How does the RPTOB election under IRC Section 163(j)(7)(B) affect the requirement to file Form 3115 when changing from MACRS to ADS?
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The election to be treated as an "electing real property trade or business" (RPTOB) under IRC Section 163(j)(7)(B) has a significant impact on the requirement to file Form 3115 (Application for Change in Accounting Method) when a taxpayer changes from the Modified Accelerated Cost Recovery System (MACRS) to the Alternative Depreciation System (ADS) for certain real property.
Below is a comprehensive analysis of the legal requirements and procedures, including the relevant exceptions, based on the sources provided:
1. Background: The RPTOB Election and Depreciation Requirements
- Section 163(j) Limitation: The Tax Cuts and Jobs Act (TCJA) generally limits the deductibility of business interest expense to 30% of adjusted taxable income (ATI), with certain exceptions and elections available.
- RPTOB Election: Under IRC §163(j)(7)(B), a taxpayer engaged in a real property trade or business (as defined in §469(c)(7)(C)) may make an irrevocable election to be an "electing real property trade or business." This election exempts the taxpayer from the §163(j) interest limitation, but requires the taxpayer to depreciate certain property using the ADS rather than MACRS.
Property Required to Use ADS Upon Election
- Nonresidential real property (§168(e)(2)(B))
- Residential rental property (§168(e)(2)(A))
- Qualified improvement property (§168(e)(6))
2. Change in Use and the Requirement to File Form 3115
A. Change in Use Triggered by the Election
- When a taxpayer makes the RPTOB election, a "change in use" occurs for affected property under Reg. §1.168(i)-4(d). This change requires the taxpayer to switch from MACRS to ADS for the property, effective in the year of the election.
B. Is a Form 3115 Required?
- No Form 3115 Required for the Initial Change in Use:
The regulations provide that a change in computing depreciation due to a change in use (such as the switch from MACRS to ADS upon making the RPTOB election) is not a change in method of accounting under §446(e). Therefore, the taxpayer is not required to file Form 3115 for the initial change in use. Instead, the taxpayer simply begins depreciating the property under ADS in the year of the election, recalculating depreciation as if ADS had always applied from the date of the change. - Reg. §1.168(i)-4(f): States that a change in computing depreciation in the year of a change in use is not a change in method of accounting, so no Form 3115 or §481(a) adjustment is required for the initial change.
C. When is Form 3115 Required?
- Form 3115 Required for Correction of Impermissible Method:
If the taxpayer fails to properly implement the required change to ADS (for example, continues to use MACRS after the election), the taxpayer is considered to have adopted an impermissible method of accounting for depreciation. In this case, the taxpayer must file Form 3115 to change from the impermissible method (MACRS) to the permissible method (ADS), and a §481(a) adjustment is required. - Rev. Proc. 2019-43, Section 6.05: Provides an automatic method change procedure for changing depreciation due to a change in use of MACRS property, including the switch to ADS required by the RPTOB election. The §481(a) adjustment is calculated as if the change in use had occurred in the year of the election.
- Rev. Proc. 2021-28: Clarifies that for residential rental property placed in service before Jan. 1, 2018, and subject to the RPTOB election, if the taxpayer did not properly switch to the 30-year ADS recovery period, a Form 3115 is required to correct the method, and the §481(a) adjustment is calculated as if the correct method had been used since the year of change.
3. Summary Table: When is Form 3115 Required?
4. Procedural Details and Special Considerations
- General Asset Accounts: If the property is included in a general asset account, special rules apply, and the change may be made on a modified cut-off basis, in which case a §481(a) adjustment is not required.
- Automatic Change Procedures: The IRS provides automatic consent procedures for these changes (see Rev. Proc. 2019-43, Sections 6.04 and 6.05).
- Time-Sensitive Amended Returns: For certain retroactive changes (e.g., the 30-year ADS period for pre-2018 residential rental property), taxpayers could file amended returns or AARs by a specific deadline, but the ability to file Form 3115 remains available.
5. Conclusion
In summary:
- The RPTOB election under IRC §163(j)(7)(B) requires a change from MACRS to ADS for certain real property.
- The initial change in use to ADS as a result of the election does not require filing Form 3115; it is not a change in method of accounting.
- If the taxpayer fails to properly implement the required change to ADS, or needs to correct an impermissible method (e.g., wrong recovery period), then Form 3115 is required, and a §481(a) adjustment must be made to correct the depreciation method.
In practice: If you are making the RPTOB election and properly switch to ADS in the year of election, you do not file Form 3115. If you need to correct a prior error (e.g., you did not switch to ADS, or used the wrong recovery period), you must file Form 3115 under the automatic change procedures, and calculate a §481(a) adjustment as if the correct method had been used since the year of change.
If you have a specific fact pattern (e.g., property in a general asset account, or a late election), additional procedural nuances may apply.
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