Jan 28, 2022 Accounting Methods Webinar Q&A January 2022
An accounting method refers to the set of rules used to report income and expenses for taxation purposes. A change in accounting method includes any change in the taxpayer’s overall method of accounting. The IRS requires taxpayers to choose an accounting method that accurately reflects their income and be consistent in their choice of accounting method from year to year. As a tax planning tool, accounting methods help taxpayers implement cost segregation studies and energy efficiency incentives, adopt beneficial provisions of the Tangible Property Regulations, and numerous other tax minimization strategies. Alex Bagne, JD, CPA, MBA, CCSP recently held a webinar and we are delighted to contribute our expertise by providing answers to your accounting methods questions. » Contact Us for more assistance
1. What if you fix 30% of the items (HVAC and electrical) once a year for 3 years in a row?
The Tangible Property Regulations have anti-abuse provisions and the IRS could view this as an attempt to circumvent these rules.
2. When and why would a taxpayer use non-auto accounting method change instead of auto method?
The list of automatic accounting method changes is finite and does not cover all situations.
3. If you have 6 rooftop HVACs, how many rooftop HVAC’s can you replace before it must be capitalized?
The IRS gives examples that have 1 of 3 rooftop units can be treated as a repair, so 2 of 6 could be replaced and still treated as a repair. The examples go as high as 40%, so if there were 10, I’d say 4 could be treated as a repair. There are rules about purchasing a building that immediately needs repair to function as a building, which would be treated as a restoration and require capitalization. Thus, if a taxpayer purchased a building with 6 rooftop units but only 4 worked, the IRS may treat the 2 units as a restoration and require capitalization.
4. If a taxpayer failed to claim regular depreciation in prior years, should they file a 3115 to catch up on this missed depreciation?
This is a tricky subject. What you described seems to be a correction of an error, which would require amending. However, if the taxpayer treated the asset as non-depreciable land and reclassified it to a depreciable asset, an accounting method would be appropriate.
5. I have been depreciating a rental property based on building/land square footage but I want to change it based upon market value instead. Would this be a change in accounting method?
Yes. You would reallocate the tax basis between land and building. This would be DCN 7.
6. If there is a change of depreciation method for tax purposes, do you also recommend to record the change in the client’s books so everything matches?
If I’m understanding your question correctly, you would want to update the tax depreciation schedule or software to reflect the change such that depreciation is calculated correctly in the current tax year and all subsequent years.
7. Wouldn’t a ghost asset write off be subject to recapture upon sale of the business?
The asset would no longer exist and as such, there would be no recapture upon it.
8. Does it make sense to do a change for single family residence rentals?
It could if there is sufficient basis in the rental. Feel free to reach out to me.
9. Client has been filing tax returns under an incorrect EIN. Is there a form he needs to file to correct the error?
This wouldn’t be fixed as an accounting method change. I believe the correct approach would be to amend. At the very least, I’d add a statement to the current year tax return.
10. Can you please give some examples of internal structural changes that would be excluded as QIP?
Examples of non-QIP items include expanding the building, adding structural walls or supports, and modifying the elevators or escalators.
11. With respect to DCN 244, if the QIP was minor and taken over 39 years, would showing it on the Form 4562 as 39-year property be considered an election OUT of bonus? Said another way, is Form 3115 required to leave things as is, over 39 years, for QIP placed in service in 2018 and 2019? Is the 8 out of 20 sinks an annual test? What if you do the other 8 more in the next calendar year?
The depreciation of QIP as 39-year real property would not be treated as an election out of bonus. A 3115 would not be required to treat it as-is. The 8 out of 20 sinks is an annual test, but there are anti-abuse provisions that may apply.
12. Can an automatic change be done with an amended return?
No, accounting method changes cannot be done on an amended return. If the taxpayer has filed an original tax return and the extended due date for that return has yet to pass, the taxpayer can file a superseding return where the IRS will treat the new return as an original return, and thus allow an accounting method change. Here’s a link that explains: https://www.irs.gov/businesses/corporations/amended-and-superseding-corporate-returns
13. It is not an accounting method change until after the second year, correct?
Correct. There would be no need for an accounting method change if it is an original method.
14. Can you elect to do the 3115 in a higher rate tax year?
Yes. It’s a common strategy to accelerate tax deductions into years where rates are going to be the highest.
15. Can you go back and reclass QIP made in prior years even though the law was different when the work was done?
Designated Change Number (DCN) 244 is specifically for QIP and would not require amending.
16. Can you use the 3115 to go back and claim bonus depreciation?
Yes. That would be DCN 7 for Depreciation, presuming that the taxpayer didn’t elect out of bonus.
17. Do you need a 3115 for cost seg for a new acquired property by a new entity?
If the taxpayer has an appetite for additional tax deductions, a cost segregation would likely be highly beneficial.
18. How do you treat replacement of shingle roof on a residential property if all shingles replaced? Repair or capitalized?
I would treat the shingles the same as a roof membrane, as discussed in the Tangible Property Regulations example, and immediately deduct them. The exception would be if the taxpayer purchased the residential property, and it immediately needed a replacement. Here, it would be a “Betterment.”
19. How does 100% bonus change the 179D Energy Efficient Commercial Building Deduction?
If the improvements qualify for bonus depreciation, then why do the 179D? If the improvements are made to an existing building, qualify as QIP, and are made when 100% bonus depreciation is in effect, there would be no need for 179D. If it is new construction, an exterior improvement (e.g., new roof, new HVAC system, etc.), or when assigned by a public agency to a designer, 179D can still prove very valuable. There are some nuances here that I’d be glad to discuss.
