Real Estate Investors Can Now Claim Bonus Depreciation Previously Prohibited By 163(J) Election

The Internal Revenue Service recently issued Revenue Procedure 2026-17, allowing eligible real estate businesses to withdraw a previously made and otherwise irrevocable electing real property trade or business (ERPTOB) tax election.  Such an election generally allows unlimited deduction of business interest, but at the cost of depreciating certain property under longer periods and less accelerated methods, as mandated by the alternative depreciation system (ADS). Real property owners who made an ERPTOB election in tax years 2022, 2023, or 2024 can now re-examine their tax position in light of changes made by the passage of the One Big Beautiful Bill Act (OBBBA) in 2025. 

The deadline to take advantage of the provisions of this revenue procedure is October 15, 2026, or potentially earlier, depending on when certain tax returns were filed previously, and real estate owners and investors need to act promptly to realize any potential tax benefits. 

Background: The Section 163(j) Election

Section 163(j) of the Internal Revenue Code (IRC) limits the deductibility of business interest expense for most taxpayers to 30 percent of adjusted taxable income (ATI) (taxable income computed without a deduction for depreciation, amortization, or depletion for taxable years beginning before January 1, 2022). Note that prior to OBBBA, ATI for taxable years beginning on or after January 1, 2022, did not include the add-back for these three items (however, see OBBBA changes as discussed later). 

The ATI limitation on interest deductibility can be avoided by electing to be an ERPTOB under IRC Section 163(j)(7)(B). This election allows full deduction of business interest expense regardless of the 30-percent ATI threshold.

However, the cost of making this election is the requirement to depreciate certain property under less advantageous ADS recovery periods. For residential rental property, the ADS recovery period extends to 30 years from 27.5, and for nonresidential real property, to 40 years from 39.  Qualified improvement property (QIP), certain improvements made to the interior of a non-residential building, is also impacted by the election requiring ADS depreciation over 20 years instead of 15 years.

In addition, making the ERPTOB election and the resultant required use of ADS prohibits claiming bonus depreciation (i.e., the ability to deduct an additional amount, potentially up to 100%, of the cost of property in the first year of ownership) under IRC Section 168(k) on ADS classified property. While residential rental property and nonresidential real property generally do not qualify for bonus depreciation, QIP generally does. As a result, QIP is not eligible for bonus depreciation when owned by a taxpayer that has made an ERPTOB election with respect to that property and can often be the most significant ‘cost’ associated with an ERPTOB election.

It should be noted that the IRC Section 163(j)(7)(B) ERPTOB election, but for Revenue Procedure 2026-17 in response to OBBBA, is irrevocable once made.

One Big Beautiful Bill Act Changes 

The passage of OBBBA gives real estate investors an opportunity to re-examine the cost-benefit analysis associated with an ERPTOB election.

First, OBBBA permanently increased the bonus depreciation rate to 100% for “qualified property” acquired and placed in service after January 19, 2025. Prior to OBBBA, the percentage had been declining each year from 2022, with a scheduled phase-out in 2027 (100% in 2022, 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% in 2027). As discussed earlier, qualified property generally includes QIP.

Second, OBBBA amended IRC Section 163(j)(8) to restore the add-back of depreciation, amortization, and depletion when computing ATI for tax years beginning after December 31, 2024. This increase in ATI increases the 30-percent base against which the interest deduction limitation is calculated. In many cases, this change can reduce or even eliminate the limitation on the deduction of interest, thereby potentially negating the primary reason for originally making an otherwise irrevocable ERPTOB election.

As a result, these two changes could have significantly altered a taxpayer’s conclusions associated with a cost-benefit analysis of an otherwise irrevocable ERPTOB election; that being the cost of the required delayed depreciation of affected assets (including bonus depreciation on QIP), compared to the benefit of interest expense deductions unlimited by IRC Section 163(j). If, under the revised law as provided by OBBBA, the IRC Section 163(j) interest expense limitation would have been reduced or eliminated, the ERPTOB election benefit is correspondingly reduced, all while the cost, by virtue of an otherwise irrevocable ERPTOB election, remains unchanged.  Accordingly, based upon a taxpayer’s specific facts and circumstances, the taxpayer may not have chosen to make an ERPTOB election given the changes in law under OBBBA.

