On Friday April 10th, the IRS released Rev. Proc 2022-22, which permits revocations of elections-out-of-163(j) made on 2018 or 2019 tax returns and allows late elections-out-of-163(j) back to 2018, if a taxpayer chooses. It also allows BBA partnerships to file amended returns to make the corrections. This is a tremendous win for taxpayers. Click here to read the latest Rev. Proc. in its entirety, and here to view all our recent CARES Act coverage.
As established in the TCJA, the 163(j) election permitted eligible taxpayers to elect out of the interest deduction limitation, capped at that time at 30% of adjusted taxable income, after certain adjustments. Many companies did choose to elect out, but that decision came with a price – these companies generally had to depreciate Residential Real Property (30 years), Non-Residential Real Property (40 years) and Qualified Improvement Property (20 years) using the longer-lived Alternative Depreciation System (ADS) instead of MACRS class-lives. Furthermore, properties depreciated using ADS are generally not eligible for bonus depreciation. Nonetheless, at that time it made financial sense for many taxpayers to elect out of the interest deduction limitation, even if that meant ADS class lives and no bonus eligibility. Only assets with a class life of 20-years or less are eligible for bonus depreciation, and these ADS class lives exceed that threshold. Furthermore, due to a TCJA drafting error, the MACRS class life of Qualified Improvement Property (QIP) was 39-year at that time, so bonus was not in play for QIP under MACRS depreciation either.
However, the recent correction to QIP class life (QIP) means that a decision made in 2018 may no longer be the best decision. This Rev. Proc. allows taxpayers to rethink their choice, allowing them to create new late elections–out-of-163(j) back to 2018, or, in what is likely to be more common, allowing them to revoke elections-out-of-163(j) previously made on 2018 or 2019 tax returns.
The CARES Act corrected the recovery period of QIP to 15-year, thus characterizing it as property eligible for bonus depreciation. Now that QIP is eligible for 100% bonus depreciation under the TCJA, many taxpayers who initially chose to opt out of 163(j) are starting to rethink that decision. Admittedly they will lose some interest expense, but access to MACRS class lives and bonus depreciation on QIP means that it might be the right call.
If a taxpayer does act on this Rev. Proc., it’s important to note that there are collateral adjustments required. If a taxpayer revokes their election-out-of-163j, they must then determine if they are now subject to the interest deduction limitation. They also must re-state their depreciation method from ADS back to MACRS and claim any associated bonus if eligible. They must also adjust their returns for any other items that are impacted by the change in taxable income.
As always, Capstan encourages you to discuss these ongoing changes with your CPA as you consider your next steps. Capstan continues to work on updating Cost Segregation reports from 2018, 2019 and 2020 with QIP. If you have not received your report yet and want to discuss the timing for delivery please contact Terri Johnson at firstname.lastname@example.org, Bruce Johnson at email@example.com or Carly Ferris at firstname.lastname@example.org.