Section 266 Planning for Section 163(j) Limited Clients

The 2017 tax reform act amended Section 163(j) to limit the amount of business interest a taxpayer may deduct. A taxpayer may reduce the amount of disallowed interest by increasing the amount of capitalized interest, which is not subject to disallowance.

Section 266

Section 266 provides that a taxpayer may elect, as provided in regulations, to charge to a capital account (either as a component of original cost or other basis under Section 1012 or as an adjustment to basis under Section 1016(a)(1)) otherwise deductible amounts paid or accrued for taxes and carrying charges relating to property. Specifically, regulations under Section 266 allow taxpayers to capitalize to personal property.  Personal property includes but is not limited to inventory and accounts receivable.

How it Works

Pursuant to Section 266, a reasonable approach must be used to calculate the carrying charges (e.g., interest) to capital accounts (e.g., accounts receivable (A/R)). Clients can leverage principles of the avoided cost method from Treas. Reg. Section 1.263A-9 to calculate the amount of interest capitalizable to A/R. This approach reasonably allocates the cost attributable to holding debt for purposes of carrying A/R.

The Section 266 election is made by attaching a statement to your original, timely filed tax return for the year of the election (i.e., it cannot be filed on an amended return).

The interaction of Section 266 and Section 163(j) is changing. Legislation passed in 2025 restricts the ability to use elective capitalization under Section 266 before the Section 163(j) limit for tax years beginning after December 31, 2025.

Benefits of Electing Section 266

For tax years beginning on or before December 31, 2025, taxpayers may realize several advantages from making the Section 266 election:

• Increase the amount deductible in the current year by recharacterizing interest expense that is limited by the Section 163(j) limitation to Inventory and/or A/R using Section 266 principles
• Section 266 is an annual election so the benefit can be realized every year the company is limited by Section 163(j).

Weaver Can Help

Contact us. Weaver offers comprehensive Section 163(j) consulting services designed to assist businesses in efficiently managing 163(j) compliance and maximizing ability to deduct interest.

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