IRS Grants Extension for Late Election to Avoid Tax-Exempt Entity Status Under § 168(h)(6)(F)(ii)

IRS Grants Relief for Late § 168(h)(6)(F)(ii) Election

A tax-exempt limited liability company wholly owned by a § 501(c)(3) organization failed to make a timely election under § 168(h)(6)(F)(ii) to avoid reclassification of its partnership property as "tax-exempt use property." The omission, attributed to the tax preparer’s oversight, risked requiring the taxpayer to use the Alternative Depreciation System (ADS) for its partnership assets, potentially resulting in significant lost depreciation deductions. The IRS granted a 60-day extension under § 301.9100-3 to correct the error.

Background and Procedural History

The taxpayer, a State domestic limited liability company wholly owned by a § 501(c)(3) organization, owned X% of Partnership and served as its managing member. Partnership’s amended operating agreement required that no portion of the Project Property be treated as "tax-exempt use property" under § 168(h).

Partnership placed the Project in service in Taxable Year 1. The taxpayer engaged Firm to prepare its federal income tax return for Taxable Year 2 and subsequent years. Firm was aware the taxpayer intended to elect C corporation status and to make an election under § 168(h)(6)(F)(ii) to avoid tax-exempt use property treatment for Taxable Year 2. Despite this, Firm failed to confirm the elections were made on the Form 1120 for Taxable Year 2.

For subsequent tax years, including Taxable Year 1, Firm prepared and filed the taxpayer’s returns as if the elections had been made in Taxable Year 2. The taxpayer timely filed its Form 1120 for Taxable Year 1 under the assumption it had elected C corporation status and avoided tax-exempt use property treatment, though the required elections were not reflected on the return.

The taxpayer later discovered the elections had not been made for Taxable Year 2, rendering the § 168(h)(6)(F)(ii) election ineffective for that year and all subsequent years, including Taxable Year 1. On Date 4, the taxpayer retroactively elected C corporation status effective the first day of Taxable Year 1 under Rev. Proc. 2009-41.

Legal Framework and Taxpayer’s Request

The taxpayer sought IRS relief under §§ 301.9100-1 and 301.9100-3 to make a late § 168(h)(6)(F)(ii) election retroactive to Taxable Year 1. This election allows a tax-exempt controlled entity—defined in § 168(h)(6)(F)(iii) as a corporation where 50% or more of its stock is held by tax-exempt entities—to opt out of tax-exempt use property treatment under § 168(h).

The election deadline is the due date of the tax return for the first taxable year it is to be effective, as prescribed by § 301.9100-7T(a)(2)(i). The election must be made by attaching a statement to the tax return for that year, per § 301.9100-7T(a)(3)(i). Because the due date is set by regulation, the election qualifies as a regulatory election under § 301.9100-1(b).

The taxpayer’s request hinged on whether the IRS could waive the missed deadline under § 301.9100-3, which allows relief for late regulatory elections if the taxpayer acted reasonably and in good faith, and granting relief would not prejudice the government.

IRS Analysis and Ruling

The IRS granted the taxpayer’s request for relief under § 301.9100-3(a), which permits extensions for late regulatory elections if three conditions are met: (1) the taxpayer acted reasonably and in good faith, (2) granting relief would not prejudice the Government, and (3) the election is subject to regulatory timing under § 301.9100-1(b). The taxpayer satisfied these requirements.

The taxpayer demonstrated reasonable action and good faith by relying on professional advice from a reputable tax firm to file the § 168(h)(6)(F)(ii) election. The taxpayer promptly corrected the oversight upon discovering the error, filing the election statement within a reasonable timeframe after the missed deadline. The IRS emphasized that the taxpayer’s reliance on expert counsel—without evidence of willful neglect—met the standard for good faith.

The IRS found no prejudice to the Government’s interests. Because the election statement had not yet been filed, the IRS retained full authority to assess tax in the relevant taxable year. The 60-day extension allowed the taxpayer to cure the procedural defect without altering the substantive tax treatment of the property.

The IRS confirmed that the § 168(h)(6)(F)(ii) election qualified as a regulatory election under § 301.9100-1(b), meaning its timing was governed by IRS rules. The IRS concluded that granting the 60-day extension would serve the regulatory purpose of ensuring compliance without imposing undue hardship.

The relief granted—an extension of 60 calendar days from the date of the ruling to file the election statement—was narrowly tailored to address the procedural lapse. The taxpayer was required to attach a copy of this ruling to the election statement and to all subsequent returns for the relevant taxable year.

Practical Takeaways

The IRS’s grant of § 301.9100-3 relief in this case highlights the importance of formally and timely executing elections on tax returns to preserve their validity. The taxpayer’s procedural lapse—failing to attach the § 168(h)(6)(F)(ii) election statement to its return—triggered the need for relief, but the IRS’s willingness to grant a 60-day extension reflects a balance between compliance and fairness.

Failing to make the § 168(h)(6)(F)(ii) election forces partnerships wholly owned by tax-exempt entities to depreciate property using straight-line ADS methods, which typically extend recovery periods and reduce annual deductions compared to MACRS. This can materially impact cash flow and investment returns, especially for long-lived assets. Practitioners should treat such elections as non-negotiable deadlines, embedding them into return-preparation checklists and client communications to avoid reliance on post-filing relief.

The ruling reaffirms the availability of § 301.9100-3 relief for missed regulatory elections, provided the taxpayer can demonstrate reasonable cause and no prejudice to the Government. This is a lifeline for taxpayers who discover errors after filing, but it is not a substitute for due diligence. The IRS’s requirement that the ruling be attached to the election statement and subsequent returns highlights the transactional nature of relief—it does not retroactively validate the election but merely permits its late filing under controlled conditions.

The non-precedential nature of Private Letter Rulings (PLRs) cannot be overstated. While this ruling offers valuable insight into the IRS’s current posture on § 168(h)(6)(F)(ii) elections, it does not bind the IRS in future cases. Taxpayers and advisors must therefore consult tax counsel or formal IRS guidance—such as Revenue Procedures or Treasury Regulations—before relying on PLRs for planning. The IRS’s emphasis on attaching the ruling to returns also signals a documentation-heavy approach to relief, reinforcing the need for meticulous recordkeeping in election processes.