The 2017 Tax Cuts and Jobs Act (TCJA) provided that residential real estate companies could make an election to not be subject to the interest expense limitation under Section 163(j) of the Internal Revenue Code. The only caveat was that instead of depreciating rental real estate properties under the modified accelerated cost recovery system (MACRS), they would need to depreciate all rental real estate property under the alternative depreciation system (ADS). The MACRS depreciable life for residential rental real estate is 27.5 years, but prior to the TCJA, the ADS depreciable life for residential rental real estate was 40 years. The TCJA changed this 40-year ADS life to 30 years for property placed in service after December 31, 2017. However, property placed in service before December 31, 2017, would still be required to use the 40-year ADS life.
This change seemed clear, but the Consolidated Appropriations Act, 2021 (CCA 2021), enacted on December 27, 2020, made another change to these rules. The CCA 2021 retroactively expanded the 30-year ADS recovery period for those residential rental real estate trades or businesses that elected out of the interest expense limitation under Section 163(j) for property placed in service prior to January 1, 2018. Thus, this 30-year ADS life is now available for all residential rental real estate property placed into service.
In June 2021, the IRS released Revenue Procedure 2021-28, which provides taxpayer guidance on how to switch from 40-year ADS to 30-year ADS based on the CCA 2021 change explained above. This revenue procedure provides two ways in which a rental real estate trade or business who elected out of the business interest limitation under section 163(j) can change to using the 30-year ADS for assets placed in service before January 1, 2018.
A taxpayer can do either of the following:
1. File Form 3115, Application for Accounting Method Change using Designated Change Number (DCN) 88 and calculate a Section 481(a) adjustment. This means any additional deduction for changing to this ADS life will be taken into account in the year the Form 3115 is filed. Depending on the magnitude of the Section 481(a), this could be a very favorable adjustment for the taxpayer’s tax return.
2. The IRS also provided that instead of filing a Form 3115, a taxpayer can file Amended tax returns (or AAR) if the taxpayer filed up to two tax returns using 40-year ADS.
The above two methods to change to the 30-year ADS method are the only two available options a taxpayer can choose. It is important for taxpayers to discuss this potential favorable change with their tax advisors to determine which method will provide the greatest benefit.
Please reach out to the author Dana Lee or your SDK advisor if you have questions or would like more information about this topic.