Tax Insight: Form 3115 May be Used for Changing to ADS Depreciation for Residential Rental Property (KROST)

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August 26, 2021 - KROST Certified Public Accountants & Consultants


This is a thought leadership article from PrimeGlobal member firm KROST in North America, looking at procedures for taxpayers to change to the Alternative Depreciation System (ADS) for certain residential rental properties.

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On June 17 2021, the IRS issued Revenue Procedure 2021-28, which provides procedures for taxpayers to change to the alternative depreciation system (ADS) for certain residential rental properties placed in service prior to January 1 2018 and held by an electing Real Property Trade or Business (RPTOB).


Insight

A RPTOB that made the election under Section 163(j) to avoid interest expense limitations for residential rental property is required to depreciate real property under ADS. Revenue Procedure 2021-28 clarifies that a Form 3115, change of accounting method, may be used to change the recovery period of residential real property placed in service prior to January 1 2018 to 30-years under ADS. The appropriate Designated Change Number (DCN) is 88.


Background

The Tax Cuts and Jobs Act (TCJA) provided that RPTOBs could elect not to apply the interest limitation provision of Section 163(j) for residential rental property. As an offset, Revenue Procedure 2019-08 provided that those RPTOB making this election are required to depreciate applicable real property under ADS. However, Revenue Procedure 2019-08 also provided that the conversion to ADS should be based on the ADS rules applicable to the year the property was placed in service, not the year in which the property was converted to ADS. RPTOBs were required to change the deprecation method for any applicable real property placed in service in years prior to the election to use ADS.

This required residential rental property placed in service prior to January 1 2018 to convert to a 40-year ADS life rather than the 30-year ADS life established by the TCJA for residential rental property placed in service after December 31 2017.

In 2021, the Consolidated Appropriations Act retroactively provided that electing RPTOBs are required to use a 30-year ADS recovery period for residential rental property placed in service prior to January 1 2018.  However, prior to the issuance of Revenue Procedure 2021-28 there was no guidance provided on how taxpayers were to effectuate this change.


Guidance

Under Revenue Procedure 2021-28, an RPTOB that owns residential rental property not depreciated using ADS and made a Section 163(j) election on a prior tax return may change the recovery period to 30-year ADS.

The Revenue Procedure provides that the use of 40-year ADS for a RPTOB that made the 163(j) election is an impermissible method of accounting, which typically may only be corrected with an accounting method change if the method was used on more than one filed tax return.  However, Revenue Procedure 2021-28 allows:

  • Taxpayers to use automatic method change procedures to correct this impermissible method (even if method was used only on one tax return).

(i) Automatic Change pursuant to Section 6.05 of Rev. Proc 2019-43 (“Change in method of accounting for depreciation due to change in use of MACRS property”)

(ii) Designated Automatic Change Number: 88

  • Allows amended returns to be filed to account for this change.

Note: A separate Revenue Procedure (2021-29) provides an option for partnerships to file amended returns to apply a 30-year ADS recovery period for residential rental property placed in service prior to January 1 2018.

  • Allows an administrative adjustment request (“AAR”) under Section 6227 to account for this change.

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