The Potential for Increased Depreciation Expense for Residential Real Estate Owners

President Trump signed the Consolidated Appropriations Act (the “Act”) on December 27, 2020. At 5,593 pages, this bill is the longest bill in U.S. history. A bill of this magnitude, as expected, contains tax provisions affecting various industries including real estate. Specifically, real estate owners, investors and fund sponsors who are active in the residential real estate market should consider a relevant new depreciation provision. This new provision that is favorable to the real estate industry allows certain assets that were previously depreciated over 40 years to be depreciated over 30 years.

Under the 2017 Tax Cuts and Jobs Act (“TCJA”), Congress enacted a rule limiting the amount of interest deductions for certain taxpayers. In addition, the TCJA allowed taxpayers to elect out of the interest deduction limitation by making a real property trade or business (“RPTB”) election. The consequence of such an election is an increase in the lives of real property depreciable assets and a reduction in the allowable annual depreciation expense. Taxpayers making the RPTB election must place all assets in service prior to January 1, 2018, with a traditional depreciable life of 27.5 years under the general depreciation system (“GDS”), or be depreciated over 40 years under the alternative depreciation system (“ADS”). For all 27.5-year assets placed in service after January 1, 2018, the TJCA reduced the recovery period from 40 years to 30 years for such assets under the ADS. The switch from a 27.5-year life to a 40-year life for pre-January 1, 2018, assets was often onerous to real estate owners and economically precluded them from making the RPTB election due to the annual reduction of depreciation expense. The Act provides relief for taxpayers with an amendment to this depreciation change requirement. It allows taxpayers that are making the RPTB election to use the 30-year recovery period for all residential rental property with a 27.5-year depreciable life under GDS including those placed in service prior to January 1, 2018.

This technical amendment has created a series of questions that will need further clarity. Will taxpayers who have already made the RPTB election prior to the Act be required to amend any returns to benefit from this provision? Will an application for change in accounting method be an acceptable alternative if amendment is not required? It will be interesting to see whether the IRS issues additional revenue procedures regarding the application of this provision as it pertains to entities that have made an RPTB election.