IRS issues guidance on how to change to 30-year depreciation period for residential rental property

On June 17, 2021, the IRS released Rev. Proc. 2021-28 and Rev. Proc. 2021-29, providing guidance for taxpayers required to use the 30-year depreciation recovery period under the alternative depreciation system (“ADS”) for certain property placed in service prior to January 1, 2018. Taxpayers who elected to be treated as an electing real property trade or business for Section 163(j) purposes are required to depreciate all nonresidential real property, residential rental property, and qualified improvement property under the ADS. Prior to the Tax Cuts and Jobs Act (“TCJA”), all residential rental property was depreciated over 40 years. The TCJA changed the ADS recovery period to 30 years for residential rental property but only for property placed in service after December 31, 2017, so residential rental property placed in service prior to January 1, 2018 was still required to be depreciated over 40 years.

The Consolidated Appropriations Act, 2021, has corrected this discrepancy for when the residential rental property was placed in service and now states that, generally, residential rental property required to be depreciated using the ADS for an electing real property trade or business is to be depreciated over a 30-year recovery period.

Beginning with the election year, an electing real property trade or business must depreciate residential rental property under ADS using a 30-year recovery period. For such property, a change in use has occurred, and if that electing real property trade or business does not depreciate residential rental property under ADS using a 30-year recovery period for the election year, then an impermissible method of accounting for depreciation for that residential rental property has been adopted.

As a result, a taxpayer must change from the impermissible method of determining depreciation to the permissible method of determining depreciation for residential rental property.

Rev. Proc. 2021-28 permits taxpayers to change to the permissible method of accounting through either of any of the following three methods: 1) file an amended federal income tax or information return, 2) file an administrative adjustment request (“AAR”), or 3) file a Form 3115, Application for Change in Accounting Method.  In addition, if the property was held in a general asset account, guidance was released on how to change the general asset account treatment for such property.

Mazars’ Insight

Filing a Form 3115 is likely the simplest method from a tax compliance perspective, although each individual taxpayer should evaluate their own situation to determine best course of action.  Taxpayers who have not filed their 2020 federal income tax return should file a Form 3115 to effectuate the change for the 2020 tax year; if the 2020 tax return has already been filed, taxpayers can get started on 2021 tax planning and file the Form 3115 for the 2021 tax year now.

Rev. Proc. 2021-29, released in tandem with Rev. Proc. 2021-28, permits eligible partnerships the option to file an amended partnership return – as an alternative to filing an AAR – for taxable years beginning in 2018, 2019, and 2020 with the “Amended Return” box checked and to issue an amended Schedule K-1 to each partner. The option to file amended returns only applies to the Bipartisan Budget Act (“BBA”) partnerships – partnerships subject to the centralized partnership audit regime – who must affix to the top of the amended return, “FILED PURSUANT TO REV PROC 2021-29,” and attach a statement with each Schedule K-1 furnished to its partners with the same notation. The BBA partnership may file the amended return electronically or by mail.

Mazars’ Insight

Partnerships may still file a Form 3115 rather than amend the Form 1065, which may ease the compliance burden of the passthrough entity and ensuing Schedule K-1s that will need to flow to all partners.  However, if partners have been added to or left the partnership since becoming an electing real property trade or business, consult the partnership agreement to determine if there is a required course of action that must be followed for items affecting income taxes.

Please contact your Mazars professional for additional information.

Published on June 28, 2021

Authored by Ryan Vaughan and Andrew Kosoy