20. I have a client that drives trucks and farms sod who built a house on their personal land. The plan to use a portion of the land for farming the sod. Is there a benefit for them?
There potentially is a benefit but we would need to gather more information. Feel free to reach out to us.
21. I have a client who inherited rental properties from her husband in 2014. She has reported the income in all years since but no deprecation. She has now sold one of the properties.
There is an automatic accounting method that seems to fit your situation for the sold property. It is DCN 107, Impermissible to permissible method of accounting for depreciation or amortization for disposed depreciable or amortizable property.
22. I have a specific scenario about the Depreciation change and when can you do it. For example, a taxpayer has a rental in 2020 but did not depreciate it. When we are going to do 2021, we found the error of the missed depreciation. Can we file a Form 3115 Depreciation change in 2021 or should I advise the client to amend the previous year since it is within 3 years or 2 when taxes paid?
The technically correct answer would be to amend. We have taken the position where the taxpayer just treated the asset as non-depreciable land, and we made an accounting method to change it.
23. I’d like to hear more details about QIP for rent home rehabbing and renting. Seems you are saying it’s 15-year property and now qualified for bonus on rent homes?
Please note that QIP does not apply to residential real estate. It applies only to commercial properties.
24. If a taxpayer file a Form 3115 for 179D study after a return is filed, how soon or can the same taxpayer file another Form 3115 if another for the study on another building if a tax return is already filed?
The taxpayer can file a 3115 for another building
25. If a client filed a Form 3115 DCN 7 on a property, then two years later wants to prepare a second one for another rental, is he prevented since he used DCN 7 on a filed Form 3115 within 5 previous years.
Fortunately, the taxpayer would be able to file a second Form 3115. There are rules that often prohibit making the same accounting method more than once within a 5-year window. However, these apply to each material item. Depreciation on the two properties is treated as separate material items, so he would be able to file a second Form 3115 within 5 years of the first. If he wanted to change depreciation on the FIRST Form 3115, he would need to wait 5 years to do so.
26. If depreciation for foreign rental was taken for the first 2 years over 27.5 vs 39 years, is a Form 3115 needed? Can taxpayer just change it in the 3rd years to a correct amount without accounting method change?
The technically correct answer would be to make an accounting method change.
27. If I have a potential method change for both depreciation and amortization, both automatic, is the best approach to file two 3115s with DCN 7, or is it possible to combine into one Form?
It would be best and likely required to file both the depreciation and amortization changes using one Form 3115.
28. Is the 481(a) adjustment taken over 4 years?
If it is a positive adjustment, it is generally spread over 4 years. If it is a negative adjustment, the taxpayer generally takes it over 1 year. Negative adjustments are generally favorable to taxpayers (e.g., such as accelerating depreciation).
29. Is there a 3-year statute of limitation issue when catching up for prior year 481(a) adjustment? In your example, you went back 4 years for the adjustment.
No. For depreciation changes, we are still going back as far as the late 1990’s.
30. Please define “Roof Membrane”. What about the plywood underneath?
For a flat roof, the membrane is the rubber layer on top that suffers the most wear. If all the plywood decking is replaced, I’d be inclined to capitalize the cost. If all the roof membrane is replaced and only a small portion of the decking and flashing is replaced, I’d be included to treat it as a repair expense. This is very much a facts and circumstances test and I’d be glad to discuss further.
31. QIP requires bonus depreciation unless elected out. Does the retroactive change require an amended return?
Designated Change Number (DCN) 244 is specifically for QIP and amending is not required.
32. Should I file a 3115 for a change from IFRS to US GAAP?
Possibly. Please remember that neither IFRS nor US GAAP is appropriate for tax purposes. For example, the federal income tax rules have its own way for calculating depreciation very different than IFRS or GAAP. If the IFRS to GAAP change affects how income tax is computed, I would presume some sort of accounting method change is necessary.
33. So have a client where the roof membrane was replaced along with a couple of rotted trusses that were under the place where a leak occurred but 80% of the trusses were fine and not replaced. Now the inside where the leak occurred and rotted the ceiling will also need replacing (probably 20% of the ceiling) would both be available for immediate deduction?
This is very much a facts and circumstances analysis but from what you describe and based upon the examples in Tangible Property Regulations, I’d likely recommend that these items be expensed.
34. So, if at the start we separate the building from some of the listed items inside the property, then no need to do a method of accounting change? Is that correct?
Yes. If you segregate the assets of a building between personal property, land improvements, and real property and haven’t yet filed the tax return, there is no need to do an accounting method change. You haven’t yet established a method to change.
35. When you change your accounting method, do you need to get approval from the IRS?
For automatic accounting methods, no IRS approval is necessary. Automatic accounting method changes are the ones with Designated Change Numbers, and most are listed on the Form 3115 instructions. All others would need approval.
36. When you file an automatic change do you file form 3115?
Yes. All accounting method changes, whether automatic or non-automatic, require a filing of a Form 3115.
37. Which DCN would the change of depreciating old assets with more accelerated depreciation be?
This generally would be DCN 7.
38. Would you catch up all that is owed for back years due to the change or just to the basis over the new life.
You would catch up all the deductions that the taxpayer is entitled to through the beginning of the current tax year using the 481(a) adjustment. For the current and future tax years, you would calculate the deductions as if the taxpayer took the accounting method change from day 1.