Opinion ID: 782365
Heading Depth: 1
Heading Rank: 4

Heading: Cross-Appeal: Change in Accounting Method

Text: 18 On cross-appeal, Cardinal contends that the district court erred in holding that the IRS's reallocation of certain of Cardinal's plant assets from one asset category to another for the purposes of MACRS depreciation, see 26 U.S.C. § 168, constituted a change in accounting method under § 446(e). 26 U.S.C. § 446(e); 26 C.F.R. § 1.446-1(e). Cardinal argues that the reclassification of certain plant assets did not constitute a change in accounting method under § 446(e), thereby requiring a § 481(a) adjustment. Instead, Cardinal asserts that the IRS merely corrected the assets' classifications by reassigning assets within the asset-groupings and cost recovery periods that Cardinal consistently had used under the MACRS method of depreciation. See notes 1, 2 supra. By shifting assets, Cardinal argues, the IRS did not change Cardinal's accounting method but rendered the asset categorization internally consistent within Cardinal's existing accounting method. See H.E. Butt Grocery Co. v. United States, 108 F.Supp.2d 709, 714 (W.D.Tex.2000) (stating the correction of an internal inconsistency is not a change in the method of accounting) (citing Lasater v. Scofield, 52-1 U.S. Tax Cas. (CCH) 9255 (W.D.Tex. Jan. 29, 1952); N. States Power Co. v. United States, 151 F.3d 876, 884 (8th Cir.1998) (holding that a power company effectively had committed a posting error and did not change its method of accounting when it filed a refund claim seeking to deduct contract losses as it consistently had other losses)). Cardinal also contends that the reclassification of assets did not change a material item. 19 Title 26 U.S.C. § 446(e) requires that a taxpayer obtain the Secretary's consent to change `the method of accounting on the basis of which he regularly computes his income in keeping his books ...' N. States Power Co., 151 F.3d at 883 (citing Treas. Reg. § 1.446-1(a)(1); 26 U.S.C. § 446(e)). Method of accounting is defined by the applicable regulations by reference: [a] taxpayer changes his or her method of accounting when he or she changes either the `overrall plan of accounting for gross income or deductions or... the treatment of any material item used in such overall plan.' Id. (citing 26 C.F.R. § 1.446-1(a)(1), (e)(2)(ii)(a)). The regulations define a material item as any item which involves the proper time for the inclusion of the item in income or the taking of a deduction. Id.; see also 26 C.F.R. § 1.446-1(e)(2)(ii)(b) (enumerating types of adjustments that are not to be characterized as changes in accounting method). 20 The dispositive issue before us is whether a change in asset categorization that changes the recovery period under MACRS constitutes a change in Cardinal's method of accounting. The regulations implementing § 446 explicitly exclude certain types of adjustments from being characterized as changes in accounting method. 26 C.F.R. § 1.446-1(e)(2)(ii)(b). 21 A change in method of accounting does not include correction of mathematical or posting errors, or errors in the computation of tax liability. Also, [it] does not include adjustment of any item of income or deduction which does not involve the proper time for the inclusion of the item of income or the taking of a deduction. 22 . . . . 23 In addition, a change in the method of accounting does not include ... an adjustment in the useful life of a depreciable asset. 24 Id. Notwithstanding the Commissioner's conclusion that the recovery period for ACRS or MACRS property (depreciable property placed in service after 1980) cannot be changed, Kurzet v. Comm'r, 222 F.3d at 844 (citing I.R.S. Pub. 538 (1993)), the Court of Appeals for the Fifth Circuit recently determined that if a change in the allocation of assets within MACRS categories falls under the useful life exception of the regulations, it cannot constitute a material alteration for purposes of IRC § 446(e), Comm'r v. Brookshire Bros. Holding, Inc., 320 F.3d 507, 510 (5th Cir. 2003). See also § 1.446-1(e)(2)(ii)(b). Although useful life is no longer the standard by which depreciation deductions are claimed pursuant to § 167, Liddle, 65 F.3d at 333 (citing General Explanation of the Economic Recovery Tax Act of 1981 at 1450), analogizing the treatment of useful life as an exception pursuant to the never-repealed, pre-MACRS regulation better accords with the overall regulatory scheme of the Tax Code and regulations than would the denial of the exception on the slender reed of that apparent linkage, Brookshire Bros. Holding, 320 F.3d at 511. We agree. 25 [T]he applicable regulations were meant to allow taxpayers to make temporal changes in their depreciation schedules without prior consent of the Commissioner. Id. Reallocating an asset into an existing asset category for the purposes of MACRS depreciation more closely resembles a correction of a reporting error or inconsistency than a wholesale change in accounting method. Although an asset reallocation, such as that which occurred in this case, may change the timing of the asset's depreciation, we conclude that the reallocation falls within the regulation's explicit exemption for an adjustment in the useful life of a depreciable asset and thus does not constitute a change in accounting method within the meaning of § 446(e). Accordingly, we conclude that the district court erred by granting summary judgment in favor of the IRS on this issue. 26 The judgment of the district court is affirmed in part and reversed in part. The case is remanded to the district court for the entry of judgment consistent with the views set forth in this opinion.