Two Section 163(j) changes from the OBBBA are hitting the Q2 2026 income tax provision simultaneously, and they pull in opposite directions.
The first is unambiguously good: the OBBBA permanently restored the EBITDA-based ATI calculation for tax years beginning after December 31, 2024. Depreciation, amortisation, and depletion are added back again when computing adjusted taxable income, raising the 30% cap and allowing more interest to be deducted in the current year. For capital-intensive companies that have been sitting on large interest expense carryforward deferred tax assets since 2022, some of those carryforwards are finally becoming deductible in 2025 and 2026. That reversal shows up as a deferred tax benefit in the Q2 provision.
The second is a new constraint: for tax years beginning after December 31, 2025, any business interest expense that is electively capitalised to property retains its character as interest and remains subject to the Section 163(j) limitation. This ordering rule is effective for the first time in the 2026 tax year. It eliminates a planning strategy that real estate developers, construction companies, and capital-intensive manufacturers have used for years to move interest expense out of the 163(j) calculation by capitalising it into asset basis.
These two changes are not independent. The EBITDA restoration increased ATI and allowed more interest to be deducted in 2025, which may have benefited companies that were also capitalising interest to manage their 163(j) exposure. Starting January 1, 2026, the capitalisation escape hatch is closed, but the EBITDA restoration continues to provide a higher deduction ceiling. The Q2 2026 provision must reflect both.
This post explains the mechanics of each change, what the interaction between them looks like in the Q2 provision, and what the Q2 10-Q disclosures must say.
What Is Section 163(j) and How Did the OBBBA Change It?
Section 163(j) limits the deductibility of business interest expense to 30% of a taxpayer's adjusted taxable income, plus business interest income and floor plan financing interest. The limitation applies to every business entity subject to US federal income tax, with exceptions for small businesses (under the Section 448(c) gross receipts test), regulated utilities, certain real property businesses that make an irrevocable election to be treated as a real property trade or business, and farming businesses.
Interest expense disallowed in the current year under Section 163(j) is carried forward indefinitely and treated as business interest expense paid or incurred in succeeding taxable years. The carryforward is not lost. It is deductible in future years when ATI is sufficient, and it carries a deferred tax asset on the balance sheet representing the future tax benefit of that deduction.
The TCJA changed how ATI is calculated in two phases. For tax years 2018 through 2021, ATI was computed on an EBITDA basis: depreciation, amortisation, and depletion were added back to taxable income before applying the 30% cap, producing a higher ATI and a higher deduction ceiling. Beginning in 2022, those add-backs expired and ATI shifted to an EBIT basis, eliminating the D&A adjustment. For capital-intensive businesses with significant depreciation, the 2022 EBIT shift materially reduced ATI and pushed more interest into disallowance. Companies that were borderline under the EBITDA calculation found themselves significantly constrained under EBIT, generating large interest carryforward DTAs.
The OBBBA made four changes to Section 163(j). Two are favourable, two are unfavourable.
Favourable change 1: EBITDA restoration. For tax years beginning after December 31, 2024, the OBBBA permanently restored depreciation, amortisation, and depletion (DDA) add-backs to ATI, returning to the EBITDA-based calculation. This change is effective for calendar-year companies starting January 1, 2025. For Q2 2026 provision purposes, it is already embedded in the annual effective tax rate from Q1 2026 and represents the second full year of the restored calculation.
Favourable change 2: Floor plan financing interest. The OBBBA permanently extends the exclusion of floor plan financing interest from the 163(j) limitation, which benefits auto, equipment, and other dealerships that were previously subject to complex interaction between floor plan financing and the general limitation.
Unfavourable change 1: Capitalised interest ordering rule. For tax years beginning after December 31, 2025, business interest expense that is electively capitalised to property under Sections 263(a) or 263(g) retains its character as interest and is subject to the Section 163(j) limitation. This rule is first effective for calendar-year companies in 2026.
