IRS consent not required for property classification change.

• Author: O'Driscoll, David

B undertook construction of gas station properties at grocery store locations in Texas. Initially, B's corporate tax returns identified the gas stations as nonresidential real property under the modified accelerated cost recovery system (MACRS) rules, and used straight-line depreciation for periods of 31.5 or 39 years on its 1993-1995 returns. B subsequently filed amended returns for those three tax years, reclassifying the gas stations as 15-year property under an IRS Industry Specialization Program Coordinated Issue Paper, and recalculating depreciation under the MACRS 150% declining balance (DB) method over a 15-year recovery period. The IRS accepted the amended returns and issued full refunds to B for 1993 and 1994, and a partial refund for 1995.

For 1996 and 1997, B continued to classify and depreciate the gas station properties in the same manner as on the amended 1993-1995 returns. B never filed Form 3115, Application for Change in Method of Accounting, for the gas station properties. As a result, the IRS issued a deficiency notice for 1996 and 1997, asserting, inter alia, that B's depreciation deductions for those years had to be decreased because B had changed its accounting method without obtaining prior consent. The IRS does not contend that the method used by B for 1996 and 1997 is either improper or impermissible.

Analysis

Sec. 446(e) requires that "a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary." Regs. Sec. 1.446-1 (e)(2)(ii)(b) states that "[a] change in method of accounting does not include adjustment of any item of income or deduction which does not involve the proper time for the inclusion of the item of income or the taking of a deduction. In addition, a change in the method of accounting does not include ... an adjustment in the useful life of a depreciable asset."

When an accounting practice merely postpones income reporting, rather than permanently avoids the reporting of income over the taxpayer's lifetime, it involves the proper time for reporting income. B neither altered its overall accounting plan for income and deductions on an accrual basis, nor changed its basic accounting system for depreciation. The change from straight-line depreciation over a 31.5- or 39-year period to the DB method over a 15-year period, however, involves the...