The American Institute of CPAs (AICPA) urged the IRS to automate its process for granting extensions for taxpayers to replace damaged property after a federally declared disaster, while still deferring gains. The change is needed, the group said in a January 5 letter, to provide taxpayers with greater certainty after a disaster.
Short of universal automatic extensions, the group is calling for automated extensions when taxpayers’ requests have been pending with the IRS for a set duration.
Replacement Period for Involuntary Conversions
Generally, under IRC § 1033(a)(2)(B), a taxpayer who purchases similar property after an involuntary conversion may defer gain for a two-year period. For condemned real property used in a trade or business or held for investment and replaced with like-kind property, the period is three years. A four-year period applies for principal residences in federally declared disaster areas.
However, these statutorily provided periods may not be sufficient for taxpayers to replace damaged property in some cases. Gerard Schreiber, chair of the AICPA Disaster Tax Relief Task Force, explained that there are many instances where a taxpayer may need additional time. This includes difficulties in working with insurance companies, finding a contractor, or finding replacement property. And taxpayers also may suffer from an illness, Schreiber said, such as during COVID.
“We have especially been challenged in the last few years by the increasing number of disasters and the need to apply for an extension,” Schreiber told Checkpoint. He sees the four-year period for personal residences as “generally satisfactory” – but finds the two-year period for business property to be “inadequate in today’s environment.”
Under current law, however, taxpayers, may request an extension of the replacement period by submitting an application to a district director. Applications generally should be submitted near the end of the replacement period and may be rejected if submitted prematurely. The IRS also may accept applications made more than two years after the close of the first tax year in which any part of the conversion gain is recognized. In this case, taxpayers must show reasonable cause for the late application and that they filed the application within a reasonable time given the circumstances.
Taxpayers also must “show reasonable cause for not being able to replace the converted property within the required period of time,” per Reg. §1.1033(a)-2. High market value or scarcity of replacement property typically are not valid grounds for an extension. However, if replacement property is being constructed but construction won’t be completed within the statutory period, the IRS will typically grant an extension.
Automated Process Needed
The AICPA, in its letter, contends that some taxpayers currently experience months-long delays in receiving a determination on their extension requests. The result, says the group, is uncertainty and “needless hesitation” in replacing destroyed property.
“Taxpayers have followed the procedure in the § 1033 Regs and been stymied by the delay in receiving a response from IRS,” said Schreiber. He described the current procedure for requesting an extension “antiquated,” adding that it “was never changed for the current way IRS has automated processes.”
The AICPA is calling on the IRS to streamline disaster-related § 1033 extension application processing via automated review. The AICPA recommends the agency harness online accounts and “software” to receive and review requests and provide determinations to taxpayers. “[T]he IRS could readily incorporate software designed to automatically determine whether the response satisfies the IRS’s criteria for an extension request,” reads the letter.
The AICPA argues that automating review of § 1033 extension requests for disaster victims could speed up the timeline for providing taxpayers with determinations. Beyond that, says the group, automation could free up IRS resources for other tasks. The group’s suggestion comes after staffing losses across the agency over the past year.
And the IRS would still have an opportunity to review automated determinations and recover funds for inappropriately granted extensions, according to the AICPA. That’s because of the three-year statute of limitations for the year where gain is deferred, the letter explains.
Short of automating all disaster-related § 1033 extension requests, the AICPA recommends the IRS adopt an automated process for extension requests that are not reviewed by agency staff within a set time period, such as 30 or 60 days.
For more on the replacement period for involuntarily converted property, see Checkpoint’s Federal Tax Coordinator 2d ¶ I-3734. For more on how to apply to for an extended replacement period, see Federal Tax Coordinator 2d ¶ I-3774.
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