Unfavourable change 2: ATI exclusions for international tax items. For tax years beginning after December 31, 2025, Subpart F income, GILTI (now NCTI), Section 78 gross-ups, and related deductions are excluded from ATI. Multinational companies with significant CFC income that had been including those items in ATI (increasing the deduction ceiling) now have a lower ATI for 163(j) purposes. The Grant Thornton analysis confirms this: the exclusion of these international tax items from ATI, effective in 2026, partially offsets the EBITDA benefit for multinational companies.
The EBITDA Restoration: How the ATI Add-Back Changes Your Q2 Deductible Interest
The practical effect of the EBITDA restoration is straightforward to model but meaningful in magnitude. ATI is higher because D&A is added back, the 30% cap applies to a higher ATI, and more current-year interest is deductible.
The Beancount analysis provides a concrete example: a contractor with $1,000,000 of taxable income before interest, $450,000 of depreciation, and $650,000 of business interest expense. Under the 2022-2024 EBIT calculation, ATI is $1,000,000 and the 163(j) limit is $300,000 (30% of $1,000,000). Under the restored EBITDA calculation, ATI is $1,450,000 and the limit is $435,000 (30% of $1,450,000). That is a $135,000 swing in deductible interest in a single year from the calculation change alone.
For a leveraged buyout company or a large manufacturer with $500 million in annual depreciation, the magnitude of the restoration is proportionally enormous. ATI increases by the full D&A amount, and the 30% cap applies to that higher base. A company that had been capped at $150 million of deductible interest under EBIT (30% of $500 million ATI) might now be capped at $285 million (30% of $950 million ATI including $450 million D&A), allowing an additional $135 million of current-year interest to be deducted.
Two things happen in the Q2 2026 provision as a result of this increase in deductible interest.
First, current-year interest that would have been disallowed under the EBIT calculation is now deductible. This produces a current tax benefit (lower taxable income, lower current tax liability) that flows through the AETR.
Second, interest expense carryforward DTAs that accumulated from 2022 through 2024 may now be expected to reverse faster than originally projected, because higher current-year ATI means the carryforward is being consumed in 2025 and 2026 rather than sitting dormant on the balance sheet. The increased expected utilisation of the carryforward does not by itself change the DTA balance, but it affects the valuation allowance assessment: if the carryforward that previously appeared unlikely to be utilised in the near term is now expected to be utilised within a shorter horizon, the valuation allowance may need to be reduced, producing a deferred tax benefit.
For companies that previously recorded valuation allowances against their interest carryforward DTAs because the EBIT calculation had produced persistent disallowance, the EBITDA restoration can be the event that removes or reduces the allowance. That allowance reversal is a discrete tax benefit that, if material, should appear in the rate reconciliation as a separate line under ASU 2023-09.
What Happens to the Interest Expense Carryforward DTA You've Been Carrying?
Every company that had interest expense disallowed under Section 163(j) in 2022, 2023, or 2024 is carrying an interest expense carryforward deferred tax asset. The carryforward does not expire, but it is only realised when future-year ATI is sufficient to allow the deduction.
Under the EBIT calculation that applied from 2022 through 2024, many capital-intensive companies accumulated significant carryforward DTAs. For a company that generates $400 million in annual business interest expense, had $200 million in D&A, and operated under the EBIT-based limitation, the annual disallowance may have been $30 million to $50 million per year, producing a cumulative three-year carryforward DTA of $90 million to $150 million (before applying the 21% tax rate to the carryforward amount).
The EBITDA restoration in 2025 changed the expected reversal pattern for that carryforward DTA in two ways.
First, the higher 2025 ATI allowed current-year interest that would have continued to be disallowed under EBIT to now be deducted. The carryforward balance stopped growing or started shrinking in 2025 for the first time since 2022.
