As discussed further here, the IRS has provided guidance for implementing the retroactive fix to the retail glitch provided by the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). In addition, relief has been granted to allow for the filing of amended returns by certain partnerships that were previously ineligible and to allow taxpayers to revoke or make late real property trade or business (RPTOB) or farming trade or business (FTB) elections made in 2018 and 2019.
As a result, partnerships that need to revoke or make a late RPTOB or FTB election to benefit from this fix may file either an amended return or an Administrative Adjustment Request (AAR). Those that did not make the elections or do not have changes related to the elections have an additional option – a change in accounting method.
A partnership’s eligibility to use each option, and the impact of their choice will vary depending on its individual circumstance.
Option 1 – Change in Accounting Method
The partnership may choose to avoid the complications associated with filing an Administrative Adjustment Request (AAR) or amending partner and partnership returns by computing and deducting a ‘catch-up’ adjustment in a later year by filing a Form 3115. However, this option may delay the potential benefit and would allocate the additional deductions to the partners in the year of the ‘catch-up’, not the partners in the year the property was placed in service.
Certain partnerships may be eligible to file a Form 3115 to account for the law change as a change in method of accounting. This process entails using a ‘catch-up’ adjustment (technically known as a section 481(a) adjustment) that causes the cumulative difference between new QIP depreciation and the taxpayer’s existing method to be taken into account in the year of change. This gives the benefit of additional deductions to the partners in the year of change, not the partners in the year the property was placed in service. No amended returns are required, and the availability of any benefits depend on the attributes of the partners in the year of change.
The partnership may be eligible to make this “catch-up” adjustment for 2018 additions on an original or superseded 2019 tax return filed before its extended due date. A Form 3115 can also be filed with an amended 2019 tax return or AAR if it is filed within six months of the original due date and follows the procedures outlined in Rev. Proc. 2015-13, section 6.03(4).
Options may also exist to adjust for both 2018 and 2019 additions on its 2020 tax return. Although this would delay the benefit, adjustments that increase losses in 2020 may provide greater benefit than those that offset 2019 income, due to other CARES Act provisions that increased partner’s ability to carryback losses to years with higher marginal rates.
As noted above, this ‘catch-up’ process is not available to partnerships that make a late election or revoke a RPTOB or FTB election. The late election or revocation of that election, and the related adjustments to QIP and other depreciation must be made on an amended return or AAR for each year. More information on the process of revoking that election is available here.
Option 2 – Amend or Supersede Tax Returns
A partnership may choose to amend or supersede income tax returns. This option may provide for more immediate benefit to the partners, but generally requires the filing of amended returns by the partners themselves. The benefits of the additional deductions are allocated to the partners in the year the property was placed in service.
A partnership may consider amending or superseding returns to implement the CARES Act changes to QIP. Although a partnership subject to the new partnership procedural regime of the Bipartisan Budget Act of 2015 (the ‘BBA’ rules) is not allowed to amend its return in the normal manner, Rev. Proc. 2020-23 allowed such partnerships a special window to file traditional amended returns through Sept. 30, 2020, for tax years 2018 and 2019.
If a partnership amends (or supersedes) its return(s) to revise its treatment of QIP, the benefits of the additional bonus depreciation deductions inure to the partners in the year the property was placed in service. This comes with an administrative cost, however, in that the partners may need to individually amend their returns to coordinate with the amended return filed by the partnership (including all the way up tiered structures).
The general accounting method rules provide, that a taxpayer (other than an electing real property trade or business revoking or making a late election) with QIP that has only used an impermissible method (recovering 2018 QIP over 39 years) for such property for one year, may file an amended tax return. However, if the taxpayer has used an impermissible method (recovering 2018 QIP over 39 years) for at least two years, they have established a method of accounting and may not file an amended return to correct the treatment.
Practically, this means that a partnership that revokes or makes a late RPTOB or FTB election must file amended returns for AARs for each year it had QIP additions. However, taxpayers that did not make these elections or change these prior elections may be limited in their ability to file amended returns. Those that have filed both their 2018 and 2019 returns may not be eligible to amend their 2018 return for QIP changes, and would not be able to include a Form 3115 related to 2018 additions on an amended 2019 return filed later than six months after the original due date (excluding any extensions).
Option 3 - AAR
A partnership may choose to file an AAR related to their 2018 or 2019 income tax returns. This option does not generally require the individual partners to amend their returns, but will delay any potential benefit until the year the AAR is filed. The benefit of the additional deductions is allocated to the partners in the year the property was placed in service. If the partners do not have other tax liabilities in the later year, the benefit may be lost.
A partnership that has the option to file an amended return, as described in Option 2 above, and has not elected out of the BBA rules, may file an AAR to take into account the QIP revisions.
Although an AAR is superficially similar to an amended return, the additional deductions are taken into account in a radically different manner. Although the favorable adjustments are “pushed-out” to the partners in the year the QIP is placed in service, the tax effect of the adjustments are not taken into account until the year the AAR is filed (necessarily no earlier than 2020). In addition, the potential benefit is limited to the otherwise applicable tax for 2020, and no interest is paid on favorable adjustments (as would be the case with an amended return).
Partnerships should closely analyze the impact of these options, as each comes with its own benefits and limitations that should be understood before taking action.