IRS Issues Guidance for Implementing ADS Change for Residential Rental Property

The Consolidated Appropriations Act of 2021 (CAA) retroactively modified the ADS recovery period for residential rental property placed-in-service prior to 2018 held by electing real property trades or businesses. Affected taxpayers are those who have elected to be exempt from the interest expense deduction limits of section 163(j).

If you are an affected taxpayer, you need to take action to modify the recovery period of these assets from 40 to 30 years. The IRS no longer views 40 years as a permissible recovery period.

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How Do I Implement the Correction Based on New IRS Guidance?

Rev. Proc. 2021-28 and Rev. Proc. 2021-29, released June 17, 2021, outline the procedures for implementing this correction and provide taxpayers with several options. 

Form 3115, Application for Change in Accounting Method
Taxpayers can file a Form 3115, Application for Change in Accounting Method, with a timely filed return and recognize the additional depreciation for all prior years as a Section 481(a) adjustment in the year of change. The revenue procedure expands on the existing automatic changes provided in Rev. Proc. 2019-43, so taxpayers that have already filed a Form 3115 for this issue do not need to take any action to apply the new procedure. 

Rev. Proc. 2021-28 allows taxpayers to file an automatic accounting method change even if the asset has only been depreciated incorrectly on one tax return (e.g., the taxpayer made the real property trade or business election in 2019 and only claimed incorrect depreciation on the 2019 return). 

Additionally, for tax years beginning in 2019, 2020, 2021 or 2022, taxpayers can request an automatic accounting method change even if they have filed a depreciation method change for the same asset in the last five years. However, taxpayers making or revoking real property trade or business elections under Rev. Proc. 2020-22 are subject to limitations on their ability to request an automatic accounting method changes for this issue. 

Form 1065 or Administrative Adjustment Request
Taxpayers can file an amended tax return, amended Form 1065, or Administrative Adjustment Request (AAR) for the year of the real property trade or business election and any succeeding taxable years. For example, if the taxpayer made a real property trade or business election for 2018, the taxpayer would be required to amend the 2018 and 2019 tax returns as well as 2020, if filed. 

The amended return(s) must take into account the change in depreciation as well as any other collateral adjustments to taxable income resulting from the change. The amended return(s) must be filed prior to April 15, 2022.

Rev Proc. 2021-29
Rev. Proc. 2021-29 allows partnerships subject to the centralized audit procedures of the BBA that filed a Form 1065 and issued Schedules K-1 for tax years beginning in 2018, 2019 or 2020 prior to the date of the revenue procedure to file amended tax returns rather than AARs for affected tax years. The amended return(s) must be filed prior to October 15, 2021, and can adjust the recovery period for residential rental property from 40 years to 30 years and make a late real property or farming business election under Section 163(j)(7) in accordance with Rev. Proc. 2020-22.

The amended return(s) replace any prior year return(s) for the tax year for purposes of determining the partnership’s treatment of partnership-related items. BBA partnerships must indicate “FILED PURSUANT TO REV PROC 2021-29” at the top of their amended returns and attach a statement to each Schedule K-1 furnished to their respective partners with this same notation.

What Do I Do if I Intend to File a Correction?

Organizations with assets affected by this change that intend to file a Form 3115 to correct the depreciation will need to file the Form 3115 with either their 2020 or 2021 tax returns. Note that organizations can still file a Form 3115 with an amended return for the 2020 tax year if the amended return is filed prior to the extended due date, regardless of whether the return has been extended. 

What Do I Do if I Intend to File an Amended Return?

Organizations intending to file amended return(s) to correct the prior depreciation need to be mindful of the deadlines for filing the returns.

Have questions regarding the deprecation changes required, filing a Form 3115, Rev. Proc. 2021-29 or other partnership related questions?

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