The following is an unfortunate example of how a simple code miss over time can create a bit of a challenge. I am having difficulty determining a path of resolution and would appreciate constructive input.

Facts and Circumstances:

An LLC rents residential and commercial properties. For years the LLC has for reasons of generosity rented a portion of its residential properties at well below fair market rents. Although these properties remained generally profitable neither the partners nor multiple preparers recognized that under IRC §280A(d)(2)(C) these residential rentals had to be treated as personal use. As such none of the deductions which the LLC was accustomed to and claimed were allowable (except for interest, taxes (10K) and casualty losses as passthroughs).

The LLC partners desire to correct the returns and comply fully with code. This appears to mean recognizing the income personally and removing depreciation and expenses except for those passthroughs allowable for itemization. Many of the properties in question have been sold and the gain or loss recognized would be potentially very different based on the depreciation and capitalization changes needed.

Questions:

• Should the partnership returns be amended for all years open under statute or should a 3115 with all adjustments be filed in the current year? This is not just a question of convenience but that moving from depreciable property to non-depreciable property is a change in accounting method. While the returns can be easily amended I am not sure that the changes to depreciation via amendment would be allowable.
  
  
• Since the LLC owns the properties what happens to the capital expenses incurred during the period the IRS is considering personal use (such as HVAC, roof, etc.) Are those carried as non-depreciable assets or simply washed off?
  
  
• Finally, since this will result not in a refund but amount owed how far back should this be chased? Open years? All years affected?
  
  

Please bear in mind I have purposefully not included a discussion of fair market rent and related code. That has been previously evaluated and my hope would be that the thread could focus largely on the issues created by treating properties as fair rentals vs personal use. Thanks in advance for your input.