Is a change from MACRS to ADS resulting from the RPTOB election under Section 163(j)(7)(B) treated differently from other method changes for depreciation purposes?
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Yes, a change from MACRS (Modified Accelerated Cost Recovery System) to ADS (Alternative Depreciation System) as a result of making the real property trade or business (RPTOB) election under Section 163(j)(7)(B) is treated differently from other method changes for depreciation purposes. The distinction lies in how the change is classified for tax accounting purposes and the procedural requirements for implementing the change.
1. Background: The RPTOB Election and ADS Requirement
- Under Section 163(j), taxpayers generally face a limitation on the deductibility of business interest expense. However, a taxpayer engaged in a real property trade or business (as defined in Section 469(c)(7)(C)) may make an irrevocable election under Section 163(j)(7)(B) to be an "electing real property trade or business" (RPTOB). This election exempts the taxpayer from the Section 163(j) interest limitation, but requires the taxpayer to depreciate certain property (nonresidential real property, residential rental property, and qualified improvement property) using the ADS under Section 168(g) rather than MACRS.
2. Treatment of the Change from MACRS to ADS for Existing Property
- When a taxpayer makes the RPTOB election, for property already placed in service (i.e., "existing property"), the switch from MACRS to ADS is treated as a "change in use" under Section 168(i)(5) and Treas. Reg. § 1.168(i)-4(d).
- Key Point: This change in use is not considered a change in method of accounting under Section 446(e). Therefore, the taxpayer is not required to file Form 3115 (Application for Change in Accounting Method), nor is a Section 481(a) adjustment required.
- Treas. Reg. § 1.168(i)-4(f): "A change in computing the depreciation allowance in the year of change for property subject to this section is not a change in method of accounting under section 446(e)."
- Rev. Proc. 2019-8 and subsequent guidance confirm that the change to ADS for existing property due to the RPTOB election is not a method change requiring IRS consent or a Section 481(a) adjustment.
- How Depreciation Is Redetermined: For the year of change and subsequent years, the taxpayer must redetermine depreciation as if the property had originally been placed in service using the ADS (i.e., straight-line method, longer recovery period, and appropriate convention). The remaining basis is depreciated over the remaining ADS life.
3. Treatment for Newly Acquired Property
- For property placed in service after the RPTOB election, the taxpayer must use ADS from the outset. This is not a change in use, but simply the required method for such property. If the taxpayer fails to use ADS for new property, this is considered an impermissible method of accounting, and a change to the correct method would require filing Form 3115 and a Section 481(a) adjustment.
4. Contrast with Other Depreciation Method Changes
- Other method changes (e.g., switching from one permissible method to another, or correcting an impermissible method) are generally considered changes in method of accounting under Section 446(e). These require:
- Filing Form 3115,
- Obtaining IRS consent (automatic or non-automatic procedures),
- Calculating and reporting a Section 481(a) adjustment to prevent duplication or omission of income or deductions.
5. Summary Table
6. Practical Implications
- The special treatment for the RPTOB election is intended to facilitate compliance and avoid the administrative burden of accounting method change procedures for what is essentially a statutorily mandated change in depreciation method and recovery period.
- Taxpayers must still maintain adequate records and ensure that the change in use is properly reflected in their depreciation schedules and tax returns.
7. Citations
- IRC § 168(g), (i)(5); Treas. Reg. § 1.168(i)-4(d), (f)
- Rev. Proc. 2019-8; Rev. Proc. 2021-28
- The Tax Adviser, "Cost recovery changes in the TCJA"
- The Tax Adviser, "New Sec. 163(j): Considerations for real estate and infrastructure..."
In summary: A change from MACRS to ADS resulting from the RPTOB election under Section 163(j)(7)(B) is treated as a "change in use," not a change in method of accounting. Therefore, it does not require Form 3115 or a Section 481(a) adjustment, which is different from most other depreciation method changes.
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