Taxpayers receive late election to capitalize property taxes

Plain-English summary

A married couple held two parcels of unimproved, unproductive real estate for investment and deducted the property taxes instead of electing under section 266 to add them to the properties' tax basis. Their return preparer had not known about the election, and the deduction provided limited benefit because the taxpayers were subject to the alternative minimum tax. After one parcel was sold, the taxpayers requested extra time to make the election for the earlier year. The IRS found that the later sale did not make the election advantageous through hindsight because the election would not change the gain computed for alternative minimum tax purposes. It granted 90 days to make the election for both parcels.

Ruling snapshot

• Question: May the taxpayers make a late section 266 election to capitalize property taxes on two investment parcels?
• Outcome: Yes, they have 90 days to make the election for the earlier year.
• Key authorities: IRC §§ 56, 164, and 266; Treas. Reg. §§ 1.266-1, 301.9100-1, and 301.9100-3

Full text (IRS public release)

Internal Revenue Service                                        Department of the Treasury
                                                                Washington, DC 20224

Number: 201607005                                               [Third Party Communication:
Release Date: 2/12/2016                                         Date of Communication: Month DD, YYYY]
Index Number: 9100.05-00
                                                                Person To Contact:
-------------------------------------------------               ----------------------------, ID No. ----------
-----------------------------
--------------------------                                      Telephone Number:
                                                                ---------------------
                                                                Refer Reply To:
                                                                CC:ITA:B6
                                                                PLR-116986-15
                                                                Date:
                                                                November 10, 2015

LEGEND

Year 1                                       =        -------

Year 2                                       =        -------

Taxpayers                                    =        -------------------------------------------------
                                                      --------------------------------------------------

Lot A                                        =        ---------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------

Lot B                                        =        ---------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------

County                                       =        -------------------------

State                                        =        --------------------

Month                                        =        -------

Year 3                                       =        -------

Dear --------------------------------------:

This letter responds to a request for an extension of time under sections 301.9100-1
and 301.9100-3 of the Procedure and Administration Regulations to elect to capitalize
property taxes pursuant to section 266 of the Internal Revenue Code for the Year 1
calendar year.

                                                     FACTS
PLR-116986-15                                 2

Taxpayers are married individuals who timely filed a joint federal income tax return for
the Year 1 calendar year on or around April 15, Year 2. Taxpayers represent that they
owned and held for investment purposes two parcels of unimproved and unproductive
real property (Lot A and Lot B) during Year 1, which are located in County, State.
Taxpayers paid property taxes on these investment properties in Year 1 and did not
elect under section 266 to capitalize these taxes to the properties. Instead, the property
taxes were reported as itemized deductions by Taxpayers on their Year 1 federal
income tax return. In Year 1, Taxpayers were subject to the alternative minimum tax
(“AMT”). Because the deduction for property taxes is not allowed in computing AMT,
Taxpayers obtained a limited tax benefit from reporting the property taxes as itemized
deductions for Year 1.

Taxpayers' tax return preparer (Preparer) was not aware of and therefore did not advise
Taxpayers of the opportunity to make an election under section 266 and sections 1.266-
1(b)(1) and (c)(3) of the Income Tax Regulations to capitalize taxes on unimproved and
unproductive real property. In Month of Year 2, Taxpayers sold Lot B for a capital gain.
In Year 3, when Preparer was completing preparation of Taxpayers’ Year 2 federal
income tax return, Taxpayers’ accountant alerted Preparer to the opportunity of
Taxpayers making the election to capitalize property taxes under section 266. Preparer
then advised Taxpayers of the opportunity to make this election, which Taxpayers did
on their Year 2 return. Preparer then also informed Taxpayers of the possibility of filing
a request for a private letter ruling granting extensions of time under sections 301.9100-
1 and 301.9100-3 to file a section 266 election for Year 1.

Preparer represents that Taxpayers relied on him to provide tax advice. Preparer states
that “Until [Year 3], I did not appreciate that the election under section 266 to capitalize
certain expenses paid or incurred with respect to nonproductive real property extended
to property taxes.”

                                  LAW AND ANALYSIS

Section 56(b)(1)(A)(ii) provides that in determining the amount of the alternative
minimum taxable income, no deduction shall be allowed for any taxes described in
section 164(a)(1).

Section 164(a)(1) provides that a deduction for state and local, and foreign real property
taxes are allowed as a deduction for the taxable year within which paid or accrued.

Section 266 provides that no deduction shall be allowed for amounts paid or accrued for
such taxes and carrying charges as, under regulations prescribed by the Secretary, are
chargeable to capital account with respect to property, if the taxpayer elects, in
accordance with such regulations, to treat such taxes or charges as so chargeable.
PLR-116986-15                                 3

Section 1.266-1(b)(1) provides in part that the taxpayer may elect, as provided in
paragraph (c) of this section, to treat the items enumerated in this subparagraph which
are otherwise expressly deductible under the provisions of subtitle A of the Code as
chargeable to capital account either as a component of original cost or other basis, for
the purposes of section 1012, or as an adjustment to basis, for the purposes of section
1016(a)(1). The items thus chargeable to capital account are –

       (i) In the case of unimproved and unproductive real property: Annual taxes,
       interest on a mortgage, and other carrying charges.

Section 1.266-1(b)(2) provides that an item not otherwise deductible may not be
capitalized under 266.

