Last minute tax benefit considerations for real estate investors

The IRS’ decision to move the deadline for individual taxpayers to file their federal income tax returns to May 17, 2021, gives individual real estate investors a little more time to make decisions on key income strategies relating to changes in the alternative depreciation system (ADS) and stimulus payments included in the American Rescue Plan (ARP). The April 15 deadline to file protective refund claims related to Affordable Care Act (ACA) taxes remains, so investors need to pay attention to changes and deadlines, or consult with their tax advisors.

ADS changes

Figuring out the best course of action related to the business interest expense limitation under IRC section 163(j) and the ADS related to residential rental property investments has been complicated by recent legislation and IRS action or inaction. The Tax Cuts and Jobs Act of 2017 (TCJA) changed the ADS recovery period for residential real property from 40 years to 30 years. The TCJA, however, didn't address property that had already been placed in service prior to 2018. The law in effect created two buckets: residential rental property placed in service before tax reform (40-year recovery period) and residential rental property placed in service after tax reform (30-year recovery period).  

The Consolidated Appropriations Act, 2021 changed the ADS recovery period for residential rental property placed in service prior to 2018 from 40 years to 30 years. This change is retroactive to tax years beginning after Dec. 31, 2017 – this means that taxpayers that made the real property trade or business election in 2018 or 2019 must change the recovery period to 30 years for their pre-2018 property.

The IRS has not yet issued formal guidance on this subject and has given no indication that they intend to do so. However, based on informal remarks at a recent tax conference, the IRS has indicated that taxpayers should rely on existing guidance under Rev. Proc. 2019-08, and treat this situation as a change in method of accounting due to a change in use of MACRS property. Based on this commentary, eligible taxpayers should file a Form 3115 Application for Change in Accounting Method to catch up depreciation for pre-2018 property, and to place their residential rental property on the new 30-year ADS recovery period.

Taxpayers that are making the real property trade or business election on their 2020 return should use 30-year ADS for all residential rental property on their timely filed original return. New property should be placed in service using 30-year ADS. Depreciation on existing property should be recomputed under the change in use rules at Reg. §1.168(i)-4. If the 2020 tax return was extended and has already been filed using MACRS or the wrong ADS period, taxpayers should file a superseding return by extended due date.