IRS Grants Extension for Late Election to Avoid Tax-Exempt Controlled Entity Status

IRS Allows Late Election to Avoid Tax-Exempt Controlled Entity Status

The IRS granted a 60-day extension under § 301.9100-3 to a taxpayer seeking to file a late § 168(h)(6)(F)(ii) election, allowing it to avoid unintended tax-exempt controlled entity status. The taxpayer requested the relief after discovering a miscommunication with its tax preparer had prevented timely filing of the election, which would have otherwise subjected its depreciable property to stricter straight-line depreciation rules under § 168(g)(1)(C). This non-precedential ruling underscores the IRS’s willingness to grant relief for reasonable errors in election procedures, provided no prejudice to the government occurs.

The Taxpayer's Mistake: A Miscommunication with Far-Reaching Consequences

The taxpayer, a limited liability company (LLC) formed under State Z law, was treated as a partnership for federal tax purposes until Taxable Year 1, when it elected to be taxed as a corporation under Form 8832. The LLC was wholly owned by a tax-exempt entity, placing it under the controlled entity rules of Section 168(h)(6)(F)(iii), which generally subjects depreciable property to straight-line depreciation under the Alternative Depreciation System (Section 168(g)(1)(C)).

The LLC owned 50% of another LLC, which in turn owned 90% of a partnership engaged in business activity X. The partnership placed depreciable property into service in Taxable Year 1 under a master lease agreement explicitly stating that no portion of the property qualified as tax-exempt use property. Despite this structure, the taxpayer needed to file a Section 168(h)(6)(F)(ii) election to avoid the stricter depreciation rules that would otherwise apply due to its tax-exempt owner.

The taxpayer retained an external tax advisor to prepare its federal income tax return for Taxable Year 1. Due to a miscommunication between the advisor and the taxpayer’s previous tax preparer, the advisor was unaware of the need for the Section 168(h)(6)(F)(ii) election. As a result, the advisor filed a Form 1065 on behalf of the taxpayer, which was timely submitted. Only after this filing did the advisor realize the election was required, following direct communication with both the taxpayer and the prior preparer.

Upon discovering the error, the taxpayer took corrective action by filing Form 8832 to request a late entity classification election, confirming with the advisor by telephone that the change to C corporation status was approved and effective retroactively. The taxpayer then submitted a letter ruling request to the IRS to formalize the relief.

The IRS's Rationale: Reasonable Reliance and No Prejudice to Government

The IRS granted the taxpayer’s request for a 60-day extension under §§ 301.9100-1 and 301.9100-3, finding that the taxpayer satisfied the statutory requirements for relief. Section 301.9100-1 authorizes the Commissioner to grant reasonable extensions of time to make regulatory elections when the taxpayer acts reasonably and in good faith, and the relief does not prejudice the Government’s interests. Section 301.9100-3 further specifies that such relief is warranted where the taxpayer demonstrates reasonable cause and no prejudice to the IRS.

The IRS concluded that the taxpayer met these standards. The taxpayer’s reliance on professional advice—demonstrated through direct communication with the advisor and the prior preparer—established reasonable cause for the failure to timely file the election. The prompt corrective action taken after discovery of the error, including filing Form 8832 and seeking formal relief via letter ruling, further supported the taxpayer’s good faith. Crucially, the IRS found no prejudice to its interests, as the late election did not impair tax administration or the statute of limitations.

As a result, the IRS granted a 60-day extension from the date of the ruling to file the election statement with an amended return, provided the taxpayer attaches a copy of the ruling to the election statement and subsequent returns. This outcome reflects the IRS’s continued willingness to grant § 301.9100 relief in cases where taxpayers act diligently upon discovering errors and demonstrate no harm to the Government’s interests.

What This Ruling Means for Taxpayers and Advisors

This ruling underscores the critical need for taxpayers and advisors to ensure proper elections are filed timely to avoid unintended tax-exempt controlled entity status under § 168(h)(6)(F)(iii). Failure to make the § 168(h)(6)(F)(ii) election—which allows a tax-exempt lessee’s controlled entity to use accelerated depreciation instead of the mandatory Alternative Depreciation System (ADS) under § 168(g)(1)(B)—can result in significant tax consequences. Taxpayers risk losing the ability to claim bonus depreciation and may face longer depreciation periods, increasing taxable income in early years.

The IRS’s willingness to grant relief under § 301.9100-3 in this case highlights a narrow but important safety net for taxpayers who act diligently upon discovering errors. However, this relief is not guaranteed and requires demonstrating reasonable cause and no prejudice to the Government. Taxpayers should proactively review their depreciation elections and ownership structures to avoid similar pitfalls.

Clear communication between taxpayers and tax preparers is essential. Missteps in filing elections—such as the taxpayer’s failure to attach the election statement to their return—can lead to costly corrections. Advisors should implement contemporaneous documentation protocols to ensure compliance with IRS requirements.

Non-precedential disclaimer: This ruling applies only to the taxpayer in question and may not be cited or relied upon as precedent under § 6110(k)(3). Taxpayers in similar situations must seek their own private letter ruling or rely on existing IRS guidance.