July 13, 2021
IRS clarifies rules on changing depreciation for certain residential rental property, allows amended returns for partnerships making change
In Revenue Procedure 2021-28, the IRS clarified how to shorten the depreciation recovery period — from 40 years to 30 years — for certain residential rental property placed in service before 2018. Specifically, the Revenue Procedure explains how a taxpayer may change its method of computing depreciation to retroactively provide a 30-year recovery period under the IRC Section 168(g) alternative depreciation system (ADS) for residential rental property placed in service before 2018 and held by an electing real property trade or business (RPTOB).
Issued at the same time, Revenue Procedure 2021-29 allows partnerships making this change to file an amended Form 1065, U.S. Return of Partnership Income, instead of an administrative adjustment request (AAR).
Change to 30-year ADS
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 electing RPTOB could elect out of this new limitation, but then had to use the ADS on residential rental and nonresidential real property and qualified improvement property. The election had to be made on a timely filed original return and was irrevocable.
The Tax Cuts and Jobs Act (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.
The Taxpayer Certainty and Disaster Relief Act of 2020, Section 202, amended the TCJA to allow residential rental properties placed into service before 2018 and held by an electing RPTOB to use the 30-year ADS recovery period (see Tax Alert 2020-2932).
Revenue Procedure 2021-28
Revenue Procedure 2021-28 details which property qualifies for the depreciation modifications discussed previously and how taxpayers can change their method of computing that depreciation.
Revenue Procedure 2021-28 states that the guidance applies to residential rental property that:
Changing the method of computing depreciation
Taxpayers can change their method of computing depreciation of eligible residential rental property held by an electing RPTOB to use the 30-year ADS recovery period by filing: (1) an amended federal income tax return or information return, (2) an administrative adjustment request (AAR) under IRC Section 6227 or (3) a Form 3115, Application for Change in Accounting Method.
Under Revenue Procedure 2021-28, changing from the old method of depreciation to the new 30-year ADS is considered a change from an impermissible method to a permissible method of determining depreciation.
Electing RPTOBs that have not adopted a method of accounting for a residential rental property (because they have held the property for only one year and filed one return) can adopt the 30-year ADS by filing a Form 3115 if the IRC Section 481(a) adjustment includes the adjustment attributable to all property, including the one-year residential rental property. Alternatively, the electing RPTOB could file (1) an amended federal income tax return or information return or (2) an AAR for the election year if they are filed before the electing RPTOB files its federal income tax return or information return for the tax year succeeding the election year.
If the residential rental property is included in a general asset account, the electing RPTOB must change to the general asset account treatment in Treas. Reg. Section 1.168(i)- 1(h)(2) for the election year. Changing the method of depreciation is considered a change from an impermissible method of accounting to a permissible one. For residential rental property that has been included in a general asset account for less than one year, the same rules apply for electing RPTOBs.
The Bipartisan Budget Act of 2015 (BBA) significantly altered the audit and income tax liability rules governing most partners and partnerships for tax years beginning after December 31, 2017. Among other changes enacted by the BBA, IRC Section 6031(b) generally prohibits BBA partnerships from amending the information required to be furnished to its partners after the due date of the partnership's return. Instead, partnerships subject to the BBA rules must follow new procedures when making corrections to a Form 1065. Specifically, once the return due date (including extensions) for the partnership's tax return has passed, a BBA partnership generally must file an AAR and additional forms required by the IRS instead of filing an amended return with amended Schedules K-1, Partner's Share of Income, Deductions, Credits.
Revenue Procedure 2021-29 allows eligible partnerships, for the purpose of applying Revenue Procedure 2021-28, to use an amended return to make the change instead of an AAR. Amended returns filed under Revenue Procedure 2021-29 may also include any other changes the partnership is entitled to make and may be filed either by mail or electronically. The partnership must "write 'FILED PURSUANT TO REV PROC 2021-29' at the top of the amended return and attach a statement with each Schedule K-1 furnished to its partners with the same notation."
Eligible partnerships are those that filed a Form 1065 and all required Schedules K-1 for tax years beginning in 2018, 2019 or 2020 before Revenue Procedure 2021-29 was issued (June 17, 2021). Additionally, the partnership must have either:
These partnerships have until October 15, 2021, to file an amended partnership return.
Partnerships that are currently under examination for a tax year beginning in 2018, 2019 or 2020 can file an amended return if the partnership sends a notice in writing of its intent to do so, along with a copy of the amended return, to the revenue agent coordinating the partnership's examination. Partnerships that have previously filed an AAR for the same tax year should use the items as adjusted in the AAR as the basis for their amended return.
Revenue Procedure 2021-28 represents welcome guidance. Nuances within the method change procedural rules, as well as certain provisions in Revenue Procedure 2019-43, had left taxpayers and practitioners unsure of how to correct the recovery period for residential rental property held by an electing RPTOB and placed in service before 2018. Revenue Procedure 2021-28 eliminates this confusion by allowing taxpayers to file a method change under Section 6.05 of Revenue Procedure 2019-43, even if the impermissible method of depreciating such property (i.e., by using a 40-year instead of a 30-year recovery period) was created in the year preceding the year of the method change.
Revenue Procedure 2021-29 likewise represents welcome guidance for taxpayers operating in partnership form, although its scope is substantially limited to certain electing RPTOBs. Such partnerships should consider their options for making the corrections to residential rental property as detailed in Revenue Procedure 2021-28, as well as all other modifications needed to accurately report taxable income.