The IRS released guidance providing temporary relief to partnerships subject to the Bipartisan Budget Act of 2015 by allowing partnerships to file amended returns and avoid the stranded overpayment problem—for now. Greg Armstrong of KPMG LLP walks through Revenue Procedure 2021-29 and notes that it is only a temporary reprieve until the issue is addressed through legislation or litigation or a change in the IRS’s position.
The IRS has provided welcome, temporary relief to partnerships subject to the Bipartisan Budget Act of 2015 (BBA partnerships) that are electing real property trades or businesses and that seek to apply a recovery period of 30 years under the alternative depreciation system for certain residential rental property.
Revenue Procedure 2021-29, released June 17, 2021, offers BBA partnerships that meet certain requirements the opportunity to file an amended return to effectuate such changes instead of filing an administrative adjustment request (AAR) under tax code Section 6227. Such amended returns must be filed on or before Oct. 15, 2021.
The AAR process under the BBA imposes new reporting requirements and features new forms and instructions. As taxpayers and practitioners continue to struggle with the new AAR procedures, the ability to amend returns using the more familiar amended return process, even if only temporary, is a welcome alternative to having to file an AAR.
Allowing partnerships to file amended returns also helps mitigate an issue that under the IRS’s interpretation of the BBA rules could affect an individual or tax-paying partner required to take into account adjustments reported on an AAR, known as the “stranded overpayment” problem. See ABA Tax Section, Comments on the BBA Stranded Overpayment Problem (March 24, 2021).
Although Rev. Proc. 2021-29 offers a temporary reprieve from the stranded overpayment problem, as discussed below, the potential for partners in BBA partnerships to miss out on refunds attributable to AAR adjustments will continue to remain an issue. Earlier this year, the Biden administration introduced a legislative proposal to address the stranded overpayment problem in its Greenbook. See May 31 KPMG report: Analysis and observations of tax proposals in Biden Administration’s FY 2022 budget.
The “Tax Cuts and Jobs Act” (TCJA) added residential rental property held by an electing real property trade or business—i.e., a real property trade or business that has elected not to apply the interest limitation provisions of Section 163(j)—to the list of property for which the use of the alternative depreciation system (ADS) under Section 168(g) is required. The TCJA also changed the ADS recovery period under Section 168(g)(2) for residential rental property placed in service after Dec. 31, 2017, from 40 years to 30 years.
Section 202 of the “Taxpayer Certainty and Disaster Tax Relief Act of 2020” (TCDTRA), enacted Dec. 27, 2020, amended the TCJA to retroactively allow for a recovery period of 30 years for residential rental property placed in service before Jan. 1, 2018. Such residential rental property must be held by an electing real property trade or business and must not have been previously subject to the ADS. Rev. Proc. 2021-28, released on the same day as Rev. Proc. 2021-29, provides guidance for taxpayers seeking to effectuate the changes made by Section 202 of the TCDTRA.
The BBA repealed the prior partnership audit procedures and introduced a new centralized partnership audit regime for taxable years beginning in 2018. (A partnership may elect the application of the BBA rules to years beginning after Nov. 2, 2015, and before Jan. 1, 2018. See Treasury Regulation 301.9100-22.) The BBA rules apply to all partnerships that are required to, or that do, file Form 1065, unless the partnership elects on Form 1065 not to have those procedures apply.
BBA partnerships generally may not file amended returns or issue amended Schedules K-1 after the partnership return due date (including extensions), unless the IRS provides otherwise. Instead, a BBA partnership must file an AAR to adjust for any taxable year subject to the BBA any partnership-related item, i.e., any item or amount reflected, or required to be reflected, on Form 1065 or Schedule K-1, or required to be maintained in the partnership’s books and records, provided the item or amount is relevant in determining any partner’s Chapter 1 tax.
Rev. Proc. 2021-29 exercises the IRS’s authority to allow BBA partnerships to file amended returns and issue amended Schedules K-1 after the return due date in lieu of having to file an AAR. Rev. Proc. 2021-29 applies to BBA partnerships that filed a return and furnished all required Schedules K-1 prior to June 17, 2021, for a tax year beginning in 2018, 2019, or 2020. The BBA partnership must be an electing real property trade or business that is seeking to change its depreciation method or general asset account treatment for residential rental property that was placed in service before Jan. 1, 2018, and that was not otherwise subject to the ADS prior to Jan. 1, 2018. The partnership may also qualify if it chooses to make a late Section 163(j)(7) election in accordance with Rev. Proc. 2020-22.
