The IRS has released guidance on dealing with the change in depreciation for qualified improvement property in Revenue Procedure 2020-25.[1]

Qualified Improvement Property Accounting Method Change

The procedure generally applies to qualified improvement property placed in service after December 31, 2017, in the taxpayer’s 2018, 2019 or 2020 taxable. But it does not apply in the following situations:

• Qualified improvement property placed in service after December 31, 2017, by a taxpayer that made a late election, or withdrew an election, under § 163(j)(7)(B) (electing real property trade or business) or § 163(j)(7)(C) (electing farming business) for the taxable year in which the qualified improvement property is placed in service by the taxpayer, in accordance with Rev. Proc. 2020-22, 2020-18 I.R.B. 745 (April 27, 2020), released on www.irs.gov on April 10, 2020. Any changes to depreciation for such qualified improvement property, or other depreciable property, affected by the late election or withdrawn election under § 163(j)(7)(B) or 163(j)(7)(C) are made in accordance with sections 4.02 and 4.03, or 5.02 of Rev. Proc. 2020-22, as applicable; or

• Qualified improvement property for which the taxpayer deducted or deducts the cost or other basis of such property as an expense.[2]

The ruling views this a change in accounting method from a now impermissible method of accounting to a permissible one.  As the ruling notes:

A taxpayer changing the depreciation of qualified improvement property within the scope of this section 3 to the depreciation method, recovery period, and convention described in section 2.01(3) of this revenue procedure is changing from an impermissible method of accounting to a permissible method of accounting. Similarly, a change from not claiming to claiming the additional first year depreciation deduction under § 168(k) for qualified improvement property that is within the scope of this section 3 and is eligible for the additional first year depreciation deduction is a change from an impermissible method of accounting to a permissible method of accounting.[3]

If the qualified improvement property was placed in service in the taxable year immediately preceding the year of change (1-Year QIP), the procedure offers up the following options to accomplish the change:

• The taxpayer may change from the impermissible method of determining depreciation to the permissible method of determining depreciation for the 1-year QIP by filing a Form 3115 for this change in accordance with section 3.02(3)(b) of this revenue procedure, provided the § 481(a) adjustment reported on the Form 3115 includes the amount of any adjustment attributable to all property, including the 1-year QIP, subject to the Form 3115; or

• The taxpayer may change from the impermissible method of determining depreciation to the permissible method of determining depreciation for the 1-year QIP by filing an amended return or AAR in accordance with section 3.02(3)(a) of this revenue procedure.[4]

If the taxpayer decides to go the Form 3115/IRC §481(a) adjustment route for the 1-Year QIP property to accomplish the change or is looking to change methods on property outside the one year window, the taxpayer takes the following steps:

A Form 3115 with the taxpayer’s timely filed Federal income tax return or Form 1065 under the automatic change procedures in Rev. Proc. 2015-13. See section 6.03(1) of this revenue procedure for the procedures for making this change in method of accounting.

Alternatively, if a taxpayer goes the amended return route to correct the depreciation claimed on 1-Year QIP property, the following steps are taken:

Except as provided in Rev. Proc. 2020-23, 2020-18 I.R.B. 749, (April 27, 2020), released on www.irs.gov on April 8, 2020, regarding the time to file amended returns by a partnership subject to the centralized partnership audit regime enacted as part of the Bipartisan Budget Act of 2015 (BBA partnership) for taxable years beginning in 2018 and 2019, a Federal amended income tax return or amended Form 1065 for the placed-in-service year of the qualified improvement property on or before October 15, 2021, but in no event later than the applicable period of limitations on assessment for the taxable year for which the amended return is being filed. In the case of a BBA partnership that chooses not to file an amended Form 1065 as permitted under Rev. Proc. 2020-23 or that cannot file an amended Form 1065 because the placed-in-service year of the qualified improvement property is a taxable year that is not within the scope of Rev. Proc. 2020-23, the BBA partnership may file an AAR for the placed-in-service year of the qualified improvement property on or before October 15, 2021, but in no event later than the applicable period of limitations on making adjustments under § 6235 for the reviewed year as defined in § 301.6241-1(a)(8). This amended return or AAR must include the adjustment to taxable income for the change in determining depreciation of the qualified improvement property and any collateral adjustments to taxable income or to tax liability. Such collateral adjustments also must be made on original or amended Federal returns or AARs for any affected succeeding taxable years…[5]

Note that a taxpayer has until October 15, 2021 to make this decision to amend the 2018 return or go for the accounting method change and file Form 3115 with a §481(a) adjustment in 2019.  Taxpayers will need to determine which year is the preferable year to make the change—and the decision may rest on how quickly the IRS could be expected to process a paper amended 2018 return.  One advantage to an accounting method change for 2019 is that the return could be filed electronically and have an immediate effect either by reducing tax due with the return or leading to a tax refund being issued.

