Update: The President signed the Consolidated Appropriations Act, 2021 on December 27, 2020.

The Consolidated Appropriations Act, 2021 (Act), passed by Congress on December 21, 2020, changes the provisions in the Tax Cuts and Jobs Act (TCJA) regarding certain electing real property trades or businesses (RPTOBs) by applying the 30-year alternative depreciation system (ADS) recovery period to all residential rental real estate, including property placed in service before 2018.

Background

The TCJA amended IRC Section 163(j) to reduce business interest expense deductions to the sum of (1) the taxpayer's business interest income, (2) 30% of the taxpayer's adjusted taxable income (ATI), and (3) the taxpayer's floor plan financing interest. An RPTOB could elect out of this new limitation, but then had to use the ADS on residential and nonresidential real property and qualified improvement property (QIP). The elections had to be made on a timely filed original return and were irrevocable.

The TCJA reduced the ADS recovery period from 40 years to 30 years for residential rental property. As clarified in Revenue Procedure 2019-08, the recovery period of residential rental property under IRC Section 168(g)(2)(C) is 30 years for residential rental property placed in service by the taxpayer after December 31, 2017, and 40 years for residential rental property placed in service by the taxpayer before January 1, 2018.

Previously, when there were changes made to depreciation schedules, particularly as they related to the IRC Section 163(j) election, the government provided relief in the form of allowing late elections and amended returns that otherwise would not be permitted. Following enactment of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the government issued guidance permitting taxpayers to make late elections under IRC Section 163(j) and to avail themselves of bonus depreciation on QIP either through amending returns or filing Form 3115, Application for Change in Accounting Method. In Revenue Procedure 2020-22, the IRS granted relief for real estate and farming businesses that wanted to withdraw or make late IRC Section 163(j) elections based on provisions of the CARES Act (see Tax Alerts 2020-0979 and 2020-9018). The IRS then issued Revenue Procedure 2020-25, providing important procedural rules related to QIP to allow taxpayers to file Form 3115 or, alternatively, amend tax returns to reflect the retroactive, technical amendment provisions of the CARES Act that provide 100% bonus depreciation for QIP (see Tax Alert 2020-1061).

Act expands TCJA change to properties placed in service before 2018

Section Title II, Section 202 amends the TCJA to allow all residential rental properties, including those placed into service prior to 2018, to use the 30-year ADS recovery period.

Implications

The changes made by the Act will provide welcome relief to taxpayers owning residential rental property placed in service prior to 2018, who otherwise were required to apply a 40-year ADS recovery period to these assets if the taxpayer elected to be excepted from the application of the IRC Section 163(j) business interest limitation rules.

Some taxpayers would have made this election if the ADS recovery period for the previously placed in service residential rental property was 30 years, rather than the 40 years that applied prior to this amendment. We may expect further relief from the government similar to that provided in the context of the QIP bonus eligibility changes made by the CARES Act, to permit taxpayers to make late elections as appropriate. If such relief is granted, taxpayers may have a significant opportunity to reevaluate their current and prior tax positions and implement various tax planning strategies.

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