Depreciation guidance for electing real property trades or businesses

| 7/22/2021
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Revenue Procedure 2021-28 provides necessary procedural guidance for electing real property trades or businesses, as defined in IRC Section 163(j)(7)(B), to implement retroactive changes made by Section 202 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (TCDTRA), which was enacted as part of the Consolidated Appropriations Act of 2021. Under TCDTRA, certain electing real property trades or businesses that placed residential rental property in service before Jan. 1, 2018, are required to use a 30-year recovery period versus 40 years established through changes made by the Tax Cuts and Jobs Act of 2017 (TCJA) for such property.

Revenue Procedure 2019-08

An eligible trade or business can make an election under IRC Section 163(j)(7)(B) to be an electing real property trade or business. An electing real property trade or business must use the alternative depreciation system (ADS) to depreciate any nonresidential real property, residential rental property, and qualified improvement property. The ADS provides a longer recovery period than provided under the general depreciation system (GDS). Revenue Procedure 2019-08 clarified that an electing real property trade or business must use ADS to depreciate such property placed in service before, during, and after the election year, and that making the election results in a change in use of such property placed in service prior to the election year. Thus, making the election under IRC Section 163(j)(7)(B) means that depreciation is determined in the year of the election and any subsequent taxable year as if the property originally had been placed in service with the longer ADS recovery period.

Changes made by TCJA

Prior to the TCJA, residential rental property was assigned a 40-year ADS recovery period. The TCJA amended the statute to provide a 30-year ADS recovery period for residential rental property but only to such property placed in service after Dec. 31, 2017. However, Section 202 of the TCDTRA, which was enacted three years after the TCJA, retroactively amended the statute to require a 30-year ADS life to any residential rental property that is placed into service before Jan. 1, 2018, and that is held by an electing real property trade or business, provided such property was not previously subject to ADS (other than by reason of the Section 163(j) election). The 30-year ADS life is mandatory. Thus, procedural guidance was necessary for taxpayers to be able to change their method of accounting to comply with the statute.

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Revenue Procedure 2021-28

Revenue Procedure 2021-28 allows electing real property trades or businesses that previously did not apply a 30-year ADS life to residential rental property placed in service before Jan. 1, 2018, for the election year and any subsequent taxable year to change their method of accounting by filing either:

  • A Form 3115, “Application for Change in Accounting Method,” with an IRC Section 481(a) adjustment.
  • For a limited period of time, an amended federal income tax return, Form 1065, “U.S. Return of Partnership Income,” or administrative adjustment request (AAR) for the election year including adjustments to taxable income for the change in determining depreciation of the residential rental property, as well as any collateral adjustments to taxable income or to tax liability. Such collateral adjustments also must be made on original or amended federal income tax returns, Forms 1065, or AARs for any affected succeeding taxable years. A separate revenue procedure provides rules for filing amended returns in lieu of an AAR.

These options apply even if the taxpayer made the election in the taxable year immediately preceding the year of change and, therefore, had not yet adopted a method of accounting for the item of residential rental property. Additional guidance is provided to those electing real property trades or businesses that hold the affected residential rental property in general asset accounts.

The procedural guidance under Revenue Procedure 2021-28 does not apply to:

  • A taxpayer that made an original election under IRC Section 163(j)(7)(B) on its federal income tax return for a taxable year ending on or after Dec. 27, 2020
  • A taxpayer that makes a late election under IRC Section 163(j)(7)(B) on an amended federal income tax return, an amended Form 1065, or an AAR, as applicable, that is filed after Dec. 27, 2020, pursuant to Revenue Procedure 2020-22
  • A taxpayer that withdraws the election under IRC Section 163(j)(7)(B) pursuant to Revenue Procedure 2020-22

Looking ahead

Taxpayers that previously made an election under IRC Section 163(j)(7)(B) and that hold residential rental property that was placed into service by the taxpayer before Jan. 1, 2018, should review their prior method of depreciating such property to determine any impact of the retroactive 30-year ADS life provided by the TCDTRA.

Given the flexibility in the revenue procedure, taxpayers should carefully consider the manner and tax year in which a method change is effectuated in order to properly apply a 30-year ADS life.

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