Section 163(j) Interest Limitation: 2026 Guide

Section 163(j) Interest Limitation: 2026 Guide

Section 163(j) Interest Limitation: 2026 Complete Guide for Real Estate Investors

The section 163(j) interest limitation is one of the most misunderstood tax rules affecting real estate investors today. For the 2026 tax year, it caps your business interest deduction at 30% of adjusted taxable income. If your portfolio carries significant mortgage debt, this rule can cost you tens of thousands in lost deductions—unless you know your options. Our real estate investor tax strategy team breaks it all down below.

This information is current as of 5/20/2026. Tax laws change frequently. Verify updates with the IRS if reading this later.

Table of Contents

• Key Takeaways
• What Is the Section 163(j) Interest Limitation?
• Who Does the Section 163(j) Limitation Apply To?
• How Is the Section 163(j) Deduction Limit Calculated?
• Can Real Estate Investors Opt Out of Section 163(j)?
• What Is the Small Business Exemption for Section 163(j)?
• How Do Disallowed Interest Carryforwards Work?
• What Are the Best Strategies to Minimize Section 163(j) Impact?
• Uncle Kam in Action
• Related Resources
• Next Steps
• Frequently Asked Questions

Key Takeaways

• For 2026, the section 163(j) interest limitation caps business interest deductions at 30% of adjusted taxable income (ATI).
• Real estate investors can elect out of this cap, but must use the Alternative Depreciation System (ADS) for affected properties.
• Businesses with average annual gross receipts of $31 million or less (for 2026) may qualify for the small business exemption.
• Disallowed interest carries forward indefinitely to future tax years.
• You must file IRS Form 8990 to calculate and report your section 163(j) limitation.

What Is the Section 163(j) Interest Limitation?

The section 163(j) interest limitation was created by the Tax Cuts and Jobs Act (TCJA) of 2017. It limits how much business interest expense a taxpayer can deduct in a given year. Before TCJA, business interest was generally fully deductible. That changed dramatically for larger investors and businesses.

For real estate investors, this rule hits directly where it hurts most: mortgage interest. When you finance rental properties or commercial buildings, your interest payments are business expenses. However, the section 163(j) limitation can reduce or eliminate that deduction, depending on your income structure.

The EBIT-Based Calculation (Post-2021)

Starting in 2022, the tax law changed how ATI is calculated. Through 2021, ATI was computed using an EBITDA-style approach (adding back depreciation and amortization). Since 2022 and continuing through 2026, ATI uses an EBIT-based approach. Depreciation and amortization are no longer added back.

This change significantly reduced the amount of deductible interest for many investors. Specifically, it lowered their ATI base—and therefore lowered the 30% cap. For a real estate investor with heavy depreciation deductions, this can cut their interest deduction dramatically.

Why the Section 163(j) Limitation Matters in 2026

Interest rates have stayed elevated compared to pre-2022 levels. As a result, borrowing costs are significantly higher for real estate portfolios. Investors who took on new debt in 2023, 2024, or 2025 are now carrying larger interest expenses. Combined with the EBIT-based ATI formula, many investors face larger disallowed interest amounts than ever before.

Understanding this rule is not optional anymore. It directly shapes how you structure deals, entities, and financing for 2026 and beyond. Work with a proactive tax strategist who understands real estate deduction rules.

Who Does the Section 163(j) Limitation Apply To?

The rule applies broadly. It covers businesses of almost every type. However, certain taxpayers are carved out. Knowing where you fall is the first step in planning.

Entities Subject to Section 163(j) in 2026

The following entity types must apply the interest limitation if they do not qualify for an exemption:

• C corporations (including REITs unless they qualify for the real estate election)
• S corporations and their shareholders
• Partnerships and their partners
• Single-member LLCs taxed as disregarded entities
• Individual investors with trade or business interest expense

Partnerships are especially important. The limitation is calculated at the partnership level first. Then each partner receives an allocable share of excess business interest expense. That partner cannot deduct it until the partnership generates excess taxable income or excess business interest income in a future year. This creates a timing mismatch that can trap deductions for years.

