Section 481 undermines SOL when a Section 446 change in accounting method (imposed by IRS) causes a rollback to closed years. For Gary Pinkston and Janice Pinkston, 2020 T. C. Memo. 44, filed 4/13/20, even having seven (count ‘em, seven) lawyers to contend with IRS’ two, cannot defeat the inexorable slugfest that IRS’ reallocation between nondepreciable land and depreciable improvements thereto wreaks on their island paradises.

Gary and Janice own a couple Hawaiian rental properties (hi, Judge Holmes). They have to use Section 168 MACRIS depreciation, so they load up the improvements and downplay the land. My former (I stress the word “former”) clients would describe this as “mach gresser, mach veyniger.”

Well, Judge Albert G (“Scholar Al”) Lauber isn’t impressed.

“Section 481, captioned ‘Adjustments required by changes in method of accounting,’ was enacted as part of the 1954 Code. It applies in situations where a taxpayer’s income for a particular year (the ‘year of change’) is computed ‘under a method of accounting different from the method under which the taxpayer’s taxable income for the preceding taxable year was computed.’ In that event section 481(a)(2) provides that ‘there shall be taken into account those adjustments which are determined to be necessary solely by reason of the change in order to prevent amounts from being duplicated or omitted.’” 2040 T. C. Memo. 44, at pp. 8-9.

Even though Section 481 has been criticized as “codified confusion,” the Courts, says Judge Scholar Al, have concluded that if prior (closed) years couldn’t be adjusted after the year of change, the statute would be virtually useless. And duty of consistency doesn’t o’ercrow the powers of Congress.

The tests for a change in method are materiality of the item and prior consistency of treatment. Well, Gary and Janice certainly were consistent over the time they owned each of their paradises. And depreciation is certainly a timing issue: if they depreciate their basis quickly, when they sell or dispose, basis lower, so their gain is greater; if depreciate slowly, basis higher, gain less. And timing issues are material.

What we have here is a change in MACRIS classes for improvements and timing of deductions. These trigger both the reporting of income and the allowance of deductions. And Gary and Janice will still recover their allowable cost bases; the only question is when and how.

Gary and Janice (and their seven lawyers) argue that IRS didn’t change their method, only the characterization of their deductions.

“Changes that affect whether, as opposed to when, an item is includible in (or deductible from) gross income generally do not implicate changes of accounting method.

“Here, it is far from clear that respondent’s basis reallocations are aptly described as involving ‘characterization’ of petitioners’ real estate. But even if they do, it would not matter. Because the IRS has initiated changes only in the timing of petitioners’ cost recovery, it makes no difference whether the changes coincide with or result from a change in character.” 2020 T. C. Memo. 44, at p. 16.

Reg. Section 1.446-1(e)(2)(ii)(d)(1) applies to Section 168 (MACRIS) property, and depreciation or amortization of same. True, the same Reg. also takes Section 167 property out of change-in-method, as far as “useful life” calculations are concerned. But what Gary and Janice have is Section 168 property, and therein are found specific statutory useful lives.

And there are no changes in underlying facts that might confine change-of-method to year of change.

But all Judge Scholar Al decides is that Section 481 is in play. Whatever other beeves exist between Gary and Janice, and IRS, are for another day.