Elections Under IRC §168

The next section deals with elections under IRC §168(g)(7) and (k). These elections are generally permanent in nature, as described in the procedure:

Section 1.168(k)-2(f)(5) provides that, in general, the § 168(k)(5) election, § 168(k)(7) election, and § 168(k)(10) election, once made, may be revoked only by filing a request for a private letter ruling and obtaining the written consent of the Commissioner of Internal Revenue (Commissioner) to revoke the election. Further, if a taxpayer timely filed its Federal income tax return or Form 1065 for the taxpayer’s taxable year beginning in 2017 and ending on or after September 28, 2017, sections 4.03, 5.04, and 6.05 of Rev. Proc. 2019-33 provide special procedures to allow the taxpayer to revoke its § 168(k)(5) election, § 168(k)(7) election, and § 168(k)(10) election, respectively, made for such taxable year. As noted in section 2.02(1) of this revenue procedure, section 168(g)(7)(B) provides that the § 168(g)(7) election, once made, is irrevocable.

The election under IRC §168(g)(7) is described as follows:

Section 168(g)(7) allows a taxpayer to make an election to depreciate under the ADS any class of property placed in service by the taxpayer during the taxable year (§ 168(g)(7) election). If the § 168(g)(7) election is made, the election applies to all property that is in the same class of property and placed in service in the same taxable year. However, for nonresidential real property and residential rental property, the election may be made separately for each property. Once made, the § 168(g)(7) election is irrevocable. See § 168(g)(7)(B). Section 301.9100-7T(a)(2) and (3) of the Procedure and Administration Regulations provide the time and manner of making the § 168(g)(7) election. Such election is made by the due date, including extensions, of the Federal income tax return or Form 1065, U.S. Return of Partnership Income, for the taxable year in which the property is placed in service by the taxpayer, and is made by attaching a statement to such return. The instructions to Form 4562, Depreciation and Amortization, provide that the § 168(g)(7) election is made by completing line 20 of Form 4562.[6]

The election under IRC §168(k)(5)(A) is described as follows:

Section 168(k)(5)(A) allows a taxpayer to make an election to apply the special rules of § 168(k)(5) to one or more specified plants that are planted, or grafted to a plant that has already been planted, by the taxpayer in the ordinary course of its farming business, as defined in § 263A(e)(4) (§ 168(k)(5) election). The rules and procedures for making the § 168(k)(5) election are set forth in § 1.168(k)-2(f)(2). Pursuant to § 1.168(k)-2(f)(2)(ii), the § 168(k)(5) election is made by the due date, including extensions, of the Federal income tax return or Form 1065 for the taxable year in which the taxpayer planted or grafted the specified plant to which the § 168(k)(5) election applies, and is made in the manner prescribed on Form 4562 and its instructions. For specified plants planted, or grafted to a plant that was previously planted, by the taxpayer before the applicability date set forth in § 1.168(k)-2(h) for § 1.168(k)-2, section 4.05 of Rev. Proc. 2017-33, 2017-19 I.R.B. 1236, provides the time and manner for making the § 168(k)(5) election and such procedures are the same as in § 1.168(k)-2(f)(2)(ii). Further, if a taxpayer timely filed its Federal income tax return or Form 1065 for the taxpayer’s taxable year beginning in 2017 and ending on or after September 28, 2017, sections 4.01(2) and 4.02 of Rev. Proc. 2019-33, 2019-34 I.R.B. 662, provide special procedures to allow the taxpayer to make a deemed § 168(k)(5) election or a late § 168(k)(5) election for a specified plant planted, or grafted to a plant that was previously planted, by the taxpayer after September 27, 2017.[7]

The election under IRC §168(k)(7) is described as:

