.4 million, allowing up to $420,000 in interest deductions. On the EBIT basis that applied for 2022 through 2024, the same business would have had an ATI of $1 million, limiting its interest deduction to $300,000. The $120,000 difference is precisely the kind of swing that the OBBBA restoration of the EBITDA computation reverses for current tax years.
Section 163(j) applies broadly, with one key exception
The business interest expense limitation applies broadly. It covers LLCs, S corporations, C corporations, partnerships, and individuals reporting business interest on personal returns. Importantly, the limit is generally computed at the entity level, as the IRS explains in its Section 163(j) guidance. Each separate entity calculates its own limitation.
This entity-level calculation creates a significant planning consideration for business owners with multiple entities. If one LLC generates a profit and another operates at a loss, the profitable LLC may deduct interest up to its own limit, but the money-losing LLC may not be able to deduct any interest at all, even if the combined businesses would support a larger deduction. The limitation does not generally allow netting across separately filing entities.
The small business gross receipts exemption
There is one important exception to this rule. Taxpayers that meet the gross receipts test under Section 448(c), and are not tax shelters, are exempt from the business interest expense limitation. The threshold is set at $25 million and adjusted annually for inflation. For tax years beginning in 2024, the threshold was average annual gross receipts of $30 million or less over the prior three-year period, and for tax years beginning in 2025 it is $31 million.
The IRS has clarified that entities under common control may be required to aggregate their gross receipts when testing against the threshold. A business owner who operates several small entities may find that combined revenue pushes the group over the exemption limit, even if no single entity exceeds it on its own. The aggregation rules that apply to this test are explained in the IRS guidance on Section 448(c).
Real estate interest deduction election under Section 163(j)
Entities engaged in a real property trade or business may elect to be excepted from the interest limitation entirely. This real estate interest deduction election can be extremely valuable for property-holding companies with significant mortgage debt. The trade-off is that any entity making the election must use the Alternative Depreciation System (ADS) for its nonresidential real property, residential rental property, and qualified improvement property, which means longer recovery periods and the loss of bonus depreciation on that property.
For many real estate investors, the ability to fully deduct interest expense outweighs the slower depreciation schedule. But the decision requires a careful cost-benefit analysis, and the election is irrevocable once made.
The related-party leasing problem
A real problem arises for closely held businesses that use a common ownership structure: one LLC owns the real estate, and a separate LLC operates the business as a tenant. Under the final regulations at Treasury Regulation 1.163(j)-9, a leasing activity does not qualify as an electing real property trade or business if at least 80% of the real property, measured by fair market rental value, is leased to a trade or business under common control with the lessor. In this context, common control generally means 50% or more common ownership under the related-party rules of Sections 267(b) and 707(b).
This rule has significant consequences. Many business owners set up a rental LLC specifically to hold property and lease it to their operating company. Where the common control test is met, that rental LLC is treated as part of an integrated business rather than as a standalone real estate entity, and the election out of Section 163(j) is denied. A narrow exception can apply where the lessor leases at least 90% of its property to unrelated parties or to commonly controlled parties that have themselves made the election.
Restructuring strategies to preserve the interest deduction
Business owners who find themselves caught by the related-party leasing rule have two main restructuring strategies to consider.
Consolidating the entities
The first approach is to bring the tenant company and the real estate company closer together. If both are structured as LLCs, the owner can create a holding company LLC that owns 100% of both entities so that they are treated as a single taxpayer for the calculation. Because the business interest expense limitation is computed on a per-taxpayer basis, combining the operating income of the tenant company with the interest expense of the real estate company allows the interest to be deducted against a larger pool of adjusted taxable income. Owners weighing this kind of reorganization often benefit from coordinated transaction advisory support to structure it correctly.
This strategy does not require electing out of the interest limitation. It simply ensures that the entity carrying the interest expense also has sufficient income to support the deduction.
Separating ownership to qualify for the election
The second approach moves the entities further apart. If the tenant company and the property-owning company are no longer under common control, the property company may qualify as an independent real property trade or business and elect out of the limitation. One way to accomplish this is to structure the ownership so that the property is not leased predominantly to a commonly controlled tenant, for instance by holding less than the 50% interest that triggers common control. The economics between the parties can be managed through rent and compensation arrangements.
