The IRS recently released final, temporary and
proposed regulations specifying when changes in depreciation and
amortization will be considered accounting-method changes under
Sec. 446 (TD 9307, 12/22/06). The rules also reflect the Service’s
attempt to provide more consistent treatment and increased
certainty for taxpayers on depreciation
or amortization. As more changes qualify, it should reduce controversy as to what
qualifies for automatic accounting-method changes. Moreover, these rules expand on
and solidify the ability to incorporate the results of cost-segregation studies into favorable accounting-method-change requests. When applicable, these requests could result in immediate current tax benefits for taxpayers.
Regs. Sec. 1.446-1(e)(2)(ii)(d)(2) retains the rules in the temporary regulations providing that changes in depreciation constitute accounting-method changes under Sec. 446(e). These include a change in the treatment of an asset from nondepreciable or nonamortizable to depreciable or amortizable, or vice versa. Additionally, a correction to require depreciation in lieu of a deduction for the cost of depreciable or amortizable assets that had been consistently treated as an expense in the year of purchase (or vice versa) is an accounting-method change. There may be significant application of this rule as a result of the recently issued rules on capitalization of tangible property and rotating spare parts.
Changes in computing depreciation generally are accounting-method changes, including a change in depreciation method, recovery period or convention of a depreciable or amortizable asset and, under certain circumstances, a change to or from claiming additional first-year depreciation. Depreciation changes due to posting or mathematical errors or changes in underlying facts are not accounting-method changes.
Not Accounting-Method Changes
Regs. Sec. 1.446-1(e)(2)(ii)(d)(3)(i) retains the rule from the temporary regulations that an accounting-method change does not include an adjustment in the useful life of a depreciable or amortizable asset for which depreciation is determined, unless the taxpayer is changing to or from a useful life (or recovery or amortization period) specifically assigned by the Code, the regulations or other guidance published in the Internal Revenue Bulletin.
Regs. Sec. 1.446-1(e)(2)(ii)(d)(5)(iv) also retains the rules as to when an adjustment in useful life that is not an accounting-method change is implemented; these rules apply regardless of whether the adjustment is initiated by the IRS or the taxpayer. Further, when implementing an adjustment in useful life that is not an accounting-method change, a Sec. 481(a) adjustment is neither required nor permitted.
Regs. Sec. 1.446-1(e)(2)(ii)(d)(3)(iii) retains the rule that a late depreciation election or revocation of a timely, valid depreciation election is not an accounting-method change. Under Sec. 179 and its regulations, a late Sec.179 election generally is made by submitting a ruling request. However, for tax years beginning after 2002 and before 2010, a taxpayer may make a Sec. 179 election by filing an amended return.
Regs. Sec. 1.446-1(e)(2)(ii)(d)(3)(v) retains the rule that any change in the placed-in-service date of a depreciable or amortizable asset is generally not treated as an accounting-method change. Further, a change in the convention of a depreciable or amortizable asset is not a change in the asset’s placed-in-service date and, thus, is not an accounting-method change. Additionally, the final regulations provide examples of a change in a placed-in-service date. Because a change in a placed-in-service date is not an accounting-method change, a Sec. 481(a) adjustment is neither required nor permitted.
Rev. Proc. 2007-16
The IRS issued Rev. Proc. 2007-16 to accompany the regulations. It supersedes Rev. Proc. 2004-11 and modifies Rev. Proc. 2002-9, which guided taxpayers on how to obtain automatic consent to change an accounting method under Sec. 446 for certain changes in depreciation or amortization.
Change in Two-Year Rule
In general, if a taxpayer uses an impermissible accounting method in two or more consecutively filed Federal tax returns, it has adopted that accounting method; see Rev. Rul. 90-38. The Service and Treasury felt that the two-year rule could increase administrative and compliance costs, because many taxpayers changing from an impermissible to a permissible accounting method for depreciation used the impermissible method for depreciable properties placed in service in the tax year immediately preceding the change year. Accordingly, the IRS and Treasury have decided to waive the two-year rule for a change in depreciation.
Mergers and Other Carryover-Basis Transactions
If depreciable property is transferred in a transaction in which the transferee is treated as the transferor for purposes of computing the property’s depreciation allowance with respect to so much of the basis in the transferee’s hands as does not exceed adjusted depreciable basis in the transferor’s hands, the transferee, under most circumstances, could file Form 3115, Application for Change in Ac-counting Method, to change from an impermissible accounting method adopted by the transferor. The Sec. 481(a) adjustment will include any needed adjustments since the property’s placed-in-service date by the transferor.
Rev. Proc. 2007-16 was extended to allow taxpayers to file Form 3115 with an original Federal return for the tax year in which depreciable property was disposed of by a tax-payer who claimed less than the depreciation allowable. While the total depreciation and gain or loss on disposition should be the same, the character could change (i.e., more or less capital gain versus ordinary income recapture).
Change vs. Error
Section 4.01 was added to clarify that a change from an impermissible method of determining depreciation for depreciable property in two or more consecutively filed Federal tax returns is an accounting-method change under Sec. 446(e) and Regs. Sec. 1.446-1(e).
Rev. Proc. 2007-16 does not apply to any (1) property for which a taxpayer is revoking a timely, valid election or making a late election under Sec. 179 or (2) accounting-method change involving a change from capitalizing and depreciating the cost or other basis of any property to deducting it as an expense.
The guidance presents opportunities for taxpayers to consider depreciation-method changes to provide immediate tax benefits if a favorable (i.e., a negative Sec. 481(a)) adjustment results, or to avoid audit exposure when an unfavorable adjustment results.