Who Is Generally Exempt?

Several types of businesses or investors may be exempt entirely or partially from the section 163(j) interest limitation:

• Small businesses meeting the gross receipts test (under $31 million for 2026)
• Electing real property trades or businesses (subject to ADS depreciation)
• Certain farming businesses that make the farming election
• Regulated utilities
• Floor plan financing for vehicle dealers

For most real estate investors, the most relevant exemption is the real property trade or business election. We cover that in detail below.

How Is the Section 163(j) Deduction Limit Calculated?

The formula sounds simple. However, the details require care. Let’s walk through each component and show a real-world example.

The Section 163(j) Formula

Your maximum deductible business interest expense for 2026 is:

• Business Interest Income (interest you earned in the business)
• PLUS 30% × Adjusted Taxable Income (ATI)
• PLUS Any floor plan financing interest (for vehicle dealers)

Any business interest expense above this limit is disallowed for 2026. However, it carries forward to future years. You report and track this on IRS Form 8990.

What Is Adjusted Taxable Income (ATI)?

For 2026, ATI is essentially your business taxable income before:

• Business interest income or expense
• Net operating loss (NOL) deductions
• The qualified business income (QBI) deduction
• Capital gains or losses (in most cases)

Importantly, depreciation and amortization are NOT added back to ATI since 2022. This is the EBIT-based approach. Many real estate investors have large depreciation deductions—especially those using cost segregation. As a result, their ATI is lower. Consequently, their 30% cap is lower too.

Example Calculation for a 2026 Real Estate Investor

Let’s use a real example. Suppose you own a portfolio of rental properties in a partnership structure for 2026:

Item	Amount (2026)
Gross Rental Income	$800,000
Operating Expenses (excl. interest)	($250,000)
Depreciation (including bonus)	($320,000)
ATI (before interest)	$230,000
30% of ATI (163(j) cap)	$69,000
Actual Business Interest Expense	$180,000
Disallowed Interest (Carried Forward)	$111,000

In this example, $111,000 of interest deductions are disallowed for 2026. They carry forward to future years as excess business interest expense (EBIE). The taxpayer also files Form 8990 with required disclosures to track this amount.

Can Real Estate Investors Opt Out of Section 163(j)?

This election is one of the most important decisions a real estate investor will make. It is irrevocable once filed. Therefore, you must analyze it carefully before 2026 returns are submitted.

Who Qualifies for the Real Property Trade or Business Election?

To make this election for 2026, your activity must qualify as a real property trade or business. That means you must be engaged in one of the following:

• Real property development or redevelopment
• Real property construction or reconstruction
• Acquisition of real property
• Conversion of real property
• Rental, operation, or management of real property
• Leasing of real property
• Brokerage for real property

Most active real estate investors who own and manage rental properties qualify. However, you cannot aggregate activities the same way you can for passive activity rules. Each separate business activity stands alone for this election under the IRS 163(j) aggregation guidance.

The ADS Depreciation Tradeoff

The real property election comes with a critical tradeoff. Once you make it, you must use the Alternative Depreciation System (ADS) for affected property categories:

• Nonresidential real property: ADS life of 40 years (vs. 39 years under MACRS—similar impact)
• Residential rental property: ADS life of 30 years (vs. 27.5 years under MACRS)
• Qualified Improvement Property (QIP): ADS life of 20 years (vs. 15-year bonus-eligible under MACRS)

The biggest cost of this election is QIP. Under MACRS, QIP qualifies for 60% bonus depreciation in 2026. Under ADS, it does not qualify for bonus at all. Therefore, investors doing tenant improvements, HVAC upgrades, or interior renovations lose significant upfront deductions when they make this election.

This is why you need a thorough cost-benefit analysis. Your Uncle Kam tax advisor can model both scenarios before you file your 2026 return.