Section 168(k)(7) allows a taxpayer to make an election not to deduct the additional first year depreciation for any class of property that is qualified property placed in service during the taxable year (§ 168(k)(7) election). The rules and procedures for making the § 168(k)(7) election are set forth in § 1.168(k)-2(f)(1). Section 1.168(k)-2(f)(1)(ii) defines “class of property” for purposes of the § 168(k)(7) election. Under § 1.168(k)-2(f)(1)(ii), qualified improvement property is included in the 15-year property class and is not a separate class of property. However, qualified improvement property, as defined in § 168(k)(3) as in effect prior to amendment by the TCJA, acquired by the taxpayer after September 27, 2017, and placed in service by the taxpayer before January 1, 2018, is a separate class of property under § 1.168(k)- 2(f)(1)(ii)(D). Pursuant to § 1.168(k)-2(f)(1)(iii), the § 168(k)(7) election is made by the due date, including extensions, of the Federal income tax return or Form 1065 for the taxable year in which the qualified property is placed in service by the taxpayer, and is made in the manner prescribed on Form 4562 and its instructions. For qualified property placed in service by the taxpayer before the applicability date set forth in § 1.168(k)-2(h) for § 1.168(k)-2, section 4.04 of Rev. Proc. 2017-33 provides the time and manner for making the § 168(k)(7) election and such procedures are the same as in § 1.168(k)-2(f)(1)(iii). Further, if a taxpayer timely filed its Federal income tax return or Form 1065 for the taxpayer’s taxable year beginning in 2017 and ending on or after September 28, 2017, sections 5.02(2) and 5.03 of Rev. Proc. 2019-33 provide special procedures to allow the taxpayer to make a deemed § 168(k)(7) election or a late § 168(k)(7) election for a class of property that is qualified property acquired by the taxpayer after September 27, 2017, and placed in service by the taxpayer during such taxable year.[8]

The election under §168(k)(10) is described as follows:

Section 168(k)(10) allows a taxpayer to make an election to deduct 50 percent, instead of 100 percent, additional first year depreciation for: (a) all qualified property acquired by the taxpayer after September 27, 2017, and placed in service by the taxpayer during its taxable year that includes September 28, 2017; and (b) all specified plants that are planted, or grafted to a plant that has already been planted, after September 27, 2017, by the taxpayer in the ordinary course of the taxpayer’s farming business during its taxable year that includes September 28, 2017, if the taxpayer makes the § 168(k)(5) election for that taxable year (§ 168(k)(10) election). The rules and procedures for making the § 168(k)(10) election are set forth in § 1.168(k)-2(f)(3). Pursuant to § 1.168(k)-2(f)(3)(ii), the § 168(k)(10) election is made by the due date, including extensions, of the Federal income tax return or Form 1065 for the taxpayer’s taxable year that includes September 28, 2017, and is made in the manner prescribed on the 2017 Form 4562 and its instructions. For qualified property placed in service, and specified plants planted, or grafted to a plant that was previously planted, by the taxpayer before the applicability date set forth in § 1.168(k)-2(h) for § 1.168(k)-2, section 6.02 of Rev. Proc. 2019-33 provides the time and manner for making the § 168(k)(10) election and such procedures are the same as in § 1.168(k)-2(f)(3)(ii). Further, if a taxpayer timely filed its Federal income tax return or Form 1065 for the taxpayer’s taxable year beginning in 2017 and ending on or after September 28, 2017, sections 6.03(2) and 6.04 of Rev. Proc. 2019-33 provide special procedures to allow the taxpayer to make a deemed § 168(k)(10) election or a late § 168(k)(10) election for all qualified property acquired by the taxpayer after September 27, 2017, and placed in service by the taxpayer during such taxable year, or for all specified plants planted, or grafted to a plant that was previously planted, by the taxpayer after September 27, 2017.[9]

Time and manner of making a late § 168(g)(7), (k)(5), (k)(7), or (k)(10) election

This section applies to:

• A taxpayer that (a) placed in service depreciable property during its 2018, 2019, or 2020 taxable year, (b) timely filed its Federal income tax return or Form 1065 for the placed-in-service year of such depreciable property and such return was filed on or before April 17, 2020, (c) wants to make a § 168(g)(7) election, § 168(k)(5) election, or § 168(k)(7) election for such depreciable property, and (d) did not previously revoke or withdraw such election(s) in accordance with section 5.02 of this revenue procedure. The taxpayer makes the § 168(g)(7) election, § 168(k)(5) election, or § 168(k)(7) election in accordance with section 2.02(1), (2), or (3), respectively, of this revenue procedure or under section 4.02 of this revenue procedure; or

• A taxpayer that (a) timely filed its Federal income tax return or Form 1065 for the taxpayer’s taxable year that includes September 28, 2017, (b) wants to make a § 168(k)(10) election for such taxable year, and (c) did not previously revoke a § 168(k)(10) election for such taxable year in accordance with section 5.02 of this revenue procedure. The taxpayer makes the § 168(k)(10) in accordance with section 2.02(4) of this revenue procedure or under section 4.02 of this revenue procedure.[10]

