First-year client forgot to depreciate residential rental property placed in service in 2018

[bill6]

A client purchased residential rental property in 2018 and did not depreciate it on his tax returns for years 2018 and 2019.  It looks as though I need to file Form 3115 Application for Change in Accounting Method as he went from an impermissible accounting method (not depreciating the property at all) to a permissible accounting method (MACRS). I (think) I filled out 3115 properly. 

Adding to my confusion is the Section 418(a) adjustment . It is asking for the adjustment, negative or positive, to income. Would I simply input the depreciation he missed out on for the last 2 years?  It seems that my tax software has already played catchup on the missed depreciation and will average it out over the remaining life which would effectively create a double dip if I also include it as a 481(a) adjustment.

Thank you, 

Lost but Hopeful

[TaxGuyBill]

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@bill6 wrote:

Would I simply input the depreciation he missed out on for the last 2 years? 

It seems that my tax software has already played catchup on the missed depreciation and will average it out over the remaining life which would effectively create a double dip if I also include it as a 481(a) adjustment.

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Yes. And enter that as an "other expense" on the tax return.

Because you now are 'catching up' on the depreciation, you need to enter that amount for the "prior depreciation".  The software will then calculate the correct current year depreciation.

[bill6]

Thanks you, very much appreciated!  I totally understand the second half of your response, no problems there.

I do want to clarify one thing on the first half of your response: When you say "Other Expense" do you mean place it directly on Schedule E in the Other Expense section? And would this description suffice: "2018 Depreciation catch-up - see form 481(a)"?

[TaxGuyBill]

Yes for where to put it on Schedule E, but I just label it as "481(a) Adjustment".

[bill6]

Will do, thank you!

[qbteachmt]

With all the late extenders, the carryback, the lookback, and so many changes, would it make sense to investigate amending those years?

Google:

Rev. Proc. 2020-25

[BobKamman]

Just another example of how the flaming-liberal accounting profession supports government regulation of even the most inconsequential business activity.  I'm still waiting for the first prosecution of someone who chose instead to file amended returns when all of the years involved were still open, as was once allowed by IRS under Rev. Rul. 75-56.  (Anyone else miss Gerald Ford?)  Eventually the pendulum will swing back that way.  

You could ask for an IRS audit.  Revenue agents are allowed to authorize those changes, without the need of a Form 3115.  See Internal Revenue Manual

4.11.6.7.5 (02-15-2017)

IRC 446(e) - Taxpayer Files Amended Return or Claim (Formal or Informal) to Make "Retroactive" Change in Accounting Method

[PATAX]

👍 Bob, you hit the nail on the head about the elite of the accounting profession and excessive government regulation ..... just wondering if maybe they should remember and consider the words "common sense" ..... Just my opinion...

[d31]

Will your answer to missed depreciation, "put it on Schedule E, but I just label it as "481(a) Adjustment " be accepted when e-filing a 2020 return on an extension.  My 2020 return is showing an NOL in the amount of  depreciation that was missed in a 2016 return in the 11th year.  I tracked it back to the '16 tax year to see where it was coming from.

[TaxGuyBill]

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@d31 wrote:

 My 2020 return is showing an NOL in the amount of  depreciation that was missed in a 2016 return in the 11th year.

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Are you saying you want to file Form 3115 to 'catch up' on the depreciation?  Was depreciation taken in 2017, 2018 or 2020?

Does the 1040 actually have a NOL, or are you saying it just has a rental loss?

[d31]

No,  I want to catch up for the missed 2016 depreciation and wondered if it would be okay to insert  "481(a) adjustment" on the "other"  line of my 2020 Schedule E rather than doing Form 3115..I am past the 3 year amendment time for the 2016 amendment.

[TaxGuyBill]

Of course you can't do that.  And it sounds like it doesn't qualify for Form 3115 either.  That depreciation deduction is lost.

[Terry53029]

@bill6 Why don't you just amend 2018, and 2019 seeing he put it in service in 2018. That seems to be the easiest way, then you don't have to worry about 3115 or 418 adjustment. Just my opinion 

[TaxGuyBill]

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@Terry53029 wrote:

Why don't you just amend 2018, and 2019 seeing he put it in service in 2018.

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Two consecutive years of an impermissible method sets the accounting method, and amending is not allowed for changing the accounting method.

[Terry53029]

Thanks @TaxGuyBill I did not realizes there was a two year rule. In years past I have amended two years for clients not taking deprecation but, I got lucky as, IRS never caught it. If I get one in future I will use 3115. again thanks for the info, muchly appreciated. 😁

[BobKamman]

So why not amend just 2019 and claim the Section 481 adjustment on it for 2018? Assuming the 2020 return has not yet been filed, because otherwise why would someone be asking about it? But even if it has been, what rule is violated by amending it, since it is the first year the accounting rule has been broken now that the 2018 and 2019 errors have been purged. Either that, or make the Section 481 adjustment on the 2021 return.

The Form 3115 is like an Alien Tax Clearance. Sure, it’s required, but if everyone complied then IRS would have no time for anything else. It’s a joke, but on a profession with no sense of humor (at least, outside of northern Minnesota).

I think it was suggested elsewhere that the Section 481 deduction can be claimed for cumulative errors going back to closed years. I don’t think that’s correct, but I suppose you can try to get away with it. Section 481(a) mentions only the “preceding taxable year,” and I think what they are getting at is a change from cash to accrual, or FIFO to LIFO, for example.

[bsj224]

I'm dealing with depreciation on a coop used as a  commercial property that was inherited in 2014 and depreciation was never taken.  How far back can a 481(a) adjustment go? 

Is it just "open" years (in this case 2018-2020).  I see in the discussions that 2 years was mentioned but for 2021 seems like you could go back to 2018.

Would be happy just taking the adjustment in 2021, rather than filing 3 1040X forms.  But need to know how much can be taken.

Thanks

[TaxGuyBill]

There is no limit for how far back you can 'catch up' on missed depreciation using form Form 3115.