Certain Senior Living Facilities Can Elect Out of the Business Interest Limitation

Seyfarth Synopsis: On December 29, 2020, the Internal Revenue Service issued Revenue Procedure 2021-9 (the “Procedure”), which provides a safe harbor that allows the owner or operator of certain senior living facilities (a “Nursing Business”) to elect out of a limitation on the amount of “business interest” that the Nursing Business can deduct each year. The election could prove very valuable to a highly-leveraged Nursing Business, but each Nursing Business will need to consult with tax counsel and accountants to determine whether the benefits outweigh potential decreases in depreciation deductions.

Background

On December 22, 2017, Congress enacted Pub. L. 115-97 (commonly referred to as the “Tax Cuts and Jobs Act of 2017”), which, among other things, created a cap (the “Business Interest Limitation”) on the “business interest” deductions that a taxpayer with average annual gross receipts in excess of $25 million can take each year. Generally speaking, the cap is equal to the sum of 30% of the taxpayer’s “adjusted taxable income” (“ATI”) plus certain types of business interest income of the taxpayer (such limit, the “ATI Limit”). However, pursuant to the recently enacted Coronavirus Aid, Relief, and Economic Security Act, if the Business Interest Limitation is applicable to a taxpayer, then (1) for tax years beginning in 2019, the ATI Limit was increased to 50% of the taxpayer’s ATI, (2) for tax years beginning in 2020, the ATI Limit was increased to 50% of the taxpayer’s ATI for 2020 or, if the taxpayer so elects, 50% of the taxpayer’s ATI for 2019, and (3) the taxpayer may make an election to opt out of these increased ATI Limits. Any business interest deductions over the ATI Limit must be deferred until future tax years. There are special rules that apply to taxpayers that are partnerships for federal income tax purposes.

“Business interest” is broadly defined to include any interest, other than investment interest, paid or accrued on indebtedness properly allocable to the taxpayer’s “trade or business” and so the Business Interest Limitation can significantly limit a highly-levered taxpayer’s business interest deductions. However, a “trade or business” excludes an “electing real property trade or business” (a “Electing RE Business”), which is broadly defined to include any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business that makes an election out of the Business Interest Limitation. Many wondered whether a Nursing Business that manages or operates a residential living facility and also provides supplemental assistive, nursing, or routine medical services to its residents could qualify as an Election RE Business. The Procedure answers that question.

The Procedure

The Procedure sets forth a safe harbor that allows a Nursing Business that managed or operates a “qualified residential living facility” to treat the facility as an Electing RE Business.

Qualified Residential Living Facilities

A “qualified residential living facility” is a residential living facility that:

1. consists of multiple rental dwelling units within one or more buildings or structures that generally serve as primary residences on a permanent or semi-permanent basis to individual “customers and patients” (i.e., residents; “Residents”);
2. provides supplemental assistive, nursing, or other routine medical services; and
3. has an average period of Resident use of individual rental dwelling units of 30 days or more.

The Procedure provides the rental dwelling units of a residential living facility serve as primary residences on a “permanent or semi-permanent basis” to Residents whose use of the units is generally long-term (30 days or more) in nature, even though some Residents may arrive at the residential living facility with significantly shortened life expectancies due to advanced age or terminal medical conditions, and some Residents otherwise may be expected to periodically reside away from the residential living facility, such as at the primary residence of a spouse or other relative, for short periods of time.

The Procedure defines “supplemental assistive, nursing, or other routine medical services” as personal and professional services that are customarily and routinely provided to individual residential Residents of nursing homes, assisted living facilities, memory care residences, continuing care retirement communities, skilled nursing facilities, or similar facilities, as needed, on a day-to-day basis. Such services generally do not include surgical, radiological, or other intensive or specialized medical services that are usually provided only in emergency or short-term in-patient or out-patient hospital or surgical settings.

The Procedure also provides a formula and example for calculating average period of Resident use.

Finally, the Procedure clarifies that a residential living facility that qualifies as “residential rental property” under section 168(e)(2)(A) of the Internal Revenue Code of 1986, as amended (the “Code”), satisfies requirements (1) and (3) above. “Residential rental property” is any building or structure if 80% or more of the gross rental income from such building or structure for the taxable year is rental income from “dwelling units” and a “dwelling unit” is any house or apartment used to provide living accommodations in a building or structure except for a unit in a hotel, motel, or other establishment in which more than one-half of the units in are used on a transient basis. In determining whether a facility is residential rental property if any portion of the building or structure is occupied by the taxpayer (i.e., the Nursing Business), the gross rental income from such building or structure shall include the rental value of the taxpayer-occupied portion.

This test is determined on an annual basis, so if a Nursing Business’ residential living facility can qualify one year, fail to qualify the next year, and then qualify again in a future year.

The Nursing Business will need to maintain books and records to substantiate that it’s residential living facility meets the above test.

Impact on Depreciation Deductions

Nursing Businesses should consult with tax counsel and accountants before deciding whether to treat their facility as an Electing RE Business. If a taxpayer treats its business as an Electing RE Business, then the taxpayer must use the alternative depreciation system (“ADS”) to depreciate any real property that is subject to the election. As such, the depreciable life of property subject to the election would be increased as follows: nonresidential real property would be increased from 39 years to 40 years, residential real property would be increased from 27.5 years to 30 years, and qualified improvement property would be increased from 15 years to 20 years. Moreover, because the Electing RE Business must use ADS to depreciate such property, to the extent any such property would otherwise be eligible for an additional depreciation deduction in the year that the property is placed in service equal to 100% of the taxpayer’s adjusted basis in the property under Code Section 168(k) (“Bonus Depreciation”), such Electing RE Business will be ineligible for claiming Bonus Depreciation. As a result, Nursing Businesses will need to do an analysis to determine whether eliminating the Business Interest Limitation or maintaining longer depreciable lives and Business Depreciation is more beneficial.

Applicability

Nursing Businesses may apply the rules of the Procedure to taxable years beginning after December 31, 2017, so they might also consider whether it would be advantageous to amend prior year tax returns to treat their qualified residential living facility as an Electing RE Business.