IRS consent not required for property classification change.

B undertook construction of gas station properties at grocery store locations in Texas. Initially, B's corporate tax returns identified the gas stations as nonresidential real property under the modified accelerated cost recovery system (MACRS) rules, and used straight-line depreciation for periods of 31.5 or 39 years on its 1993-1995 returns. B subsequently filed amended returns for those three tax years, reclassifying the gas stations as 15-year property under an IRS Industry Specialization Program Coordinated Issue Paper, and recalculating depreciation under the MACRS 150% declining balance (DB) method over a 15-year recovery period. The IRS accepted the amended returns and issued full refunds to B for 1993 and 1994, and a partial refund for 1995.

For 1996 and 1997, B continued to classify and depreciate the gas station properties in the same manner as on the amended 1993-1995 returns. B never filed Form 3115, Application for Change in Method of Accounting, for the gas station properties. As a result, the IRS issued a deficiency notice for 1996 and 1997, asserting, inter alia, that B's depreciation deductions for those years had to be decreased because B had changed its accounting method without obtaining prior consent. The IRS does not contend that the method used by B for 1996 and 1997 is either improper or impermissible.

Analysis

Sec. 446(e) requires that "a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary." Regs. Sec. 1.446-1 (e)(2)(ii)(b) states that "[a] change in method of accounting does not include adjustment of any item of income or deduction which does not involve the proper time for the inclusion of the item of income or the taking of a deduction. In addition, a change in the method of accounting does not include ... an adjustment in the useful life of a depreciable asset."

When an accounting practice merely postpones income reporting, rather than permanently avoids the reporting of income over the taxpayer's lifetime, it involves the proper time for reporting income. B neither altered its overall accounting plan for income and deductions on an accrual basis, nor changed its basic accounting system for depreciation. The change from straight-line depreciation over a 31.5- or 39-year period to the DB method over a 15-year period, however, involves the timing of deductions rather than the total amount of lifetime income. At first glance, this appears to be a material difference and, thus, potentially an accounting-method change. However, this putative change is subject to the exception for an adjustment in a depreciable asset's useful life.

The applicable regulations were meant to allow taxpayers to make temporal changes in their depreciation schedules without prior IRS consent. Clearly, doing so would produce changes in the period over which deductions are taken, as well as concomitant changes in the deduction amount for any given tax year; such a change under MACRS would produce exactly the same results. Thus, B's change in the classification of its gas station properties from straightline depreciation of nonresidential real estate to DB depreciation of 15-year property is not a change in the taxpayer's accounting method for Sec. 446 purposes and does not require IRS consent.

Time Bar

Even if there was a change in accounting method not exempt under the useful-life exception, there still was only one change, the one that was made for 1993. Because depreciation for all the following years was treated identically, there was no change for any subsequent year (specifically, none for 1996 and 1997). Thus, for the IRS to challenge B's switch from straight-line to DB under MACRS, it would have to have done so for 1993. However, that year was closed by the time the IRS assessed a deficiency.

Regs. Sec. 1.446-1(e)(3)(i) requires the taxpayer to secure IRS consent "during the taxable year in which the taxpayer desires to make the change in method of accounting." Thus, the IRS is (1) time-barred from asserting lack of consent for the closed tax year ending in 1993 and (2) precluded from challenging the continued use of the 1993 change by assessing deficiencies in subsequent open years, beginning with 1996.

BROOKSHIRE BROS. HOLDING CO., 5TH CIR., 1/29/03

REFLECTIONS: The Fifth Circuit's holding affirmed the Tax Courts decision; see TC Memo 2001-150 (discussed in Holland and Mackles, Tax Clinic, "Is Property Classification under MACRS an Accounting-Method Change?" TTA, March 2002, p. 153). In Green Forest Manufacturing, Inc., TC Memo 2003-75, Green's prior depreciation deductions had to be reduced, because they should have been computed using the alternative depreciation system for tangible property used outside the U.S. Thus, the equipment had to be reclassified under Sec. 168(g)(1)(A) and depreciated using the straight-line method and a 10-year recovery period. Following the Fifth Circuit's derision in Brookshire Bros. Holding above, the Tax Court concluded that it did not constitute an accounting-method change and did not require a Sec. 481(a) adjustment.