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IRS Simplifies ‘Other Real Estate Owned’ Deductions Process for Banks
On January 24, 2014, the IRS issued new rules to help banks that have been required to capitalize holding costs (e.g., taxes, maintenance, and legal fees) for non-income producing other real estate owned (OREO) property.
In Revenue Procedure 2014-16, the IRS simplified the process for banks to change accounting methods for acquisition and holding costs on foreclosed real property.
“This new rule means that with their next tax return — which for most banks is the year that ended December 31, 2013 — banks no longer have to capitalize OREO holding costs, and can immediately deduct previously capitalized costs. For banks that have significant capitalized OREO costs, this will be extremely beneficial,” says Rod MacLachlan, a financial institutions principal with CliftonLarsonAllen.
Historically, most banks deducted the holding costs of OREO property in their tax returns as they were incurred. Several years ago, however, the IRS decided that these costs should be capitalized, unless the OREO property was income producing, such as rental property.
Many banks and their tax advisors disagreed with this assertion, but the IRS’ position was written into its examination guide and IRS agents across the country were forcing banks to capitalize these holding costs under audit. As a result, many community banks have had significant deferred tax deductions associated with their OREO properties that were unavailable until the properties were sold.
In February 2013, the IRS issued a Legal Advice Memorandum which changed its position, and said that OREO holding costs could be expensed as incurred after all. This did not help many banks though, since by capitalizing those OREO costs the banks had adopted an accounting method which could not be changed without IRS approval. Getting such IRS approval is expensive and time consuming, so most banks did not pursue this.
New consent method
Under the new rules, a bank can now receive free and automatic consent from the IRS to change its accounting method for capitalized OREO holding costs.
To do this, the bank must attach Form 3115, Application for Change in Accounting Method to its next income tax return, and send a copy of the application to the IRS at 1973 North Rulon White Blvd, Mail Stop 4917, Ogden, UT 84404.
The change will be automatically granted if the correct procedures are followed.
How we can help
Your tax advisor can provide more information on how to claim a deduction for previously capitalized OREO holding costs.