Second, where the company's 2025 and projected 2026 deductible interest capacity exceeds its current-year interest expense, some of the historical carryforward may become deductible in 2025 and 2026. The portion that is expected to be deducted in the next few years moves from the "indefinite future" category of utilisation to the "near-term" category, which affects both the valuation allowance assessment and the presentation of the DTA in the balance sheet.
The ASC 740 mechanics of carryforward DTA reversal under the EBITDA restoration: the DTA for each carryforward year is recognised at the 21% corporate rate on the carryforward amount. When the carryforward is deducted, the DTA reverses: current tax expense decreases (tax benefit from the deduction), and deferred tax expense increases (DTA removal). The net income statement effect is zero or near-zero if the deferred tax benefit from new disallowance equals the deferred tax expense from prior-year carryforward utilisation. The net effect is a shift from deferred to current.
Where the company previously maintained a valuation allowance against the carryforward DTA because it was considered more-likely-than-not that it would not be realised, the EBITDA restoration may change that conclusion. The allowance reversal produces a deferred tax benefit that does not reverse and that flows through the Q2 effective tax rate as a discrete or AETR item depending on the period in which the reversal is determined.
The New Q2 2026 Rule: Why Capitalizing Interest No Longer Bypasses 163(j)
This is the unfavourable side of the Q2 2026 Section 163(j) change, and it is the first year it is in effect for calendar-year companies.
Under prior law and the existing final regulations at Reg. Section 1.163(j)-3, Section 163(j) applied only to business interest expense that would otherwise be deductible in the current year without regard to Section 163(j). This meant that interest expense that was electively capitalised to property under Section 263(a) or Section 263(g) was not counted as business interest expense for Section 163(j) purposes. The interest was still deductible, just through a different mechanism: it was capitalised into the basis of the asset, and then flowed through the income statement as depreciation over the asset's life rather than as a current-period interest expense.
For companies approaching their 163(j) limit, this created a planning opportunity. By electing to capitalise interest that would otherwise be disallowed under Section 163(j), companies could move that interest out of the 163(j) calculation entirely. The interest became part of the asset's depreciable basis, the depreciation created a DDA deduction that increased ATI in future years (benefiting the 163(j) calculation in those years), and the company avoided the permanent disallowance risk of an interest carryforward that might never be utilised.
The OBBBA's new ordering rule, contained in Section 163(j)(10) and effective for tax years beginning after December 31, 2025, eliminates this planning technique. The new rule provides that the business interest limitation applies without regard to whether the taxpayer would otherwise deduct or capitalise the business interest. The Tax Adviser analysis confirms the mechanics: even if a taxpayer capitalises interest to an asset under Section 263(a) or 263(g), that interest retains its character as business interest expense for Section 163(j) purposes and is counted in the Section 163(j) calculation.
The practical effect is that a company capitalising $50 million of interest to construction-in-progress in 2026 can no longer exclude that $50 million from the business interest expense denominator of the 163(j) analysis. The $50 million is counted as business interest expense, the 30% ATI cap applies to it, and if the company's ATI is insufficient to allow the full deduction, the excess becomes a carryforward.
The Grant Thornton analysis confirms that while the effectiveness of capitalising interest to mitigate the limitation is terminated in 2026, evaluation of other tax methods and elections to manage ATI remains available. The Tax Adviser analysis specifically discusses the opportunity to use cost-recovery accounting methods, including UNICAP (Section 263A) capitalisation of additional costs to property basis, as an alternative to interest capitalisation for increasing future DDA and therefore future ATI.
Which Companies Are Most Affected by the Capitalized Interest Change?
The companies most affected by the new 2026 capitalised interest ordering rule are those that have been using elective interest capitalisation as an active Section 163(j) planning strategy. The Keiter analysis identifies real estate developers and construction companies as the primary affected population.
