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Automatic method changes beneficial for leasing

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Automatic method changes beneficial for leasing The IRS released the new comprehensive list of automatic method changes (Rev. Proc. 2019-43) on Nov. 8 providing favorable modifications to two existing automatic method changes that impact common leasing arrangements. The guidance also makes the audit protection procedures more generous for certain changes under Section 263A, adds new automatic method changes for certain revenue recognition changes, incorporates all of the new automatic changes in method issued since Rev. Proc. 2018-31 was released and makes various housekeeping changes.

The new procedures are effective for a Form 3115 filed on or after Nov. 8, 2019, for a year of change ending on or after March 31, 2019. Taxpayers planning to file automatic method changes after Nov. 9, 2019, should review Rev. Proc. 2019-43 to determine if their method change is affected.

Background Rev. Proc. 2019-43 supersedes Rev. Proc. 2018-31 as the new comprehensive list of accounting method changes that are eligible for automatic consent. This list is separate from Rev. Proc. 2015-13, which contains the actual procedures for requesting consent for both automatic and non-automatic accounting method changes. The list of automatic method changes is kept separately so the IRS can update it easily, which they have been doing annually since 2015.

Leasing impact One the more significant modifications provided by Rev. Proc. 2019-43 is a Section 481(a) adjustment and audit protection to two existing automatic changes related to common leasing issues:

  • Section 6.03, which relates to changes in characterization of sale, lease, or financing transactions, applies to a taxpayer (lessee or lessor) that wants to change its method of accounting from improperly treating property as sold (or purchased) by the taxpayer to properly treating property as leased or financed by the taxpayer, or vice versa
  • Section 6.08, which applies to a taxpayer (lessee or lessor) that wants to change its method of accounting for tenant construction allowances (other than allowances that qualify under Section 110) from improperly treating the taxpayer as having a depreciable interest in the property subject to the tenant construction allowances for federal income tax purposes to properly treating the taxpayer as not having a depreciable interest in such property for federal income tax purposes, or vice versa. The change only applies to amounts that are spent on depreciable property, so tenant allowances spent on moving expenses are not eligible.

Under the prior procedures, these method changes were made on a cut-off basis without audit protection, which meant the proposed method only applied to new agreements entered into on or after the year of change. If a taxpayer wanted to change its method of accounting for either characterization or for tenant construction allowances under existing agreements, the taxpayer had to use the non-automatic change procedures of Rev. Proc. 2015-13. By filing a non-automatic change, the taxpayer was provided a Section 481(a) adjustment and audit protection, but generally only to the extent that the taxpayer provided a representation, signed under a “penalties of perjury” statement, from the counterparty to the agreement that the counterparty’s treatment was consistent with the taxpayer’s proposed method. For example, if a taxpayer changed its accounting method for tenant construction allowances so as to stop treating itself as having a depreciable interest in the property, then the counterparty had to provide a signed “penalties of perjury” statement that the counterparty treated itself as having a depreciable interest in the property.

The new procedures provide that a change in method of accounting for a transaction entered into before the beginning of the year of change is eligible to be made under the automatic change procedures of Rev. Proc. 2015-13 with a Section 481(a) adjustment. Importantly, the procedures now simply require a statement with the name of the counterparty instead of the representation, signed under penalties of perjury, from the counterparty. Finally, the new procedures provide that the audit protection rules in Section 8 of Rev. Proc. 2015-13 apply, but ruling protection is not provided on the characterization of any transaction as a lease, sale, or financing transaction or on the ownership of property constructed with a tenant construction allowance. That is, while the IRS cannot change the characterization in prior years if it was impermissible, the IRS can challenge whether the proposed method is the right permissible method under the taxpayer’s facts.

GT Insight: Many taxpayers were reluctant to file under the prior procedures, because the automatic procedures only applied to new agreements, and there was no audit protection for the treatment of the existing agreements. This meant that they did not actually allow taxpayers to change their methods for existing agreements. Additionally, filing under the non-automatic procedures was burdensome for taxpayers with many leases, as the taxpayers had to obtain a signed, “penalties of perjury” statement from the counterparty to every lease for which the taxpayers wanted to change. The ability to change automatically with a Section 481(a) adjustment, audit protection and no requirement to obtain the signed statement from the counterparty is a welcome update and will encourage compliance.
Other changes Rev. Proc. 2019-43 makes the audit protection procedures more generous to taxpayers that file changes to conform to the final regulations under Section 263A, related to the capitalization of costs to property produced or acquired for resale, by temporarily suspending the default rule that taxpayers under exam do not receive audit protection. Although taxpayers under exam receive audit protection in these situations, the provision that shortens positive Section 481(a) adjustments to a two-year spread period for taxpayers under exam (see Section 7.03(3)(b) of Rev. Proc. 2015-13) remains applicable, unless one of the exceptions, such as filing in the three-month window, applies.

