August 13, 2025 | By Eric Lucas, Complex Tax Accounting Methods and Elections Leader

There is a time sensitive opportunity to reduce the limitation on deducting interest expense under section 163(j). For taxable years that begin before January 1, 2026, a taxpayer may elect to capitalize interest expense to inventory, machinery and other tangible property under either section 266 or section 263(a).1 Capitalized interest expense is no longer considered interest subject to section 163(j) and becomes part of the basis of acquired or produced property. The expense is recovered more quickly (e.g., through cost of goods sold) than under the carry over provisions of section 163(j). The election to capitalize expense is a year-by-year election and must be made by the extended due date for filing the return. Thus, timing is critical for 2024 calendar year taxpayers filing on extension. 

Although other structures may be considered, the most common scenario involves the following:

  • Taxpayer is subject to the section 163(j) limitation, whether in a taxable income position or an NOL.
  • Taxpayer holds debt in the same entity that produces or resells inventory (e.g., utilities that sell electricity, gas, etc.). Restructuring or moving debt may also be considered.
  • Taxpayer holds debt in the same entity that produces or resells inventory (e.g., utilities that sell electricity, gas, etc.). Restructuring or moving debt may also be considered.

In addition to the timing benefit, other benefits may include the removal of interest expense from base erosion payments (BEAT) under section 59A, increasing the tax basis of property that is eligible for the investment tax credit, increasing foreign source income for foreign tax credit utilization under section 861, reduction in expenses allocated to foreign derived intangible income (FDII), and state margin tax benefits by reducing net margin subject to tax.

The implementation of the strategy requires careful analysis, particularly with multi-national corporations and intercompany loan arrangements. Please contact us to discuss further.

Footnotes

 

[1] The One Big Beautiful Bill treats capitalized interest as interest subject to section 163(j) for taxable years that begin after December 31, 2025.