Real estate developers and construction companies. Real estate developers regularly capitalise interest expense to real property under construction under Section 263(a). Construction companies capitalise interest to long-term contracts under Section 263(g). For these entities, interest capitalisation has served two functions: it is economically appropriate (the interest costs are directly attributable to the construction project), and it has allowed the interest to bypass the Section 163(j) limitation by removing it from the business interest expense calculation. Starting January 1, 2026, the bypass function is eliminated. The interest continues to be capitalised for cost accounting purposes, but it is now also counted in the 163(j) analysis.
Capital-intensive manufacturers with significant construction in progress. Large manufacturers building new facilities (including those potentially qualifying as QPP under Section 168(n), discussed in the separate Section 168(n) blog) may have been capitalising construction-period interest to reduce their 163(j) exposure. The 2026 change requires those companies to include the capitalised interest in their business interest expense for 163(j) purposes, even though the interest is still added to the asset's basis for depreciation purposes.
Leveraged buyout companies. Companies with acquisition debt often capitalise acquisition financing costs and related interest during the period that assets are being integrated or placed in service. The 2026 change requires all business interest that is electively capitalised to be counted in the 163(j) analysis.
Companies that made a real property trade or business election under Section 163(j)(7) to opt out of the interest limitation (and that accepted the resulting ADS depreciation requirement for their nonresidential real property) are not subject to the capitalised interest ordering rule for their real property interest. But they are still subject to ADS depreciation, which reduces their depreciation deductions and reduces the benefit of the EBITDA restoration in their ATI calculation.
Note the planning asymmetry the Keiter analysis identifies: in 2025, before the capitalised interest rule took effect, companies had the last opportunity to use interest capitalisation to manage their 163(j) exposure. A company that capitalised interest in 2025 to mitigate its 163(j) exposure is in a different position from one that did not. For 2026, the capitalisation strategy no longer reduces 163(j) exposure, but it does still produce capitalised basis that generates depreciation, and that depreciation increases ATI through the EBITDA add-back.
What Do These Two Changes Look Like Together in Your Q2 Effective Tax Rate?
The Q2 2026 effective tax rate reflects the net effect of the EBITDA restoration and the capitalised interest rule working simultaneously.
For most capital-intensive companies, the EBITDA restoration is the larger of the two effects. Higher ATI means more interest is currently deductible, reducing the current-year disallowance and accelerating the reversal of prior carryforward DTAs. The net direction for most companies is a lower effective tax rate in 2025 and 2026 compared to 2022-2024, driven by the increased deductibility of current-year interest.
The capitalised interest rule moderates that benefit for companies that have been relying on interest capitalisation to manage their 163(j) exposure. By requiring capitalised interest to be included in business interest expense for 163(j) purposes, the rule increases the gross business interest expense before the 30% ATI cap is applied. If the higher ATI from the EBITDA restoration does not fully offset the higher gross business interest expense from the capitalised interest inclusion, the net disallowance in 2026 could be higher than in 2025.
The multinational ATI exclusion for Subpart F, NCTI, and Section 78 gross-ups (effective for the first time in 2026) adds a third variable. Multinational companies that have been including CFC-related income in ATI now have lower ATI, reducing the deduction ceiling and partially offsetting the EBITDA benefit. The RSM analysis specifically flags this: the OBBBA also modifies the treatment of international tax items in the ATI calculation, with implications for companies that have made CFC group elections.
For the Q2 provision AETR calculation, the tax director should model the combined effect of all three 2026 changes by legal entity and confirm that the AETR reflects the correct Q2 year-to-date position. The key inputs are: current-year interest expense by entity, current-year ATI by entity (including the EBITDA add-back and the international item exclusions), the amount of capitalised interest that must now be included in business interest expense for 163(j) purposes, and the prior-year carryforward balance that is expected to be utilised in 2026.
If the AETR analysis produces a material change in 163(j) disallowance compared to Q2 2025, ASU 2023-09 requires that change to appear as a separately quantified line item in the rate reconciliation if it exceeds the 5% threshold.
What Disclosures Are Required in Your Q2 2026 10-Q for 163(j)?
