Tax Filing Requirements Under the IRS Repair Regulations

Landlords will need to file Form 3115 to change their “method of accounting” for rental property they own and depreciate--an onerous task.

The repair regulations took full effect on January 1, 2014 and are also retroactive—that is, they have to be applied to expenses for repairs and improvements to rental property owned before 2014 as well as after. Applying the regulations to years before 2014 will be a lot of work for landlords. You’re supposed to review your depreciation schedules and other available documentation (such as invoices for repairs and improvements) for all rental property you are currently depreciating and figure out if there would have been any difference if you had applied the new regulations to the property before 2014.

If some (or many) of your pre-2014 decisions about which expenses to deduct and which to depreciate don’t jibe with the new rules, you may need to make adjustments to the deductions or depreciation you took in past years. “Adjustments” (also called “Section 481(a) adjustments”) mean either you owe the IRS money or the IRS owes you money. Landlords who in past years aggressively claimed that substantial changes made to property were deductible repairs instead of improvements that had to be depreciated may end up owing the IRS substantial adjustments. On the other hand, the adjustments may be in your favor if, like many smaller landlords, you were conservative about classifying work as an improvements instead of a repair.

Under longstanding rules governing tax accounting, applying the new regulations to years prior to 2014 and making any necessary adjustments constitutes a change in your “method of accounting.” You need to obtain IRS consent for this change which you do by filing the required form--IRS Form 3115, Application for Change in Accounting Method. Unfortunately, Form 3115 is an extraordinarily complex form that few landlords will be able to file without the help of a knowledgeable tax professional.

See Nolo's article, Tax Filing Requirements Under the IRS Repair Regulations, for more on how to comply with the new IRS tax filing requirements under the repair regulations.