If a company revokes its real property trade or business election, can it revert to the General Depreciation System (GDS) for land improvements in subsequent years?
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Yes, if a company revokes its election to be treated as an electing real property trade or business under section 163(j)(7)(B), it can generally revert to using the General Depreciation System (GDS) for land improvements placed in service in subsequent years, provided certain conditions are met.
1. Legal Background
1.1. Electing Real Property Trade or Business and ADS Requirement
- Under section 163(j), a taxpayer may elect to be an "electing real property trade or business." This election exempts the taxpayer from the business interest deduction limitation, but requires the use of the Alternative Depreciation System (ADS) for certain property, including nonresidential real property, residential rental property, and qualified improvement property (see section 168(g)(1)(F)).
- Once the election is made, it is generally irrevocable for as long as the taxpayer is engaged in the electing trade or business.
1.2. Revocation of the Election
- IRS guidance (Rev. Proc. 2020-22) provides procedures for withdrawing a section 163(j)(7) election for certain years. If a taxpayer withdraws the election, the taxpayer is treated as if the election was never made for that year.
- Upon withdrawal, the taxpayer must adjust depreciation for the affected property in accordance with section 168, which means the taxpayer may use GDS for property placed in service after the revocation, unless otherwise required to use ADS.
1.3. Depreciation of Land Improvements
- Under MACRS, land improvements are generally 15-year property under GDS and 20-year property under ADS.
- If the taxpayer is not required to use ADS (e.g., not an electing real property trade or business, not subject to other ADS requirements), land improvements placed in service after the revocation can be depreciated under GDS.
1.4. Effect on Existing and New Property
- For property placed in service before the revocation, a change in use occurs, and the taxpayer may need to adjust depreciation accordingly. The taxpayer may elect to continue using ADS for such property or switch to GDS, subject to the rules in section 1.168(i)-4(d).
- For property placed in service after the revocation (i.e., in subsequent years), the taxpayer is not required to use ADS unless another rule applies. Therefore, GDS is available for new land improvements.
2. Summary of Steps
- Withdraw the Election: The company must properly withdraw its section 163(j)(7)(B) election following IRS procedures.
- Depreciation for Existing Property: For land improvements placed in service before the revocation, the company may elect to continue ADS or switch to GDS, following the change-in-use rules.
- Depreciation for New Property: For land improvements placed in service after the revocation, the company may use GDS, unless another provision requires ADS.
3. Caveats and Considerations
- The withdrawal of the election is subject to IRS procedural requirements and may have collateral effects, such as adjustments to taxable income and depreciation schedules for existing property.
- The company must ensure that it is not otherwise required to use ADS for the property in question (e.g., due to foreign use, tax-exempt use, etc.).
- The election to use GDS for new property is prospective; it does not retroactively change the method for property placed in service while the election was in effect.
4. Conclusion
A company that revokes its real property trade or business election can generally revert to using the General Depreciation System (GDS) for land improvements placed in service in subsequent years, provided it is not otherwise required to use ADS. The company must follow the proper procedures for revocation and apply the appropriate depreciation method to both existing and new property in accordance with the Internal Revenue Code and IRS guidance.
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