The Consolidated Appropriations Act of 2021 (“CAA”) signed at the end of December once again changed the depreciation rules for tax years following the effective date of the Tax Cuts and Jobs Act (“TCJA”). Similar to the qualified improvement property (“QIP”) correction that was included in the CARES Act earlier in 2020, the CAA retroactively modifies the depreciation recovery period for certain assets for tax years beginning in 2018 or later years.
The assets impacted by the CAA change are residential rental property assets placed-in-service prior to January 1, 2018, that are held by taxpayers engaged in real estate or farming businesses who elected to be exempt from the interest expense deduction limits in Section 163(j). Under Section 163(j)(7), taxpayers engaged in qualifying real estate or farming businesses can elect to fully expense their interest expense but must depreciate certain classes of assets – including residential rental property – using the longer recovery periods under the Alternative Depreciation System (“ADS”). Under the original TCJA language, residential rental property placed-in-service after January 1, 2018, could use an ADS recovery period of 30-years but properties placed-in-service prior to 2018 were required to use an ADS recovery period of 40-years.
The CAA modifies the ADS recovery period for pre-2018 residential rental property to 30-years. As a result, taxpayers who elected to be exempt from Section 163(j) and depreciated residential rental property over 40-years are now required to modify their prior depreciation deductions claimed. Taxpayers will likely be required to file an accounting method change or amended return to make this correction but additional guidance from the IRS is anticipated – stay tuned!
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