Updated Guidance for Banks and Ag Lenders

The IRS has recently issued interim guidance pertaining to Section 139L.

As a reminder, the One Big Beautiful Bill Act introduced a provision that allows banks and qualified lenders to exclude 25% of the interest income from eligible agricultural and rural real estate loans from gross income for federal tax purposes. At the time of enactment, there were numerous questions regarding the criteria for qualification. This interim guidance answers some of these questions, though certain aspects remain open to interpretation. It’s anticipated that additional regulations will be provided.

“Banks should apply reasonable and consistent standards when determining which loans qualify,” advises Sandy Sporleder, financial institutions tax advisor with Pinion.

“The eligibility criteria provide guidance around this tax benefit, but we are recommending tracking and documentation for reporting purposes.”  

As part of the guidance, the IRS is requesting comments, which are due by January 20, 2026. Sporleder notes that Pinion will likely be filing tax returns before more information comes out.

How to navigate the criteria, and what it means to your financial institution:

Tax Benefit

  • 25% of the interest income from qualified loans is excluded from gross income.
  • Section 265 is amended to disallow 25% of the related interest expense, similar to the TEFRA penalty that banks might be familiar with on their municipal bonds.
  • This prevents double-dipping: banks cannot both exclude income and deduct the full cost of funds.

Eligibility Criteria

  • Loans must be originated after July 4, 2025.
  • Loans must be secured by rural or agricultural real estate or a leasehold mortgage on such property.
  • Property must be substantially used for the production of one or more agricultural products, any real property which is used for farming, ranching, aquaculture, fishing, or seafood processing within the U.S. or its territories. Note: The term ‘substantially’ is not yet defined in the guidance.
  • Only interest on new loans is eligible for the deduction. Refinancing an existing loan does not qualify for the new tax benefit unless additional principal is included. The guidance specifies that any loan used to pay off or replace a pre-July 4, 2025, loan is not treated as new and would not qualify. New funds (and increase in principle beyond the old loan’s payoff) would qualify for the interest exclusion.
  • The interim guidance establishes an 80% loan to value safe harbor. If the fair market value of the agricultural collateral is at least 80% of the loan’s principal at origination, the entire loan qualifies. If the collateral is less than 80%, then the tax benefit would be prorated for the qualified portion of the collateral.
  • Subsequent fair market value testing is NOT required. If the lender initially determines the loan is secured by qualified property and reasonably believes in good faith that the loan continues to be secured, the lender can rely on that initial determination.
  • The purpose of the loan does not affect whether a loan may be treated as a qualified loan. The collateral is the determining factor.

Practical Considerations

After reviewing the relevant guidance and consulting with bankers, Pinion advisors have identified several important considerations for practical situations:

  • Annual operating loans for farmers often renew each year. If agricultural real estate secures the operating loan, consider issuing a new loan (with a new loan number), using subsequent payments to retire the old loan, and making all advances on the new loan.
  • Because we now have guidance indicating a portion of the interest may qualify even if less than 80% of the loan value is covered by real estate value, it may make sense to include real estate as collateral on operating lines. For example, if you have an operating loan of $1,000,000, if the real estate collateral is worth $400,000, then 40% of the interest qualifies.
  • It may be to your advantage to include the ag real estate as collateral on all loans to a borrower. The guidance does not restrict you to pledge the same collateral on multiple loans.
  • If a loan is refinanced where a different bank is the original ledger, it does not matter. It will still be considered a refinance and not qualify if there are no changes to loan amount, collateral, etc.

Documentation

Banks should begin tracking these qualified loans for tax reporting. The following will be needed to calculate the loan deduction:

  • Interest income on the qualified loans (on a cash or accrual basis, depending on your tax method)
  • Average loan balances for the qualified loans for the tax year

Additional Considerations

  • Lenders will need to determine whether a loan qualifies (and what portion of it qualifies) at origination. Given the timing of this guidance, they may want to consider reviewing all loans originated since July 4th.
  • The guidance gives flexibility on what can be included as a qualified loan but may require additional work on your end to track and document qualified loans.
  • Banks should make a reasonable, good faith effort to determine which loans qualify and be consistent in their approach.

The full interim guidance can be found at Interim Guidance Regarding Interest on Loans Secured by Rural or Agricultural Real Property under Section 139L of the Internal Revenue Code.

Please reach out to your Pinion tax advisor if you have any questions or need help in determining whether a loan qualifies for the tax deduction.