The Q2 2026 10-Q income tax footnote for Section 163(j) has three specific areas that must be addressed where material.
Rate reconciliation disclosure under ASU 2023-09. If the EBITDA restoration produces a material deferred tax benefit from carryforward DTA reversal or valuation allowance release, and if that benefit causes a line item in the rate reconciliation to exceed 5% of the product of pre-tax income and the statutory rate, that line must be separately quantified. The description should identify the item as a Section 163(j) interest limitation change related to the OBBBA EBITDA restoration.
Deferred tax asset disclosure. Where the interest expense carryforward DTA is material, the footnote should describe the carryforward balance, the expected reversal pattern, and the basis for any valuation allowance conclusion. A company that released a valuation allowance against the carryforward DTA in connection with the EBITDA restoration should describe the release and the basis for concluding that the DTA is now more-likely-than-not realisable.
Accounting policy and method change disclosure. Where the capitalised interest ordering rule required a change in the company's approach to characterising interest expense for Section 163(j) purposes, the footnote should describe the change and its effect. The Tax Adviser analysis notes that the ordering rule under Section 163(j)(10) is statutory, not elective, so no method change election is required. The change is simply applied in the first tax year beginning after December 31, 2025. However, if the company previously disclosed a specific accounting policy under which electively capitalised interest was excluded from the 163(j) calculation, that disclosure should be updated.
Known trend or uncertainty in MD&A. If the combined effect of the EBITDA restoration and the capitalised interest rule produces a material change in the company's expected effective tax rate for full-year 2026 compared to 2025, the MD&A results of operations discussion should quantify that change and explain its drivers. The combination of a lower disallowance rate (from EBITDA) and a higher gross interest exposure (from capitalised interest inclusion) may produce a net effect that is not intuitively obvious to an investor reading the rate reconciliation without explanation.
Should Your Company Model Whether Rev. Proc. 2026-17 CFC Group Election Applies?
The OBBBA also modified the interaction between Section 163(j) and controlled foreign corporation groups. Rev. Proc. 2026-17, issued by the IRS in March 2026, provides guidance on the CFC group election available under Section 163(j)(9)(B), which allows certain US shareholders of CFC groups to treat the CFC group as a single entity for purposes of calculating the interest limitation.
The CFC group election was introduced prior to the OBBBA and has been available since 2018. The OBBBA's exclusion of NCTI, Subpart F income, and Section 78 gross-ups from domestic ATI (effective 2026) directly affects companies that have made a CFC group election, because those income items were previously included in the domestic taxpayer's ATI calculation and inflated the deduction ceiling. With those items now excluded from ATI, the domestic 163(j) limitation is calculated on a lower ATI, potentially producing more disallowance for companies that relied on CFC income to support a higher ATI.
Rev. Proc. 2026-17 provides updated procedures for making, modifying, or revoking the CFC group election in light of the OBBBA changes. The RSM analysis of Rev. Proc. 2026-17 confirms that companies with existing CFC group elections should evaluate whether their election remains beneficial under the new ATI exclusion rules.
For Q2 2026 provision purposes, the question is whether the company's current CFC group election is optimally calibrated given the new ATI exclusions. A company that made the election when Subpart F income or GILTI income inflated its domestic ATI may find that the election is less valuable under the 2026 ATI exclusion rules, and may want to model whether revoking or modifying the election produces a better net outcome. This is a long-form modelling exercise that should be completed before the 2026 tax return is filed, not in the Q2 provision close. But if the modelling reveals a material effect on the expected 2026 AETR, the Q2 provision should reflect the expected full-year position.
Frequently Asked Questions
What did the OBBBA change about Section 163(j)?
The OBBBA made four changes. Two are favourable: permanent restoration of the EBITDA-based ATI calculation (effective 2025) and permanent extension of the floor plan financing interest exclusion. Two are unfavourable: a new ordering rule requiring that electively capitalised interest be included in business interest expense for Section 163(j) purposes (effective 2026), and exclusion of Subpart F income, NCTI, Section 78 gross-ups, and related deductions from ATI (effective 2026). The EBITDA restoration and the capitalised interest ordering rule are both hitting Q2 2026 simultaneously.
