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TAX CLINIC

Rev. Proc. 2021-28, which is made on a that own and operate residential liv- Background
modified cut-off basis, and, accordingly, ing facilities were given a safe harbor If a partnership has an election under
a Sec. 481(a) adjustment is neither per- to consider themselves eligible to be Sec. 754 in effect, a basis adjustment
mitted nor required. a real property trade or business, and under Sec. 743(b) to partnership prop-
An illustration of the Sec. 481(a) taxpayers that had already made the erty is made upon a sale or exchange of
computation under Section 6.05 of Rev. real property trade or business elec- a partnership interest or a transfer of a
Proc. 2019-43 may be helpful. A taxpay- tion were given procedural guidance partnership interest on the death of a
er placed in service a residential rental to allow them to take advantage of partner. Additionally, even if a partner-
property with a $5 million basis in early the shortened ADS recovery period. ship does not have an election under
2016, depreciated the property straight However, as noted above, the option Sec. 754 in effect, if the partnership has
line over a 27.5-year life, and claimed to take advantage of the 30-year ADS a “substantial built-in loss,” the partner-
approximately $350,000 of depreciation recovery period by amending a tax re- ship is required to make a Sec. 743(b)
expense as of Dec. 31, 2017. Therefore, turn or filing an AAR is time-sensitive, basis adjustment upon such a transfer.
the taxpayer had an adjusted basis in the as the due date for both is April 15, A substantial built-in loss with regard
property of about $4,650,000 immedi- 2022. Taxpayers that either cannot to a transfer of an interest in a partner-
ately prior to making the real property meet that deadline or that do not want ship is present if (1) the partnership’s
trade or business election. In its timely the administrative burden of amending adjusted basis in the partnership prop-
filed 2018 return, the taxpayer makes the several years’ worth of tax returns may erty exceeds by more than $250,000 the
real property trade or business election request an automatic method change. fair market value (FMV) of the property,
and properly follows the change-in-use This means that the taxpayers have or (2) the transferee partner would be
rules to begin depreciating the property additional time to assess their situ- allocated a loss of more than $250,000 if
using the 40-year ADS recovery period. ations and take actions accordingly the partnership assets were sold for cash
As of Dec. 31, 2020, the taxpayer had to take advantage of the taxpayer- equal to their FMV immediately after
claimed an additional $365,000 of de- favorable procedure. such transfer.
preciation using its new life. From Caleb Cordonnier, CPA, The definition of a substantial
The taxpayer chooses to use the Washington, D.C., and Jason Seo, J.D., built-in loss was broadened in the law
revised automatic method change pro- LL.M., Washington D.C. known as the Tax Cuts and Jobs Act,
vided by Rev. Proc. 2021-28 to correct P.L. 115-97. Prior to the amendment
the ADS depreciable life of the property in 2017, a substantial built-in loss was
in 2021. To compute the Sec. 481(a) Partners & Partnerships present only if the first part of the defi-
adjustment, the taxpayer calculates nition was met — i.e., the partnership’s
depreciation expense as if the property Reporting aspects of adjusted basis in the partnership prop-
had been depreciated using the correct Sec. 743(b) adjustments erty exceeded by more than $250,000
recovery period from the date that the The reporting rules for partnerships the FMV of the property. A Sec. 743(b)
real property trade or business election regarding basis adjustments under Sec. basis adjustment is made only with
was made, which is Jan. 1, 2018. There- 743(b) have been in place for over 20 respect to the transferee; it differs from
fore, the taxpayer recalculates its 2018, years, but, often, not all the pieces of the a basis adjustment under Sec. 734(b),
2019, and 2020 depreciation expense rules are stuck in the memory of a part- which is a common basis adjustment
using the 30-year ADS recovery period, nership’s advisers. Thus, at compliance that is not isolated to one partner. The
which is about $495,000 of depreciation work time, as well as throughout the substantive aspects of Sec. 743(b) adjust-
through Dec. 31, 2020. The additional year, a review of the various pieces of the ments are not the focus of this discus-
$130,000 of depreciation expense is a rules will help ensure that a partnership sion. Rather, this discussion focuses on
favorable Sec. 481(a) adjustment that the return is complete and that computa- their reporting aspects.
taxpayer will include entirely in its 2021 tions are accurate. Knowing the report- The current reporting rules for
tax return. ing rules is important; but, of course, partnerships with regard to Sec. 743(b)
there is no substitute for gathering adjustments were promulgated in T.D.
Taking advantage of complete information and understand- 8847, in which the Sec. 743(b) adjust-
taxpayer-favorable changes ing the Subchapter K rules to apply ment rules, along with other basis
The last year has brought several them properly. However, the reporting adjustment and allocation rules, were
favorable changes for taxpayers that rules need to be more detailed to address overhauled. At that time, the IRS and
own residential properties. Taxpayers certain common transactions. Treasury affirmatively moved to place

24 February 2022 The Tax Adviser