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ADS recovery period clarified for rental property

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Tax Hot Topics newsletter The IRS recently issued two revenue procedures (Rev. Proc. 2021-28 and Rev. Proc. 2021-29) to allow certain taxpayers with residential rental property to take advantage of the shorter alternative depreciation system (ADS) recovery period provided in recent legislation.

Rev. Proc 2021-28 provides taxpayers with flexible procedures to change their method of computing depreciation for certain residential rental property held by an electing real property trade or business (RPTB) to use a 30-year ADS recovery period. Rev. Proc. 2021-29 provides an alternative process for an eligible partnership to file an amended federal return, in lieu of an administrative adjustment request (AAR) under the Bipartisan Budget Act of 2015 (BBA), in order to apply the 30-year ADS recovery period. Both procedures have a limited timeframe for taxpayers to implement the favorable depreciation changes for residential rental property that was placed in service before Jan. 1, 2018.

The Tax Cuts and Jobs Act (TCJA) reduced the ADS recovery period of residential rental property placed in service after Dec. 31, 2017, from 40 years to 30 years. In addition, the TCJA limited the deductibility of interest expense under Section 163(j). However, certain eligible taxpayers are allowed to make a RPTB election that exempts them from the interest expense limitation but requires them to use ADS for qualified improvement property, residential rental property and nonresidential real property. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (TCDTRA) retroactively changed the effective date for the 30-year ADS recovery period so that it can be applied to residential rental that is placed in service before Jan. 1, 2018, held by an electing RPTB and not previously subject to ADS.

Rev. Proc. 2021-28 provides guidance to taxpayers with property affected by the changes made by TCDTRA to change from an impermissible ADS recovery period of 40 years to a more favorable ADS recovery period of 30 years. The procedures allow taxpayers to use one of three options to make this correction:

  • File an amended federal income tax return
  • File an AAR
  • File an accounting method change

If a taxpayer chooses to amend a federal tax return, that must happen no later than April 15, 2022. Taxpayers must amend the tax year in which they made the RPTB election even though, generally, an impermissible method is only established if it has been used consistently on two consecutive tax returns. These modifications should allow most taxpayers to be eligible under the automatic change procedures.

Rev. Proc. 2021-29 allows an “eligible BBA partnership” to file an amended return, in lieu of an AAR, to apply the 30-year ADS recovery period for 2018, 2019, and 2020 taxable years. The BBA enacted a centralized partnership regime that generally requires most partnerships to file an AAR (as opposed to an amended return) in order to correct an item or amount with respect to a partnership.

For purposes of Rev. Proc. 2021-29, an “eligible BBA partnership” is one that filed Form 1065 and furnished Schedules K-1 for the partnership taxable years beginning in 2018, 2019, or 2020 prior to the issuance of Rev. Proc. 2021-29; and either is (i) a BBA partnership that has residential rental property and that chooses to change either or both of their method of depreciation or general asset account treatment for such property by filing an amended Form 1065; or (ii) a BBA partnership that chooses to make a late Section 163(j)(7) election by filing an amended Form 1065. To amend for 2018, 2019, or 2020 taxable years, the partnership must file amended returns (and furnish Schedules K-1) on or before Oct. 15, 2021. The amended returns must take into account tax changes under Section 202 of the TCDTRA, but eligible BBA partnerships may make any changes on their amended returns. There are special rules under Rev. Proc. 2021-29 for partnerships under examination, partnerships that previously filed an AAR for these taxable years, and partnerships applying the proposed and final GILTI regulations.

This guidance provides an opportunity for taxpayers to take advantage of the shorter ADS life of certain residential rental properties placed in service before Jan. 1, 2018. However, taxpayers have a limited timeframe in which to implement these changes. Taxpayers should begin to evaluate and plan for their filing alternatives.

Contact:
Grace Kim
Principal
Washington National Tax Office
T +1 202 521 1590

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