This strategy requires careful execution. The IRS retains the authority to challenge arrangements that appear designed primarily to avoid the interest limitation. Additionally, changing ownership percentages can affect passive activity loss rules, at-risk limitations, and other provisions on the owner’s tax return. No restructuring should be undertaken without consulting a qualified tax advisor who can evaluate the full range of consequences.
Excess business interest expense: what carries forward and for how long
When a partnership’s interest expense exceeds its limit, the disallowed amount becomes “excess business interest expense” (EBIE). For partnerships and LLCs taxed as partnerships, this excess is allocated to partners and tracked at the partner level. Partners can deduct their allocated excess business interest expense in future years only when the same partnership allocates them excess taxable income or excess business interest income.
The carryforward for disallowed business interest expense at the corporate level is indefinite, with no expiration date. However, partners and S corporation owners must track their amounts carefully, as the rules for when and how those amounts become deductible are complex and depend on the entity’s future income and the partner’s individual tax situation.
Why the business interest expense limitation still matters
The seesaw between EBIT and EBITDA computations has reshaped the math for capital-intensive businesses more than once. The 2022 through 2024 EBIT period tightened the limitation, and the OBBBA restoration of the EBITDA addback for tax years beginning after 2024 loosened it again. Even with the more favorable computation back in place, the 30% ceiling continues to bind for many highly leveraged businesses.
This is especially relevant for businesses that have taken on debt to finance acquisitions, real estate purchases, or capital improvements. OBBBA also layered in new rules, including coordination with interest capitalization and changes to how certain foreign income figures into ATI. Business owners should work with their tax advisors to model the impact of the current rules on their specific situation, evaluate whether restructuring makes sense, and ensure that any disallowed interest expense carryforwards are properly tracked for future use.
Frequently Asked Questions
What is business interest expense?
Business interest expense is any interest paid or accrued on debt that is properly allocable to a trade or business. It includes interest on business loans, lines of credit, mortgages on business property, and other indebtedness used in a business context. Investment interest and certain other categories of interest are excluded from the Section 163(j) limitation and governed by separate rules.
What happens to excess business interest expense in the final year?
When a partner disposes of their entire partnership interest, any remaining excess business interest expense that has not been previously deducted generally increases the partner’s basis in the partnership interest immediately before the disposition. This basis increase reduces the gain, or increases the loss, recognized on the sale, so that the disallowed interest is recovered through the disposition rather than lost.
Who must file Form 8990?
In general, a taxpayer with business interest expense, a disallowed business interest expense carryforward, or excess business interest expense subject to Section 163(j) must file Form 8990, Limitation on Business Interest Expense Under Section 163(j). This includes taxpayers carrying forward a disallowed amount from a prior year, even if their current-year interest expense is within the limit. Taxpayers that qualify for the small business gross receipts exemption generally do not need to file the form, though there are exceptions, so check the current form instructions.
Can a real estate LLC elect out of the business interest expense limitation?
Yes, but only if the LLC qualifies as a real property trade or business and is not disqualified by the related-party leasing rule, which can apply when at least 80% of the property is leased to a commonly controlled tenant. If the election is available, the LLC must use the Alternative Depreciation System for its real property, which results in longer depreciation periods and the loss of bonus depreciation on that property.
How does the small business gross receipts exemption work?
A taxpayer is exempt from the business interest expense limitation if it meets the Section 448(c) gross receipts test and is not a tax shelter. The threshold is $25 million indexed for inflation, which was $30 million for tax years beginning in 2024 and $31 million for tax years beginning in 2025, measured as average annual gross receipts for the three preceding tax years. For commonly controlled groups, the gross receipts of related entities may be aggregated for this test.
How should business owners restructure to preserve interest deductions?
Business owners can either consolidate their operating and real estate entities under a single holding company to increase the ATI base, or separate ownership so that the real estate entity qualifies independently for the election out of Section 163(j). Both strategies carry trade-offs and should be evaluated with a tax advisor to avoid unintended consequences related to passive losses, at-risk rules, or IRS challenge.
