Under the Consolidated Appropriations Act, 2021, a real property trade or business that elects out of the deduction limitations for business interest under Code Sec. 163(j) and is required to depreciate all of its residential rental property using ADS beginning with the tax year of election may use a 30-year ADS recovery period to depreciate residential rental property placed in service before 2018. Previously, a 30-year ADS period only applied to residential rental property placed in service after 2017 and a 40-year period applied to residential rental property placed in service before 2018.

Background

The Tax Cuts and Jobs Act (Tax Cuts Act) imposed limitations on the deduction of business interest by taxpayers with average annual gross receipts in excess of $25 million, effective for tax years beginning after 2017. A real property trade or business, however, is allowed to make an irrevocable election out of these limitations.

If the election out is made, any nonresidential real property, residential rental property, and qualified improvement property held by the electing real property trade or business must be depreciated using ADS beginning in the year of the election. The Tax Cuts Act reduced the ADS recovery period for a residential rental property to 30 years, effective for property placed in service after December 31, 2017. The 40-ADS recovery period for residential rental property placed in service before January 1, 2018, remains unchanged.

However, the Consolidated Appropriations Act, 2021 allows a real property trade or business that elects out of the business interest limitations to use a 30-year ADS recovery period for residential rental property placed in service before 2018.

The amended effective date applies to residential rental property:

  1. placed in service before January 1, 2018;
  1. held by a real property trade or business that elects out of the business interest limitations in a tax year beginning after 2017; and
  1. which was not depreciated under ADS before January 1, 2018.

We expect the IRS will issue guidance for real property trades or businesses which previously elected out of the business interest limitations and filed returns applying the rules to switch to a 40-year ADS recovery period for residential rental property placed in service before 2018. Under the new law, the 30-year recovery period retroactively applies to this residential rental property as of the year of the prior election.

Possible solutions to account for the difference between the ADS depreciation claimed using the 40-year period and the ADS depreciation retroactively allowed using the 30-year period are to reapply the change to the 2020 return, file an amended return if only one return was filed using the 40-year ADS period (e.g., election out was made in 2019 tax year and 2020 return is not filed), or file an accounting method change on Form 3115 for 2020 if two returns have been filed (e.g., election out was made in 2018, and 2018 and 2019 returns have been filed).

Please call our office to discuss the accelerated recovery period for residential rental property. We can assist you in making the change to your tax returns.