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Electing
the Ratable Accrual Method to Accrue Real Property Taxes
Pursuant to Internal Revenue Code Section 461: General Rule for Taxable Year of Deduction by William Brighenti, Certified Public Accountant, Certified QuickBooks ProAdvisor Accountants CPA Hartford, LLC of Berlin, Connecticut  You
have chosen the accrual method as the accounting method on your tax
return. You recognize revenues when earned and expenses when
incurred. Last year you received real property tax bills but did
not paid them because of insufficient cash flow. You deducted the
real property taxes on your tax return since you are on the accrual
method for tax purposes. You are subsequently audited by the
Internal Revenue Service and denied this deduction. Why?According to the Internal Revenue Code Section 461, in order for a liability to have been incurred, allowing the deduction of an expense for Federal income tax purposes, ordinarily several criteria need to be met, two of which are contained in the “all events test” and one in the concept of “economic performance”. The all-events test has been met when:
Like many of the tax rules promulgated by the Treasury Department, there is an exception to the requirement of payment of the tax for economic performance to occur in order for its deductibility on one’s tax return: “certain recurring items”, mentioned in paragraph (g)(6), are treated as incurred during the year and, hence, deductible for Federal income tax purposes. For an item to be regarded as a recurring item during the year, it needs to possess these following characteristics:
Referring to a Senate Report issued in 1986, the United States Tax Court made clear in its memorandum decision of the case, Madler v. Commissioner, the meaning of active participation on the part of the taxpayer: the
taxpayer participates,
e.g., in the making of management decisions or arranging for others to
provide services (such as repairs), in a significant and bona fide
sense. Management decisions that are relevant in this context
include approving new tenants, deciding on rental terms, approving
capital or repair expenditures, and other similar
decisions.
For any entity that is not a tax shelter, that entity is permitted to adopt the recurring item exception as part of its method of accounting for any type of item meeting the criteria mentioned above for the first taxable year in which that type of item is incurred, thus allowing it to meet the economic performance requirement and to deduct it on its current year’s tax return. The election is effected simply by deducting the item in its first year of incurrence. There is no form required to be filed with the tax return stating overtly its election for the recurring item(s). The act of doing such in its first year’s occurrence suffices. Conversely, any partner who receives more than 35% of the profits and losses of the partnership and who does not actively participate in the management of said partnership has characterized that partnership as a tax shelter to the IRS; consequently, that partnership would not be able to accrue real property taxes under the recurring item exception under IRC Sec. 461(h)(3). For those partnerships and other entities that are construed as tax shelters by the IRS, making them ineligible for the recurring items exception to the recognition of economic performance prior to payment, there is an election available to them to ratably accrue real property taxes. This method is not surprisingly referred to as the “ratable accrual method” and is briefly described in Section 461(c). Under this method, the real property taxes are presumed to accrue ratably, or in proportion to the amount of time, over the periods to which they relate. For instance, if real property taxes relate to years beginning July 1st and ending June 30th, then under the ratable accrual method, if the current tax year is 2010, one-half of the real property taxes for the property tax year ending June 30, 2010, and one-half of the real property taxes for the property tax year ending June 30, 2011 would be deductible to the calendar year taxpayer for the year 2010. Unlike the recurring item exception method, the ratable accrual method does require a statement of election to be filed along with the taxpayer’s tax return for the first year in which the property tax is incurred, even though consent is not required from the Internal Revenue Service. In other words, the election is automatic upon filing a statement of election. The statement needs to include the following information:
The taxpayer is also required here to include its method of accounting for taxes since the election is available to accrual basis taxpayers. For real property taxes, the period of time to which the taxes relate refers to the tax year of the real property taxes and not that of the taxpayer. If the real property tax year was July 1st through June 30th, the taxpayer would indicate the time period for one's fiscal or calendar tax year as follows: July 1, through June 30. The computation of the deduction for real property taxes for the first year of the election need not be overly complicated; however, it should tie-in to the amount reported on the tax return. For instance, assume real property taxes for the real property tax year of July 1, 2009 through June 30, 2010 were $6,000; and assume real property taxes for the real property tax year of July 1, 2010 through June 30, 2011 were $7,000. A summary schedule as follows would ordinarily suffice on the election statement:
It is advisable to include an appropriate heading to the election statement. For instance, the heading might read as follows: Election to Ratably Real
Property Taxes
The taxpayer [or
partnership] elects under IRC 461(c) to ratably accrue real property
taxes.
The following information is provided in accordance with Regulation 1.461-(1)(c)(3)(i). If the taxpayer wishes to elect this method after the first year of its incurrence, then it would require the consent of the Internal Revenue Service. The taxpayer would need to file a written request within ninety days after the beginning of the taxable year and would need to include the information mentioned above as well as additional information:
This article is provided for informational purposes and is not intended to be construed as legal, accounting, or other professional advice. For further information, please consult appropriate professional advice from your attorney and certified public accountant. Have a tax, a QuickBooks, or an accounting question? Please feel free to submit it under "Comments" on our blog, Accounting, QuickBooks, and Taxes by William Brighenti, Certified Public Accountant, Accountants CPA Hartford, LLC. For information and assistance on any tax, QuickBooks, or accounting issue, please visit our website: Accountants CPA Hartford, LLC. Please visit our sister website, Intense Flavors, and see how you can have a gourmet meal on us when we do your accounting, QuickBooks, and taxes. If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. The above tax advice was written to support the promotion or marketing of the accounting practice of the publisher and any transaction described herein. The taxpayer recipients of this offering memorandum should seek tax advice based on their particular circumstances from an independent tax advisor. |
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