Taxpayer Opportunity to Accelerate Depreciation Expense Relating to RPTOB Election for Residential Rental Property

January 2021

The December 27, 2020 emergency coronavirus relief package introduced a taxpayer-favorable change related to the real property trade or business (RPTOB) election made by taxpayers that own residential rental property. As a refresher, taxpayers that make the RPTOB election are exempt from the Section 163(j) business interest expense deduction limitation, but must depreciate nonresidential real property, residential rental property and qualified improvement property over longer recovery periods under the alternative depreciation system (ADS).

Prior to the amendment made by the Consolidated Appropriations Act, 2021, taxpayers making the RPTOB election were required to use an ADS recovery period of 40 years with respect to residential rental property placed in service before January 1, 2018, and 30 years for residential rental property placed in service after December 31, 2017. The Act changed the recovery period for residential rental property placed in service before 2018 to 30 years, thereby making the ADS life consistent for all residential rental property for an electing RPTOB, regardless of the placed-in-service date. Note that this modification only affects taxpayers that made (or will make) the RPTOB election, and only with respect to residential rental property placed in service before 2018. Accordingly, taxpayers that elect or are required to use ADS for reasons other than making the RPTOB election will continue to amortize pre-2018 residential rental property using a 40-year recovery period.
 
As the amendment applies retroactively to taxable years beginning after December 31, 2017, taxpayers that made the RPTOB election on their 2018 or 2019 tax returns and depreciated residential rental property using the 40-year recovery period are now considered to be on an impermissible method of accounting. To correct this issue, Rev. Proc. 2019-8 indicates that an electing RPTOB that fails to depreciate its nonresidential real property, residential rental property and qualified improvement correctly under the ADS (including using an impermissible recovery period) must file an automatic Form 3115 (DCN #88) with a timely filed (including extensions) federal income tax return for the year of change and a copy of the Form 3115 must be filed with the IRS Ogden, UT office no later than the filing date of that return. Thus, it is not necessary to amend prior year tax returns. The additional depreciation allowed as a result of the modification will be reflected entirely on the tax return for the year of change as a favorable Section 481(a) adjustment. As it is possible that the IRS will issue new procedural guidance to address this specific fact pattern in the near future, taxpayers should check for any additional updates before they begin preparing method changes.
 
The Accounting Methods group within BDO USA’s National Tax Office has extensive experience assisting taxpayers of all industries and sizes with their accounting method issues and filing accounting method change requests with the IRS.
 
 
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