IRS Guidance Issued on Change in Useful Life for 2020 Tax Returns
AAFCPAs would like to make clients aware that the IRS recently released long awaited guidance detailing how a taxpayer must change the method of computing depreciation to provide a 30-year recovery period under the alternative depreciation system (ADS) for some properties controlled by a business that started renting before 2018.
Rev. Proc. 2021-28 explains how an electing real property trade or business can change its method of computing depreciation for residential rental property that was (1) placed in service before 2018, and (2) subject to a change in use in a prior tax year because of the real property trade or business election. This guidance is especially relevant for AAFCPAs’ Affordable Housing clients, as well as businesses operating residential rental property.
This revenue procedure modifies Rev. Proc. 2019-08 related to the depreciation for certain property held by an electing real property trade or business, and also modifies Rev. Proc. 2019-43, which provides the list of automatic changes in methods of accounting, to expand the applicability of the automatic accounting method change procedures for a change in use of residential rental property held by an electing real property trade or business.
How to Change the Recovery Period Retroactively
The guidance provides options on how to change the recovery period retroactively, by filing:
- an amended Federal income tax return or information return;
- an administrative adjustment request (AAR); or
- a Form 3115, Application for Change in Accounting Method.
The guidance details reduced filing requirements of Form 3115 for qualified small taxpayers. A “qualified small taxpayer” is a taxpayer whose average annual gross receipts (as determined under § 1.263(a)-3(h)(3)) for the three preceding taxable years is less than or equal to $10,000,000.
The IRS also released Revenue Procedure 2021-29 which specifies that a BBA partnership (i.e. Bipartisan Budget Act of 2015) may file an amended return for tax years beginning in 2018, 2019, and 2020 and furnish the corresponding Schedules K-1 on or before October 15, 2021. This would allow BBA partnerships to make the change without filing an administrative adjustment request (AAR).
These rules apply primarily to partnerships that made certain elections to accelerate interest deductions under IRC 163(j), as adjusted by the CARES Act. IRC 163(j) is a business interest deduction limitation that certain entities were able to “opt out” of under Revenue Procedure 2019-08. Entities which elected to opt out were required to make certain changes to their methods of depreciation.
Correcting Impermissible Methods of Accounting
Rev. Proc. 2021-28 specifies that the use of 40 years instead of 30 years as the ADS recovery period is an impermissible method of accounting. Impermissible accounting methods used on only one return can be easily corrected with an amended return. Generally, if an impermissible method of accounting is used on more than one tax return it may only be corrected with an accounting method change.
Rev. Proc. 2021-28 allows taxpayers to use the automatic accounting method change procedures to correct this impermissible method even if it has been used on only a single tax return. In addition, it allows amended returns to be filed for tax years prior to the immediately preceding tax year so long as the amended return is filed by April 15, 2022.
The revenue procedure also provides rules specific to residential rental property held by an electing real property trade or business and accounted for in a general asset account.