Section 1.266-1(c)(2)(i) provides that an election with respect to an item described in
paragraph (b)(1)(i) is effective only for the year for which it is made.

Section 1.266-1(c)(3) provides in part that if the taxpayer elects to capitalize an item or
items under this section, such election shall be exercised by filing with the original return
for the year for which the election is made a statement indicating the item or items
(whether with respect to the same project or to different projects) which the taxpayer
elects to treat as chargeable to capital account.

Under section 301.9100-1(c), the Commissioner has discretion to grant a reasonable
extension of time to make a regulatory election under all subtitles of the Code except
subtitles E, G, H, and I, provided that the taxpayer acted reasonably and in good faith
and granting relief will not prejudice the interests of the Government. Section 301.9100-
1(b) defines a “regulatory election” as an election whose due date is prescribed by a
regulation published in the Federal Register, or a revenue ruling, revenue procedure,
notice, or announcement published in the Internal Revenue Bulletin. An “election”
includes an application for relief in respect of tax as well as a request to adopt, change,
or retain an accounting method.

Section 301.9100-3 provides extensions of time to make regulatory elections under
Code sections other than those for which section 301.9100-2 expressly permits
automatic extensions.

Section 301.9100-3(a) provides in part that the Commissioner will grant a request for an
extension of time when a taxpayer provides the evidence, including affidavits described
in paragraph (e), establishing to the Commissioner's satisfaction that the taxpayer acted
reasonably and in good faith, and that the grant of relief will not prejudice the interests
of the Government.

Section 301.9100-3(b)(1) provides in part that except as provided in paragraphs (b)(3)(i)
through (b)(3)(iii), a taxpayer is deemed to have acted reasonably and in good faith if
PLR-116986-15                                  4

(A) the taxpayer failed to make the election because, after exercising reasonable
diligence (taking into account the taxpayer's experience and the complexity of the return
or issue), the taxpayer was unaware of the necessity for the election or (B) the taxpayer
reasonably relied on a qualified tax professional and the tax professional failed to make,
or to advise the taxpayer to make, the election.

Section 301.9100-3(b)(3) provides in part that a taxpayer is deemed to have not acted
reasonably and in good faith if the taxpayer (i) seeks to alter a return position for which
an accuracy-related penalty has been or could be imposed under section 6662 at the
time the taxpayer requests relief, and the new position requires or permits a regulatory
election for which relief is requested; (ii) was informed in all material respects of the
required election and related tax consequences, but chose not to file the election; or (iii)
uses hindsight in requesting relief. The Internal Revenue Service will ordinarily not
grant relief because of the use of hindsight if specific facts have changed since the due
date for making the election that make the election advantageous to the taxpayer. In
such a case, the Service will grant relief only when the taxpayer provides strong proof
that the taxpayer's decision to seek relief did not involve hindsight.

Section 301.9100-3(c)(1)(i) provides in part that the interests of the Government are
prejudiced if granting relief would result in the taxpayer having a lower tax liability in the
aggregate for all taxable years affected by the election than the taxpayer would have
had if the election had been timely made (taking into account the time value of money).

Taxpayers have shown that they acted reasonably and in good faith. No specific facts
have changed since the due date for making the section 266 election for Year 1 that
make the election advantageous to Taxpayers, despite the fact that Lot B was sold after
the due date for making the election. Because property taxes are not deductible for
purposes of computing alternative minimum taxable income, the property taxes are not
added to Taxpayers’ Lot B alternative minimum tax basis if a section 266 election is
made. See section 56(b)(1)(A)(ii) & section 1.266-1(b)(2). Accordingly, the amount of
Taxpayers’ capital gain that they must recognize in computing alternative minimum
taxable income arising from the sale of Lot B is not affected by Taxpayers’ election to
capitalize property taxes in lieu of claiming those taxes as deductions for Year 1.
Furthermore, the Taxpayers have shown that the interests of the Government are not
prejudiced by granting the requested relief for an extension of time under section
301.9100-1(c) for Year 1.

                                          RULING

Based solely on the facts and representations submitted, consent is hereby granted to
Taxpayers for Year 1 to comply with the requirements of section 266 for making an
annual election to capitalize property taxes on unimproved and unproductive real
property. Accordingly, Taxpayers are granted an extension of time until 90 days from
the date of this private letter ruling to make the election to capitalize taxes under section
PLR-116986-15                                  5

266 for Year 1 for Lot A and Lot B. The election shall be made in accordance with the
regulations under section 266 and shall be filed with the appropriate office of the
Service having jurisdiction over the Taxpayers' federal income tax return for Year 1.
Please attach a copy of this private letter ruling to the amended return, schedules, and
forms filed in connection with making the election under section 266 when such
documents are filed.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this private letter ruling. The ruling contained in this letter ruling is based upon facts and
representations submitted by Taxpayers with accompanying penalty of perjury
statements executed by appropriate parties. While this office has not verified any of the
material submitted in support of this request for an extension of time to make the
section 266 election, all material is subject to verification on examination.

This private letter ruling is directed only to Taxpayers. Section 6110(k)(3) provides that
it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this private
letter ruling is being sent to Taxpayers' authorized representative.

                                       Sincerely,



                                       Cheryl L. Oseekey
                                       Senior Counsel, Branch 6
                                       Office of Associate Chief Counsel
                                       (Income Tax & Accounting