GT Insight: Taxpayers subject to Section 263A must conform to the new final regulations, generally for taxable years beginning on or after Nov. 20, 2018. For taxpayers currently under exam, this is welcome relief, as such taxpayers may change to the final regulations and receive audit protection, as long as Section 263A is not an issue under consideration. This is the same language the IRS recently used for method changes to conform to the proposed regulations under Section 451(b) and (c). For more details, see our Tax Insights.
Rev. Proc. 2019-43 also modified Section 16.12 of Rev. Proc. 2018-31 relating to changes in the timing of income recognition under Sections 451(b) and (c), to permit taxpayers without an applicable financial statement to:

  • Make a deemed change in method of accounting without a Form 3115 to comply with Prop. Treas. Reg. §1.451-8(d) when the Section 481(a) adjustment required by the change is zero
  • Make a change to defer advance payments based on earned income under Prop. Treas. Reg. §1.451-8(d)(4)(ii) determined using a straight-line ratable basis over the term of the agreement

The procedures also modified Section 26.04, relating to changes in basis of computing reserves under Section 807(f) for insurance companies.

The remaining changes made by Rev. Proc. 2019-43 are mostly housekeeping. For example, the new procedures incorporate the new automatic changes in method issued since Rev. Proc. 2018-31 was released, including:

  • Rev. Proc. 2019-37, which added new automatic procedures and modified existing automatic procedures for proposed regulations under Section 451(b) and (c)
  • Rev. Proc. 2019-10, which added new automatic procedures for an insurance company to obtain automatic consent to change its accounting method to comply with changes that the Tax Cuts and Jobs Act of 2017 (TCJA) made to Sections 807 and 848, as modified by Rev. Proc. 2019-34
  • Rev. Proc. 2018-60, which added new automatic procedures to change accounting methods to comply with certain rules under Section 451(b)
  • Rev. Proc. 2018-56, which added new automatic procedures to make certain method changes to conform to the final regulations under Section 263A
  • Rev. Proc. 2018-44, which added add temporary rules for corporations changing from a cash to an accrual method of accounting in connection with revoking S corporation status
  • Rev. Proc. 2018-40, which added procedures for making method changes to implement the new $25 million gross receipts threshold added to Sections 263A, 448, 460, and 471 by the TCJA.

The revenue procedure makes modifications to remove obsolete language from several automatic changes, such as temporary waivers of the eligibility rule in Section 5.01(1)(f) of Rev. Proc. 2015-13, which generally states that taxpayers are not allowed to file a method change for the same item if they changed that item in the past five taxable years. The waivers were temporary and had already expired.

Effective date The new comprehensive list of automatic method changes is effective for a Form 3115 filed on or after Nov. 8, 2019, for a year of change ending on or after March 31, 2019. Transition rules similar to those provided in Rev. Proc. 2018-31 are available, allowing taxpayers that filed non-automatic method change before Nov. 8 to convert it to an automatic change if the taxpayer is otherwise eligible.

Next steps Taxpayers will want to take advantage of the Section 481(a) adjustment and audit protection for revised leasing automatics. Additionally, many taxpayers must file changes in method of accounting related to revenue recognition stemming from changes made by the TCJA and the implementation of ASC 606. Moreover, taxpayers with inventories generally must conform to the final regulations under Section 263A. Having all the modifications to the procedures in one comprehensive listing will make it easier for taxpayers to trace whether their proposed changes in method of accounting are eligible under the automatic procedures. Taxpayers planning to file automatic method changes after Nov. 9, 2019, should review Rev. Proc. 2019-43 to determine if their method change is affected.

For more information contact:
Sharon Kay
Partner
Washington National Tax Office 
Grant Thornton LLP
T +1 202 861 4140

Caleb Cordonnier
Senior Manager
Washington National Tax Office 
Grant Thornton LLP
T +1 202 521 1555

John Suttora
Managing Director
Washington National Tax Office 
Grant Thornton LLP
T +1 202 521 1523

Jon Terrill
Senior Manager
Washington National Tax Office 
Grant Thornton LLP
T +1 213 596 6754

Jason Seo
Senior Associate
Strategic Federal Tax Services
Grant Thornton LLP
T +1 202 521 1556

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