How to Make the Election for 2026

You make the real property trade or business election on your 2026 tax return. For partnerships, it is made at the entity level on Form 1065. For corporations, it is made on Form 1120 or 1120-S. For individuals with sole proprietorships or single-member LLCs, it is made on the Schedule C or Form 8990 attachment. Since the election is irrevocable, consult your tax advisor before filing. You cannot undo this choice in later years.

What Is the Small Business Exemption for Section 163(j)?

This exemption exists to protect smaller operations from the administrative burden and cash flow impact of the limitation. The threshold adjusts annually for inflation. For 2026, the IRS-confirmed threshold is $31 million in average annual gross receipts.

How the Gross Receipts Test Works

You calculate the test by averaging gross receipts over the three preceding tax years. For a 2026 return, that means averaging 2023, 2024, and 2025. If the average is at or below $31 million, you qualify. You are then exempt from the section 163(j) limitation for 2026.

However, the aggregation rules apply. If you own multiple entities with common ownership or control, you may need to aggregate their gross receipts. This prevents taxpayers from artificially splitting businesses to stay under the threshold. The IRS has published detailed guidance on these aggregation rules for the 163(j) small business exemption.

Gross Receipts Examples for Real Estate Investors

For real estate investors, gross receipts generally include rental income, sales proceeds, and any other trade or business income from the activity. Here is a comparison:

Investor Profile	3-Year Avg Gross Receipts	Exempt for 2026?
Small landlord (5 rentals)	$480,000	✅ Yes
Mid-size investor (25 rentals)	$3.2 million	✅ Yes
Large portfolio (commercial + residential)	$18 million	✅ Yes (under $31M)
Institutional investor group (aggregated)	$55 million	❌ No — 163(j) applies

If you qualify for this exemption, your entire business interest expense is deductible in 2026 without limitation. This is a significant advantage, and you should confirm your eligibility every year since portfolio growth can push you over the threshold.

How Do Disallowed Interest Carryforwards Work?

The indefinite carryforward is one of the more taxpayer-friendly aspects of section 163(j). The deduction is not lost permanently—it is simply deferred. This matters especially for real estate investors who may have low ATI in years with high depreciation.

Partnership Carryforward Rules Are More Restrictive

For partnerships, the rules are stricter. Disallowed interest at the partnership level is allocated to partners as excess business interest expense (EBIE). The partner can only deduct their EBIE in a future year if the same partnership allocates sufficient excess taxable income (ETI) or excess business interest income (EBII) to that partner.

In other words, if you sell your partnership interest, your EBIE does not automatically become deductible. There are specific rules governing what happens to EBIE upon a sale or transfer. Consult your advisor to understand the tax consequences before selling a partnership interest holding disallowed interest.

How Carryforwards Become Deductible

For non-partnership taxpayers, your disallowed interest carryforward from 2026 becomes deductible in a future year when:

• Your actual business interest expense in that future year is lower than your 30%-of-ATI cap, creating available capacity
• Your ATI increases due to higher income or lower depreciation, raising the 30% cap
• You sell the business or dispose of the assets in a transaction that triggers deductibility

Tracking these carryforwards accurately is critical. Each year’s disallowed interest must be recorded separately. All of this is done on IRS Form 8990. Proper recordkeeping now prevents errors and missed deductions in future years. This is exactly the type of proactive tax compliance work Uncle Kam handles for clients.

What Are the Best Strategies to Minimize Section 163(j) Impact?

The section 163(j) interest limitation is not a death sentence for your deductions. It rewards investors who plan proactively. Here are the most effective strategies for 2026.

Strategy 1: Evaluate the Real Property Trade or Business Election

This is the most powerful option for qualifying real estate investors in 2026. If your interest deductions are significantly limited by the 30% cap, opting out could restore full deductibility. The cost is slower depreciation on residential property and QIP. Therefore, this works best when:

• You carry large mortgage balances with high annual interest
• Your QIP activity is minimal or the properties are fully improved
• Your ATI is depressed by large depreciation, limiting your 30% cap
• You are holding properties long-term and do not rely heavily on front-loaded deductions

Strategy 2: Structure Your Entities Thoughtfully

How you structure your real estate investments affects how the section 163(j) limitation applies. For example, a real estate investor who holds properties in separate single-member LLCs may have more flexibility than one using a partnership. However, the IRS aggregation rules can still combine separate entities with common ownership.