A taxpayer covered by this procedure may make a late election under IRC § 168(g)(7), (k)(5), (k)(7), or (k)(10) election in one of two manners:

• Except as provided in Rev. Proc. 2020-23 regarding the time to file amended returns by BBA partnerships for taxable years beginning in 2018 and 2019, a Federal amended income tax return or amended Form 1065 for the placed-in-service year of the property on or before October 15, 2021, but in no event later than the applicable period of limitations on assessment for the taxable year for which the amended return is being filed. In the case of a BBA partnership that chooses not to file an amended Form 1065 as permitted under Rev. Proc. 2020-23 or that cannot file an amended Form 1065 because the placed-in-service year of the property is a taxable year that is not within the scope of Rev. Proc. 2020-23, the BBA partnership may file an AAR for the placed-in-service year of the property on or before October 15, 2021, but in no event later than the applicable period of limitations on making adjustments under § 6235 for the reviewed year as defined in § 301.6241-1(a)(8). This amended return or AAR must include the adjustment to taxable income for the late election and any collateral adjustments to taxable income or to tax liability. Such collateral adjustments also must be made on original or amended Federal returns or AARs for any affected succeeding taxable years; or

• A Form 3115 with the taxpayer’s timely filed original Federal income tax return or Form 1065 (a) for the taxpayer’s first or second taxable year succeeding the taxable year in which the taxpayer placed in service the property, or (b) that is filed on or after April 17, 2020, and on or before October 15, 2021. The late § 168(g)(7), (k)(5), (k)(7), or (k)(10) election under this section 4.02(2) will be treated as a change in method of accounting with a § 481(a) adjustment only during this limited period of time. The time and manner of making this late election are described in section 6.03(2) of this revenue procedure.[11]

Revoking or Withdrawing Certain Elections Under §168

This section applies to:

• A taxpayer that (a) placed in service depreciable property during its 2018, 2019, or 2020 taxable year, (b) made a § 168(k)(5) election or § 168(k)(7) election on its timely filed original Federal income tax return or Form 1065 for the placed-in-service year of such depreciable property and such return was filed on or before April 17, 2020, or made a § 168(k)(5) election or § 168(k)(7) election in accordance with section 4 or 5 of Rev. Proc. 2019-33, respectively, for the placed-in-service year of such depreciable property on or before April 17, 2020, and (c) wants to revoke such election. If the taxpayer revokes the § 168(k)(7) election in accordance with section 5.02(2) of this revenue procedure, the revocation applies to all property included in the class of property and placed in service during the same taxable year;

• A taxpayer that made a § 168(k)(10) election on its timely filed original Federal income tax return or Form 1065 for the taxpayer’s taxable year that includes September 28, 2017, and such return was filed on or before April 17, 2020, or made a § 168(k)(10) election in accordance with section 6 of Rev. Proc. 2019-33 for the taxpayer’s taxable year that includes September 28, 2017, on or before April 17, 2020, and that wants to revoke the § 168(k)(10) election. If the taxpayer revokes the § 168(k)(10) election in accordance with section 5.02(2) of this revenue procedure, the revocation applies to (a) all qualified property acquired by the taxpayer after September 27, 2017, and placed in service by the taxpayer during its taxable year that includes September 28, 2017, and (b) all specified plants that are planted, or grafted to a plant that has already been planted, after September 27, 2017, by the taxpayer in the ordinary course of the taxpayer’s farming business during its taxable year that includes September 28, 2017, if the taxpayer made the § 168(k)(5) election for that taxable year; or

• A taxpayer that (a) placed in service depreciable property during its 2018, 2019, or 2020 taxable year, (b) made a § 168(g)(7) election on its timely filed original Federal income tax return or Form 1065 for the placed-in-service year of such depreciable property and such return was filed on or before April 17, 2020, and (c) wants to withdraw such election. If the taxpayer withdraws the § 168(g)(7) election in accordance with section 5.02(3) of this revenue procedure, the taxpayer will be treated as if the election was never made for all property included in the class of property and placed in service during the same taxable year. However, if the taxpayer withdraws the § 168(g)(7) election for an item of nonresidential real property or residential rental property in accordance with section 5.02(3) of this revenue procedure, the taxpayer will be treated as if the election was not made for that specific item of nonresidential real property or residential rental property.[12]

A taxpayer covered by this section of the ruling is given consent revoke its §168(k)(5) election, §168(k)(7) election, or §168(k)(10) election, or consent to withdraw its §168(g)(7) election if the follows the procedures outlined.[13]

If a taxpayer who wishes to revoke a §168(k)(5), (7), or (10) election can do so by following either of the following procedures:

