When a taxpayer switches from MACRS to ADS due to the RPTOB election under IRC Section 163(j)(7)(B), is this change exempt from being treated as a method change requiring Form 3115 or a Section 481(a) adjustment?
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When a taxpayer makes an election to be treated as an "electing real property trade or business" (RPTOB) under IRC §163(j)(7)(B), it is required to use the alternative depreciation system (ADS) for certain property, including nonresidential real property, residential rental property, and qualified improvement property, as specified in IRC §168(g)(8) and related guidance. The question is whether the switch from MACRS (Modified Accelerated Cost Recovery System) to ADS for these assets, as a result of the RPTOB election, is considered a change in method of accounting that requires filing Form 3115 and a Section 481(a) adjustment.
Key Legal Details and Analysis:
1. Change in Use vs. Change in Method of Accounting
- Reg. §1.168(i)-4(d): When a taxpayer makes the RPTOB election, the requirement to switch from MACRS to ADS for existing property is treated as a "change in use" of the property. The regulations provide that, in the year of change, the taxpayer must redetermine depreciation for the property prospectively, using the ADS method and recovery period, starting with the year of the election.
- Reg. §1.168(i)-4(f): Specifically states that a change in computing depreciation for the year of change due to a change in use (such as the RPTOB election) is not a change in method of accounting under IRC §446(e). Therefore, the taxpayer is not required to file Form 3115 for this change, nor is a Section 481(a) adjustment required for the switch to ADS for existing property.
2. IRS Guidance and Revenue Procedures
- Rev. Proc. 2019-08 and subsequent guidance confirm that when a taxpayer makes the RPTOB election, the switch to ADS for existing property is not a change in method of accounting. The taxpayer simply begins depreciating the property under ADS in the year of the election, and no Form 3115 or Section 481(a) adjustment is required for this initial switch.
- Rev. Proc. 2021-28 and related guidance clarify that if a taxpayer fails to properly switch to ADS in the year of the RPTOB election and continues to use MACRS, the taxpayer has adopted an impermissible method of accounting. In that case, a change to the correct method (ADS) does require a Form 3115 and a Section 481(a) adjustment, but only to correct the prior error.
3. Summary Table from Rev. Proc. 2025-23
- The list of automatic changes in Rev. Proc. 2025-23 includes changes in method of accounting for depreciation, but specifically excludes changes due to a change in use under Reg. §1.168(i)-4(d) from being treated as a method change requiring Form 3115, unless the taxpayer failed to make the required change in the year of the election.
4. Section 446(e) and Method Change Requirements
- IRC §446(e): Requires the consent of the Secretary (i.e., filing Form 3115) to change a method of accounting, but this does not apply to changes in depreciation due to a change in use as described above.
5. Conclusion
When a taxpayer switches from MACRS to ADS for existing property as a result of making the RPTOB election under IRC §163(j)(7)(B), this change is treated as a change in use, not a change in method of accounting. Therefore, the taxpayer is not required to file Form 3115 or make a Section 481(a) adjustment for this switch. The taxpayer simply begins depreciating the property under ADS in the year of the election. However, if the taxpayer fails to make the required switch in the year of the election and continues to use MACRS, correcting this error in a later year would require a Form 3115 and a Section 481(a) adjustment.
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