Additionally, using an S corporation or C corporation in your structure can change how interest flows through to your personal return. Each structure has different tradeoffs. Our entity structuring specialists can model the most efficient setup for your 2026 portfolio. Also consider using our LLC vs S-Corp Tax Calculator to compare entity options and potential tax savings.

Strategy 3: Time Your Depreciation and Income

Since ATI excludes depreciation and amortization under the EBIT approach, your depreciation elections directly affect your 30% cap. If you take large bonus depreciation in a given year—for example, through a cost segregation study—you reduce your ATI significantly. This lowers your deductible interest for that year.

Consider the timing carefully. In some cases, deferring a cost segregation study to a future year can preserve ATI in the current year and allow more interest to be deducted now. In other cases, the upfront depreciation benefit outweighs the lost interest deduction. Run the numbers for your specific situation with your tax advisory team.

Strategy 4: Manage Debt Strategically

The section 163(j) limitation only applies to business interest expense. It does not apply to investment interest or personal interest. Therefore, classifying debt correctly is important. If you have both business and investment debt, proper allocation can reduce the portion subject to the limitation.

Furthermore, paying down high-interest debt in years when ATI is low can reduce the disallowed amount. Refinancing to lower interest rates also shrinks the gap between your actual interest and your 30% cap. In a high-rate environment, this is particularly relevant for investors who refinanced in 2022 through 2024.

The high-net-worth investor strategies page covers advanced debt management approaches that can work in tandem with 163(j) planning.

 

 

Uncle Kam in Action: How Marcus Recovered $94,000 in Disallowed Interest

Client Snapshot: Marcus is a 44-year-old real estate investor based in Michigan. He owns 18 rental properties across residential and commercial categories, structured in a multi-member LLC taxed as a partnership.

Financial Profile: Annual gross rental income of approximately $1.4 million. Mortgage balances totaling $9.2 million at an average rate of just over 6%. Annual business interest expense of approximately $552,000.

The Challenge: Marcus came to Uncle Kam after his prior CPA told him $94,000 of his 2025 interest was disallowed under section 163(j). His ATI had been crushed by $380,000 in bonus depreciation from a recent cost segregation study. The 30% cap was only $210,000 on his ATI of $700,000. His actual interest was over $300,000 higher than that cap. Marcus was frustrated. He was paying real interest expense but could not deduct it.

The Uncle Kam Solution: Our team analyzed Marcus’s entire portfolio for 2026. We identified that his LLC qualified as a real property trade or business. However, we also modeled the ADS depreciation impact. Several of his properties had significant QIP from renovations in 2024 and 2025. For those properties, bonus depreciation under MACRS was valuable. For his older, fully improved properties, the bonus depreciation benefit was minimal.

Our solution: We separated his portfolio into two LLCs. The properties with ongoing improvements stayed in the original LLC under MACRS. The stabilized, fully improved properties moved to a new LLC that made the real property election. The election restored full interest deductibility for those properties without costing him meaningful depreciation upside.

The Results for 2026:

• Tax Savings: $94,000 in previously disallowed interest was made fully deductible in 2026, saving Marcus approximately $37,600 in federal tax at his 40% effective rate.
• Uncle Kam Investment: $5,800 in advisory and restructuring fees.
• First-Year ROI: Over 6x return on his investment in professional guidance.

Marcus now has a clear annual strategy. Each year, Uncle Kam reviews his portfolio composition to determine whether any additional properties should be moved into the electing LLC. See more results like Marcus’s on our client results page.

