Opportunities for taxpayers with residential rental properties and residential living facilities.

• Author: Cordonnier, Caleb

During 2021, the IRS issued a series of taxpayer-favorable procedures that allow certain taxpayers that have made the real property trade or business election under Sec. 163(j)(7)(B) with residential rental property to depreciate such property using the shorter 30-year recovery period, using the alternative depreciation system (ADS), and certain other taxpayers with qualified residential living facilities to be eligible for the real property trade or business election. Both of these developments create favorable opportunities for affected taxpayers, who may want to reevaluate their current status and make a change.

Background

The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, enacted a limitation on how much interest expense a taxpayer can deduct each year, known as the Sec. 163(j) interest limitation. The TCJA, however, allowed certain taxpayers that make a real property trade or business election to be exempt from applying the Sec. 163(j) interest limitation. The TCJA defines an electing real property trade or business by reference to Sec. 469(c)(7)(C), which defines a real property trade or business as any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

As a trade-off, electing taxpayers are required to depreciate their nonresidential real property, residential rental property, and qualified improvement property using the ADS. The TCJA also modified the ADS recovery period of residential rental property placed in service after Dec. 31, 2017, from 40 years down to 30 years but did not apply that change to property placed in service on or before that date. Rev. Proc. 2019-8 clarified that for real property trades or businesses with real property placed in service prior to the date of election, a change in use occurs for such properties, and the applicable ADS life for residential rental property placed in service before Jan. 1, 2018, would be 40 years, not 30 years.

After the TCJA, some taxpayers with a trade or business of providing housing in residential living facilities, and which also included supplemental assistive, nursing, or routine medical services, were left wondering if they could also make the real property trade or business election under Sec. 163(j) to claim that benefit.

The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (TCDTRA), Division EE of the Consolidated Appropriations Act...