Taxpayers making the real property trade or business (RPTOB) election (“electing RPTOBs”) are required to use the alternative depreciation system (ADS) for residential rental property. The change to ADS is treated as a change in use. Under the Tax Cuts and Jobs Act (TCJA), the ADS recovery period was changed from 40 years to 30 years for residential rental property placed in service after Dec. 31, 2017, but remained 40 years for property placed in service before Jan. 1, 2018. The Consolidated Appropriations Act passed in December 2020 (the Act) retroactively changed the ADS recovery period for residential rental property placed in service before Jan. 1, 2018, to 30 years.
Because of the change made by the Act, electing RPTOBs must use a 30-year ADS life for residential rental property regardless of whether it was placed in service before or after Jan. 1, 2018. Using a 40-year ADS life for such assets is impermissible.
On June 17, 2021, the IRS released Revenue Procedure 2021-28, which provides procedural guidance for an electing RPTOB to change its method of depreciation for residential rental property placed in service prior to Jan. 1, 2018, to a 30-year ADS life.
Concurrently, the IRS also released Revenue Procedure 2021-29, which provides certain partnerships subject to the Bipartisan Budget Act of 2015 (BBA), or “BBA partnerships,” with the ability to file amended tax returns to change the ADS recovery period of residential rental property placed in service before Jan. 1, 2018, to 30 years, as opposed to filing an administrative adjustment request (AAR).
Revenue Procedure 2021-28
Revenue Procedure 2021-28 generally allows an electing RPTOB to change its method of depreciation for residential rental property that was placed in service prior to Jan. 1, 2018, and that is not currently using a 30-year recovery period under the ADS, by filing either:
1. An automatic Form 3115, “Application for Change in Accounting Method,” using Designated Change Number (DCN) 88 and including a Section 481(a) adjustment; or
2. Amended tax returns (or AARs) for the election year(s) on or before April 15, 2022. (See below for timelines for BBA partnerships.)
Both options are available to taxpayers regardless of whether the taxpayer filed two tax returns, or only a single tax return, using an impermissible ADS recovery period. A Form 3115 filed under Rev. Proc. 2021-28 has reduced filing requirements for small business taxpayers.
See the full Revenue Procedure 2021-28 here.
Revenue Procedure 2021-28 recognizes that some electing RPTOB taxpayers may have already filed Forms 3115 to change their method of accounting for residential rental property under Section 6.01 of Revenue Procedure 2019-43 (i.e., using DCN 7). Rev. Proc. 2021-28 states that changes filed before June 17, 2021, using DCN 7 (and that include a section 481(a) adjustment) will be respected. Electing RPTOB taxpayers that have prepared Form 3115 to change their method of accounting for residential rental property using DCN 7 but have not yet filed that Form 3115 should update the change to use DCN 88 in accordance with the new revenue procedure.
Additionally, some electing RPTOB taxpayers may have already filed their 2020 tax returns and continued using a 40-year recovery for residential rental property due to the lack of guidance previously released. Such taxpayers can either: (1) file an automatic Form 3115 with a Section 481(a) adjustment as outlined above with a 2021 tax return; or (2) amend the 2020 return and file it on or before April 15, 2022.
Please note that if a taxpayer chooses to implement this change by filing a Form 3115, a Section 481(a) adjustment must be included.
Also, Revenue Procedure 2021-28 does not provide taxpayers with the ability to treat this change as a second change in use and therefore change the recovery period and depreciation for residential rental property prospectively.
Please note: Filing a Form 3115 or amended tax return(s) as outlined above are now the only permissible options for taxpayers to use.
Other areas discussed
Revenue Procedure 2021-28 also provides guidance for an electing RPTOB to change its general asset account treatment for certain residential rental property to comply with the requirements under Treas. Reg. Section 1.168(i)-1(h)(2). Additionally, the revenue procedure also describes the applicability to transferee-taxpayers in transactions described in Internal Revenue Code (IRC) Section 168(i)(7)(B).
Revenue Procedure 2021-29
Revenue Procedure 2021-29 gives a BBA partnership that is an electing RPTOB the option to file an amended partnership return to change its method of accounting for residential rental property placed in service prior to Jan. 1, 2018, rather than by filing an AAR. This option is available to BBA partnerships for tax years beginning in 2018, 2019, and 2020.
Per the revenue procedure, an eligible BBA partnership that has already filed its tax returns and provided Schedules K-1 to its partners for the 2018, 2019, or 2020 tax years, and did so prior to the release of Revenue Procedure 2021-29, may file amended partnership returns and provide the resulting Schedules K-1 to its partners on or before Oct. 15, 2021. Please note that the amended returns must include the aforementioned change for residential rental property, but may include other changes as well.
What does CohnReznick think?Taxpayers should consult their tax advisors to review their facts and determine their best course of action. For many electing RPTOB taxpayers, filing Form 3115 to change to a 30-year recovery period with respect to residential rental property placed in service prior to Jan. 1, 2018, may be the best option to adopt a permissible method of accounting for such property. However, situations may exist where filing an amended tax return may be a better option, such as if a taxpayer is already amending a tax return for other items. Contact your advisors to discuss your options or for assistance with the preparation of any necessary filings.
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