What is the EBITDA restoration for 163(j) ATI purposes?
The EBITDA restoration returns the ATI calculation to the pre-2022 framework, where depreciation, amortisation, and depletion are added back to taxable income before applying the 30% interest deduction cap. This increases ATI, raising the ceiling on deductible interest. For capital-intensive companies with significant D&A, the restoration can produce a large increase in deductible interest compared to the 2022-2024 EBIT-based calculation.
What is the new 2026 rule on capitalised interest and 163(j)?
Under the new ordering rule in Section 163(j)(10), business interest expense that is electively capitalised to property under Sections 263(a) or 263(g) retains its character as business interest expense and is subject to the Section 163(j) limitation. This rule eliminates the prior planning technique under which companies could move interest outside the 163(j) calculation by capitalising it to asset basis. The rule is first effective for calendar-year companies for the tax year beginning January 1, 2026.
What happens to my interest expense carryforward DTA under the EBITDA restoration?
The higher ATI produced by the EBITDA restoration may allow prior-year interest carryforwards to be deducted in 2025 and 2026, reversing the carryforward DTA. The reversal produces current tax benefit and deferred tax expense, but the net income statement effect is close to zero if the reversal was anticipated. The more significant impact is on valuation allowances: companies that previously maintained allowances against carryforward DTAs because utilisation was not more-likely-than-not may be able to release those allowances under the restored ATI calculation, producing a deferred tax benefit.
Does Section 163(j) affect my Q2 2026 effective tax rate disclosure?
Yes, where the combined effect of the EBITDA restoration and the capitalised interest ordering rule produces a material change in current-year deductible interest or in prior-year carryforward utilisation. Under ASU 2023-09, material Section 163(j)-related changes in the effective tax rate must be separately quantified in the rate reconciliation. The MD&A should also address any material change in the expected full-year 163(j) position compared to 2025.
Key Takeaways
- The OBBBA permanently restored the EBITDA-based ATI calculation for Section 163(j) for tax years beginning after December 31, 2024. Depreciation, amortisation, and depletion are added back to ATI, raising the ceiling on deductible business interest. This change has been in effect since January 1, 2025, and is embedded in the Q2 2026 annual effective tax rate.
- Starting January 1, 2026, business interest expense that is electively capitalised to property under Sections 263(a) or 263(g) retains its character as business interest expense and is subject to the Section 163(j) limitation. The prior planning technique of capitalising interest to bypass the limitation is eliminated for 2026 and later years.
- Companies with large interest expense carryforward DTAs from 2022-2024 EBIT-based disallowance should assess whether the EBITDA restoration makes those carryforwards more-likely-than-not realisable, which would require releasing prior valuation allowances and recognising a deferred tax benefit.
- For 2026, ATI also excludes Subpart F income, NCTI, Section 78 gross-ups, and related deductions. For multinational companies, this partially offsets the EBITDA benefit by reducing ATI for 163(j) purposes.
- The Q2 2026 income tax footnote must address: the AETR impact of the EBITDA restoration and the capitalised interest rule, the interest carryforward DTA balance and any valuation allowance changes, and the ASU 2023-09 rate reconciliation line if the Section 163(j) changes exceed the 5% materiality threshold.
- Rev. Proc. 2026-17, issued March 2026, provides updated procedures for the CFC group election under Section 163(j)(9)(B). Companies with CFC group elections should evaluate whether their election remains optimal under the new ATI exclusion rules.
- Real estate developers, construction companies, and capital-intensive manufacturers are most affected by the capitalised interest ordering rule. These entities should confirm that their Q2 2026 provision includes the capitalised interest amounts in the business interest expense denominator of the 163(j) calculation.
