Pages 84-85: “Adopting the Routine Maintenance Safe Harbor”
Pages 101-107: “How New IRS Regulations Affect Prior Years”
Pages 139-141: “Deducting Costs for Replaced Building Components—New IRS Rules”
Page 154: “Change in Accounting Method”
In response to widespread complaints about the expense and difficulties involved in filing IRS Form 3115 to obtain automatic IRS consent to apply the IRS repair regulations to years before 2014, the IRS issued new regulations in mid-February 2014 (Revenue Procedure 2015-20). These new regulations provide most taxpayers with optional relief from the requirement that they apply the IRS repair regulations retroactively to years before 2014. Taxpayers who take advantage of this option need not file IRS Form 3115 with their 2014 tax return.
Landlords who choose the relief provided by Revenue Procedure 2015-20 need only apply the repair regulations prospectively—that is, starting on January 1, 2014. They need not go back to years before 2014 and make any changes in how they classified expenses as repairs or improvements or make any changes in their depreciation deductions. And they do not have to file the complex Form 3115, Application for Change In Accounting Method.
The relief provided by Revenue Procedure 2015-20 is available only for “smaller” taxpayers. This includes all taxpayers with (1) assets under $10 million (as of the first day of the tax year) or (2) less than $10 million in annual gross receipts for each distinct business they own. Obviously, the vast majority of landlords will qualify to use Revenue Procedure 2015-20. However, large landlords with assets or receipts over $10 million who are not eligible for the relief provided by Revenue Procedure 2015 must apply the repair regulations retroactively and file IRS Form 3115, Application for Change In Accounting Method.
To use the new regulations, you simply file your 2014 tax return as you normally do. There is no need to include any statement in your return that you’re adopting Revenue Procedure 2015-20. You don’t need to complete or include IRS Form 3115 with your return, which will result in a much simpler return.
You still need to include any required annual elections with your return—these are not affected by these new regulations. Such elections include the Safe Harbor Election for Small Taxpayers (covered on page 79) and the De Minimis Safe Harbor election (covered on page 152). With the routine maintenance safe harbor, there is no annual election or filing required, so taxpayers can simply start using the routine maintenance safe harbor and apply the IRS repair regulations prospectively, starting with tax year 2014. (See pages 84-85 “Adopting the Routine Maintenance Safe Harbor.”) Landlords also can use the materials and supplies deduction starting in 2014 without filing Form 3115 or making any other filing (see page 154, “Change in Accounting Method”).
You must apply all the new IRS repair regulations starting on January 1, 2014. This means you must determine whether the building expenses you incurred during 2014 qualified for one of the safe harbors (covered on pages 74-85); and, if not, whether they should be classified as repairs or improvements under the new regulations (covered on pages 86-101).
The relief provided by Revenue Procedure 2015-20 is optional—meaning you don’t have to take it. You can still file Form 3115. This requires you to apply the repair regulations to years before 2014. If, like many smaller landlords, you were conservative about classifying past building expenses as improvements instead of repairs, there may be many pre-2014 expenses that you’ve mistakenly been depreciating for many years. You’ll be able to take an immediate deduction in 2014 for such items. This could result in a substantial tax savings in 2014, even a tax refund. The value of such favorable adjustments on your past years’ taxes could far outweigh the time and expense involved in examining your old depreciation schedules and completing Form 3115. This is something you should discuss with your tax professional.
Also, one of the most significant changes brought about by the new repair regulations is a new rule that allows building owners to take an immediate loss when a building structural component such as a roof or HVAC system is replaced. This is done by making a partial disposition election on your tax return and then deducting the adjusted basis (cost minus depreciation taken) of the component. (See pages 139-141 for a detailed discussion of partial dispositions.) Such losses have never been allowed before. If you file Form 3115 and apply the repair regulations retroactively, you have the option of making partial disposition elections for building components you replaced in years before 2014. This could result in a substantial tax deduction. If you don’t file Form 3115 in 2014, you lose forever the ability to make such a partial disposition election for years before 2014. Again, you and your tax pro should consider whether the value of such deductions makes it worthwhile to file Form 3115 in 2014.
Finally, if you file Form 3115 in 2014 you obtain audit protection for years before 2014. This limits the ability of the IRS to audit you and unilaterally change the way you’ve classified repairs and improvements in past years. You get no audit protection if you don’t file Form 3115 with your 2014 return.
The proposed IRS regulations discussed in Every Landlord’s Tax Deduction Guide have been finalized by the IRS (see page 139, “Deducting Costs for Replaced Building Components—New IRS Rules”). However, the final regulations do not include discounting the cost of the replacement asset by the Consumer Price Index as an example of a reasonable method of determining the basis of a disposed asset (discussed on page 141). Instead, the Producer Price Index for Finished Goods (and its successor, the Producer Price Index for Final Demand) may be used--but only if the replaced asset is a restoration, not a betterment or adaptation to a new use. (See IRS Reg. §1.168(i)-8.)