Related Resources

• Real Estate Investor Tax Strategies — Uncle Kam
• Entity Structuring for Real Estate Portfolios
• 2026 Tax Strategy Planning for Investors
• Uncle Kam Tax Guides Library
• Business Tax Calculators for Investors

Next Steps

The section 163(j) interest limitation affects your bottom line—but it is manageable with the right strategy. Here is what to do now:

• Calculate your 2026 ATI and compare it to your projected business interest expense to see if you face a limitation.
• Determine if you qualify for the small business exemption with $31 million or less in average annual gross receipts.
• Analyze whether the real property trade or business election saves more in interest deductions than it costs in ADS depreciation.
• Review your entity structure to confirm it is optimized for the 163(j) rules in 2026.
• Work with Uncle Kam’s tax advisory team to build a 2026 interest deduction strategy before you file.

Frequently Asked Questions

Does the section 163(j) interest limitation apply to rental property mortgage interest?

Yes, if your rental activity qualifies as a trade or business. Rental mortgage interest is classified as business interest expense for investors who actively manage their portfolios as a trade or business. If the activity is merely investment-level—not a trade or business—then the passive activity rules and investment interest rules apply instead of 163(j). Most active landlords and real estate investors will face the 163(j) limitation unless they qualify for an exemption.

Can I deduct disallowed interest if I sell my rental property?

For non-partnership taxpayers, disallowed interest generally does not automatically become deductible just because you sell a property. The carryforward must flow through future years of excess capacity. However, when a business entirely ceases, specific rules may allow remaining carryforwards to be deducted in the final year. For partnership investors, the rules differ. When a partner disposes of their full interest, a special rule may allow remaining EBIE to be treated as a deduction—but it is limited. Review IRS guidance on business interest expense for the full details. Always consult your tax advisor before selling.

Is there a way to increase my ATI and deduct more interest in 2026?

Yes. Several strategies can raise your ATI for 2026. First, deferring bonus depreciation to a future year reduces the depreciation deduction that would otherwise lower ATI. Second, accelerating income into 2026 increases the ATI base. Third, if you have multiple business activities, consider whether income from non-real estate activities can be included in your ATI calculation. Fourth, converting passive activities to active trade or business status can add income to ATI. Each of these moves has tradeoffs, so model them carefully with your advisor.

What is Form 8990 and when must I file it?

Form 8990 is the IRS form used to calculate and report the section 163(j) interest limitation. You must file it if you have business interest expense subject to the limitation—unless you are exempt. Partnerships must include it with Form 1065. C corporations include it with Form 1120. S corporations include it with Form 1120-S. Individuals include it with Form 1040. The form tracks current-year deductible interest, disallowed interest, and carryforward amounts. Accurate completion of this form is essential for avoiding IRS scrutiny and preserving future deductions. You can find the current form and instructions at IRS.gov Form 8990.

Does the real property trade or business election affect bonus depreciation on all my assets?

No. The ADS depreciation requirement only applies to specific property categories used in the electing real property trade or business. The three main categories affected are: nonresidential real property (40-year ADS life), residential rental property (30-year ADS life), and Qualified Improvement Property (20-year ADS life, no bonus). Personal property and short-lived assets used in your business—such as appliances, computers, or vehicles—are generally not affected by this election. However, the QIP restriction is significant. If you plan major interior improvements in 2026, losing bonus depreciation on that work could cost more than you save on interest. Model both scenarios carefully before making this irrevocable election.

How does the section 163(j) interest limitation interact with passive activity rules?

These are separate limitations that apply in a specific order. The section 163(j) limitation applies first to reduce business interest expense at the entity level. Then the passive activity loss rules apply to the remaining income or loss that flows to you as an investor. If you have disallowed interest at the 163(j) level, that amount never even reaches the passive activity analysis for the current year. Additionally, qualifying as a Real Estate Professional (REPS) for passive activity purposes does not automatically affect your section 163(j) exposure. Both issues require independent analysis. Work with a comprehensive tax strategy advisor who understands both sets of rules.

Last updated: May, 2026