To take advantage of the Revenue Procedure relief, the partnership must file Form 1065, check the “Amended Return” box, and indicate at the top of the return “FILED PURSUANT TO REV PROC 2021-29.” The partnership must also furnish corresponding amended Schedules K-1 to each of its partners with an attached statement bearing the same notation. An amended return filed under Rev. Proc. 2021-29 must be filed on or before Oct. 15, 2021. The Rev. Proc. requires that the amended return must take into account changes under Section 202 of the TCDTRA; however, the partnership also may make any other change on the amended return.
This is a welcome clarification given that one change on the Form 1065 or a Schedule K-1 can lead to multiple changes to other items on the return, or it may be the case the partnership has adjustments both related to and unrelated to Section 202 of the TCDTRA. In Rev. Proc. 2020-23, the IRS provided similar relief allowing eligible BBA partnerships to file amended returns and issue amended Schedules K-1 for certain 2018 and 2019 tax years. The relief under Rev. Proc. 2020-23, however, was available for any adjustments to the original return and did not require adjustments to be made under a specific statutory provision.
Filing an amended return under Rev. Proc. 2021-29 does not affect the application of the BBA rules to the taxable year for which the amendment was filed. For example, the BBA rules will still apply to an IRS examination of the partnership return or if further amendments to the return are necessary after Oct. 15, 2021, an AAR would need to be filed (absent further IRS relief). Unlike an AAR, the amended return generally will not extend the statute of limitations for the taxable year.
An amended return filed under Rev. Proc. 2021-29 constitutes the partnership’s return for the taxable year for purposes of the consistent reporting rules under Section 6222. Rev. Proc. 2021-29 provides special rules for partnerships that are under IRS examination, that previously filed an AAR, or that fall within the ambit of Notice 2019-46 (regarding application of the proposed regulations under proposed Section 1.951A-5).
Notwithstanding the relief afforded by Rev. Proc. 2021-29, a partnership may file an AAR to effectuate a change required by Section 202 of the TCDTRA. A partnership that chooses to file an AAR should be aware that in some cases as a result of the IRS’s interpretation of the BBA rules an overpayment arising from an AAR adjustment can become “stranded” in a prior year, as described below.
When a partnership files an AAR, the partnership must determine whether the AAR adjustments result in an imputed underpayment. The partnership may elect to have its partners take into account such adjustments by pushing out the adjustments to each partner on Form 8986. The partnership must push out on Form 8986 any AAR adjustments that do not result in an imputed underpayment.
An individual or tax-paying partner that receives a Form 8986 generally must determine the tax effect of the BBA adjustments on the partner’s Chapter 1 tax liability for years affected by the adjustments and report the aggregate tax effect on its return for the year that includes the date the Form 8986 was furnished (the “reporting year”). If the aggregate tax effect of the adjustments is an overall decrease in tax, that decrease in tax can reduce the partner’s reporting year Chapter 1 tax liability to zero, allowing for a refund of taxes overpaid for the reporting year.
However, it is the IRS’s position that any excess amount cannot independently generate a refund. Thus, to the extent the aggregate tax effect from the BBA adjustments exceeds the reporting year taxes paid, it appears the IRS would not issue a refund for the excess. The end result is that the partner, on a cumulative basis, has overpaid tax and the partner may be left with a “stranded overpayment” in a prior year.
How to recoup that stranded overpayment is unclear under current IRS guidance, and more troubling, the prior year refund statute of limitations may be closed by the time the partner is aware of the BBA adjustments. The mechanics described above and the stranded overpayment problem also apply in the case of adjustments made by the IRS in a partnership-level examination and that are pushed out by the partnership to its partners.
Although Rev. Proc. 2021-29 provides a temporary reprieve from the stranded overpayment problem, the issue will continue to be of concern to taxpayers in partnerships filing future AARs or that become subject to an IRS examination. The Biden administration’s Greenbook introduced a legislative proposal that would address the stranded overpayment problem.
See May 31 KPMG report: Analysis and observations of tax proposals in Biden Administration’s FY 2022 budget. Absent the issue being addressed through legislation or litgation, a change in the IRS’s position, or further relief from the government, a partnership that is considering whether to file an AAR should be attuned to the potential impact of the stranded overpayment problem on its partners.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Greg Armstrong is a director in the Tax Controversy & Dispute Resolution Services group in the Washington National Tax practice of KPMG LLP. Greg would like to thank Ossie Borosh and Lynn Afeman for their insights and comments on earlier drafts of this article.
The information in this article is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the author(s) only, and does not necessarily represent the views or professional advice of KPMG LLP.
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