Revenue Procedure 2026-17 to the Rescue

Revenue Procedure 2026-17 (i) permits eligible taxpayers to withdraw a previously made ERPTOB election (and allows a taxpayer to choose to retroactively elect out of bonus depreciation for certain affected assets), and (ii) streamlines procedures for filing amended returns

• Withdrawal of the IRC Section 163(j)(7) ERPTOB Election. Taxpayers that made an ERPTOB election for tax years beginning in 2022, 2023, or 2024 may now withdraw that election. The withdrawal is made by filing an amended federal income tax return, amended Form 1065, or Administrative Adjustment Request (AAR), as applicable, for the taxable year for which the election was initially made. If withdrawn, the taxpayer will be treated as though the election was never made, and depreciation must be recalculated accordingly under the non-ADS depreciation rules. If the election was made by a partnership, the capital accounts of the partnership will not be considered to be maintained in accordance with the rules regarding substantial economic effect unless the effect of the withdrawal is reflected in the capital accounts of the partners. 
• Late IRC Section 168(k)(7) Election. Taxpayers withdrawing an IRC Section 163(j)(7) election may simultaneously make a late election under IRC Section 168(k)(7), allowing them to elect out of bonus depreciation for specific classes of property, which otherwise may have applied because of the withdrawal of the ERPTOB election. As discussed above, without an IRC Section 163(j)(7) election, QIP may have been eligible for bonus depreciation. As a result, a withdrawal of such an ERPTOB election could result in significantly more depreciation for a taxpayer in an affected year. The late IRC Section 168(k)(7) election allows taxpayers to choose if they want bonus depreciation to apply to specific assets (specifically QIP) to which such an election was initially inapplicable because the property was subject to an ERPTOB election at the time it was placed in service, and thus not eligible for bonus depreciation. This choice may help taxpayers withdraw a now undesired ERPTOB election while potentially limiting, if desired, the creation of significant adjustments to taxable income or loss (from such additional bonus depreciation) for such a year. Effectively, if the taxpayer withdraws the ERPTOB election but would have elected out of bonus depreciation for affected property in the year it was placed in service (but didn’t because such an election was unnecessary at the time), the taxpayer is able to do so via the Revenue Procedure 2016-17 late IRC Section 168(k)(7) election.

The basis of the property affected by a withdrawn 163(j)(7) election, and if applicable, a late IRC Section 168(k)(7) election, must also be adjusted to take into account any depreciation changes.

Relief for BBA Partnerships

Partnerships that are subject to the provisions of the Bipartisan Budget Act of 2015 (the BBA) can take advantage of a streamlined procedure to file amended Forms 1065 and issue amended Schedules K-1 for tax years 2022, 2023, and 2024.  This obviates the need to comply with the more burdensome AAR process, as long as filing deadlines and procedural requirements (discussed below) are satisfied.

The Filing Deadline and Procedural Requirements

The deadline for filing an amended return or amended Form 1065 is the earlier of October 15, 2026, or the end of the applicable period of limitations on assessment for the taxable year for which the amended return is being filed (generally the later of three years from (i) the date the return was filed for the taxable year or (ii) the date the return was due, determined without regard to extensions).

An AAR must be filed by the earlier of October 15, 2026, or the last day of the period during which the partnership may file an AAR for the taxable year for which the election was made (generally the later of three years from (i) the date on which the partnership return is filed, or (ii) the last day for filing the partnership return for such year, determined without regard to extensions).

Importantly, the amended federal income tax return, amended Form 1065, or AAR, must include the adjustments to taxable income due to the withdrawn ERPTOB election, and as applicable, any late IRC Section 168(k)(7) election, and any collateral adjustments to taxable income or to tax liability.

A taxpayer must also file amended tax returns, amended Forms 1065, or AARs, as applicable, for any affected succeeding taxable years to reflect any adjustments to taxable income due to the withdrawn ERPTOB election, and as applicable, any late IRC Section 168(k)(7) election, and any collateral adjustments to taxable income or tax liability. Any such amended return for a succeeding taxable year must also be filed by the earlier of October 15, 2026, or the end of the applicable period of limitations on assessment for the taxable year for which the amended return is being filed, or the last day of the period during which the partnership may file an AAR for the taxable year for which the AAR is being filed.

Amended returns must bear the notation "FILED PURSUANT TO REV. PROC. 2026-17" and include a formal election withdrawal statement specifying the taxpayer's name, address, taxpayer identification number, and a statement confirming the ERPTOB withdrawal and IRC Section 168(k)(7) late election, as applicable. 

Why This Requires Expert Guidance

While Revenue Procedure 2026-17 provides a welcome opportunity to withdraw an otherwise irrevocable ERPTOB election, a careful, property-by-property analysis must be undertaken to determine the ultimate impact of such a withdrawal.  The continued desirability of the interest deduction must now be re-evaluated in light of the recalculation of depreciation and the ability to retroactively elect out of otherwise mandatory bonus depreciation.

In addition, tax items in subsequent tax years, in addition to the year in which the election was originally made, may be affected.  Moreover, the filing impact on partners (of which there may be many levels) must also be considered.

Our firm's real estate tax professionals have the technical expertise and practical experience to assess whether withdrawal of the ERPTOB election is advantageous for your specific circumstances, quantify the potential tax benefit, and manage the amended return/AAR filing process in full compliance with Revenue Procedure 2026-17. Contact your Eisner Amper professional to discuss whether the provisions of Revenue Procedure 2026-17 will benefit you.