IRS issues automatic method change procedure to currently deduct OREO expenses

On Jan. 24, 2014, the IRS issued Revenue Procedure 2014-16, which allows banks to automatically change their accounting method from capitalizing to currently deducting certain costs of acquiring and holding other real estate owned (OREO). To qualify for this automatic change, a taxpayer must:

  • Originate, or acquire and hold for investment, loans that are secured by real property; and
  • Acquire the real property that secures the loans at a foreclosure sale, by deed in lieu of foreclosure, or in another similar transaction.

Banks changing their method under Rev. Proc. 2014-16 will be allowed a deduction in the year of change to reverse qualified previously capitalized expenses for acquiring and holding OREO property. However, banks should note that certain costs incurred for improvements or betterments made to increase the value of the property may still be required to be capitalized.

By way of background, prior to March 2013, the IRS had been auditing banks and requiring that expenses associated with non-income-producing OREO property be capitalized for tax purposes. However, on March 1, 2013, the IRS chief counsel released a legal advice memo (GLAM 2013-001), which reversed this position. The memo stated that “where the loan-originating Bank acquires real property through foreclosure or deed -in-lieu of foreclosure and promptly attempts to sell the OREO without improvement, we conclude that the property is not ‘property acquired for resale’ within the meaning of § 263A(b)(2)(A).” Since the property was not acquired for resale, but rather to mitigate losses on the loan, the capitalization rules of § 263A(b)(2) do not apply.

New automatic method change

Prior to the issuance of Rev. Proc. 2014-16, taxpayers who had capitalized expenses of holding OREO property in order to comply with the pre-March 2013 position of the IRS, generally would have been required to file a nonautomatic method change with the IRS (and pay an associated filing fee) in order to change their method to currently deduct these expenses.

While taxpayers will still be required to file a Form 3115, Application for Change in Accounting Method, in order to make this change, there is no associated filing fee with the IRS. The original Form 3115 should be filed with the bank’s federal income tax return for the year of change and a signed copy should be filed with the IRS in Ogden, Utah, no earlier than the first day of the year of change and no later than the date the taxpayer files the original Form 3115 with its federal income tax return for the year of change. 

This new automatic method change generally is effective Jan. 24, 2014. The Revenue Procedure also provides transition rules for taxpayers who previously filed a nonautomatic method change prior to Jan. 24, 2014, and wish to modify or amend that request under the newly issued automatic change procedures.

For more information on this topic, or to learn how Baker Tilly banking specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.