Technical Correction for Depreciating Real Estate
As of March 12, 2021, the Internal Revenue Service (“IRS”) has issued no formal guidance on how taxpayers can reduce the ADS cost recovery period for residential rental property from 40 years to 30 years. In the past, however, the IRS has directed taxpayers to use Form 3115, Application for Change in Accounting Method, when making similar depreciation changes. Comparable guidance is expected from the IRS on the ADS residential real property change. For now, taxpayers may use Form 3115 to realize this potentially significant depreciation adjustment.
Among the many provisions of the Consolidated Appropriations Act, 2021 is one that corrects a drafting error in an earlier law.
A “real property trade or business” may elect out of the limitation on the deductibility of business interest expensed as imposed by section 163(j) of the Internal Revenue Code, which was enacted as part of the Tax Cuts and Jobs Act of 2017 (“TCJA”). If a real property trade or business makes this election, it is required to use the longer cost recovery periods under the alternative depreciation system (“ADS”).
When TCJA was enacted, the ADS cost recovery period for residential rental property was reduced from 40 years to 30 years. However, due to a drafting error, this reduction in the cost recovery period for residential rental properties applied only to buildings placed into service or acquired in 2018 or later. Consequently, a real property trade or business with a residential rental property at the end of 2017 that elected out of the limitation on the deductibility of business interest would be required to use the 40-year cost recovery period.
The Act retroactively corrects the error so that the 30-year cost recovery period is available for all residential rental property regardless of when it was placed into service.