• Except as provided in Rev. Proc. 2020-23 regarding the time to file amended returns by BBA partnerships for taxable years beginning in 2018 and 2019, a Federal amended income tax return or amended Form 1065 for the placed-in-service year of the property on or before October 15, 2021, but in no event later than the applicable period of limitations on assessment for the taxable year for which the amended return is being filed. In the case of a BBA partnership that chooses not to file an amended Form 1065 as permitted under Rev. Proc. 2020-23 or that cannot file an amended Form 1065 because the placed-in-service year of the property is a taxable year that is not within the scope of Rev. Proc. 2020-23, the BBA partnership may file an AAR for the placed-in-service year of the property on or before October 15, 2021, but in no event later than the applicable period of limitations on making adjustments under §6235 for the reviewed year as defined in § 301.6241-1(a)(8). This amended return or AAR must include the adjustment to taxable income for the revocation of the §168(k)(5), (k)(7), or (k)(10) election and any collateral adjustments to taxable income or to tax liability. Such collateral adjustments also must be made on original or amended Federal returns or AARs for any affected succeeding taxable years; or

• A Form 3115 with the taxpayer’s timely filed original Federal income tax return or Form 1065 (i) for the taxpayer’s first or second taxable year succeeding the taxable year in which the taxpayer placed in service the property, or (ii) that is filed on or after April 17, 2020, and on or before October 15, 2021. The revocation of the § 168(k)(5), (k)(7), or (k)(10) election under this section 5.02(2)(b) will be treated as a change in method of accounting with a § 481(a) adjustment only during this limited period of time. The time and manner of making this revocation are described in section 6.03(2) of this revenue procedure.[14]

A withdrawal of §168(7) election is accomplished as follows:

A taxpayer within the scope of this section 5 may withdraw a § 168(g)(7) election by filing an amended Federal income tax return, amended Form 1065, or AAR, as applicable. Except as provided in Rev. Proc. 2020-23 regarding the time to file amended returns by BBA partnerships for taxable years beginning in 2018 and 2019, the Federal amended income tax return or amended Form 1065 for the placed-in-service year of the property must be filed on or before October 15, 2021, but in no event later than the applicable period of limitations on assessment for the taxable year for which the amended return is being filed. In the case of a BBA partnership that chooses not to file an amended Form 1065 as permitted under Rev. Proc. 2020-23 or that cannot file an amended Form 1065 because the placed-in-service year of the property is a taxable year that is not within the scope of Rev. Proc. 2020-23, the BBA partnership may file an AAR for the placed-in-service year of the property on or before October 15, 2021, but in no event later than the applicable period of limitations on making adjustments under § 6235 for the reviewed year as defined in § 301.6241-1(a)(8). This amended return or AAR must include the adjustment to taxable income for the withdrawal of the § 168(g)(7) election and any collateral adjustments to taxable income or to tax liability. Such collateral adjustments also must be made on original or amended Federal returns or AARs for any affected succeeding taxable years.[15]

Section 6 of the procedure has the detailed procedures for filing the necessary accounting method changes for this procedure.

The procedure also contains a modification to Revenue Procedure 2015-56 that details a safe harbor method accounting for determining whether expenditures paid or incurred to remodel or refresh a qualified building are deductible under § 162(a) of the Internal Revenue Code (Code), must be capitalized as improvements under § 263(a), or must be capitalized as the costs of property produced by the taxpayer for use in its trade or business under § 263A in Section 7 of the procedure.

[1] Revenue Procedure 2020-25, April 17, 2020, https://www.irs.gov/pub/irs-drop/rp-20-25.pdf, retrieved April 17, 2020

[2] Revenue Procedure 2020-25, Section 3.01

[3] Revenue Procedure 2020-25, Section 3.02(1)

[4] Revenue Procedure 2020-25, Section 3.02(2)

[5] Revenue Procedure 2020-25, Section 3.02(3)(a)

[6] Revenue Procedure 2020-25, Section 2.02(1)

[7] Revenue Procedure 2020-25, Section 2.02(2)

[8] Revenue Procedure 2020-25, Section 2.02(3)

[9] Revenue Procedure 2020-25, Section 2.02(4)

[10] Revenue Procedure 2020-25, Section 4.01

[11] Revenue Procedure 2020-25, Section 4.02

[12] Revenue Procedure 2020-25, Section 5.01

[13] Revenue Procedure 2020-25, Section 5.02(1)

[14] Revenue Procedure 2020-25, Section 5.02(2)

[15] Revenue Procedure 2020-25, Section 5.02(3)