Correcting Depreciation

[rsandy]

Here's a challenge! We recorded the purchase of a client's F150 in his Sub Chapter S corp on 12/18/06 in the amount of 6685.00 Regular depreciation was taken on the vehicle through the loss date of 04/18/08. The corporation received an insurance check for 10734.00 for its loss due to fire. Upon preparation of the 2008 return, we noticed that the truck's original asset value had been recorded incorrectly and should have been 13450.00.
Must we amend the prior year returns to reflect the difference in depreciation expense and the corresponding difference in remaining basis or may we adjust the asset value difference in 2008, choose not to depreciate the additional value from Jan 1 to April 18th and thereby reduce the gain resulting from the receipt of the insurance claim check on the 2008 return. I suppose that answer is to amend the prior year returns and carry the appropriate new values forward, but I'm hoping there is something in the code that would allow us to make the one adjustment in 2008.

[Nashville]

Yes, But

You may correct as far back as 2006 if the depreciation was miscalculated, essentially refiling Scorp (and individual) returns for 2006 and 2007 if you wish. Hopefully, there is enough tax benefit to the parties to pay your fee and still come out. You may change a mistake, but you cannot change an election if the election was valid.

You MAY do this, but your question is: MUST you do this?

And it's a good question. Purists will insist that you do so, and I won't dispute that with them. However, my comment will be construed as one coming from the "Hoary-headed Swain" [vis a vis Thomas Gray's "Elegie"] and not a purist.

Errors in depreciation schedules are rampant. Even if you know what you're doing, you often inherit equipment lists from previous preparers or from clients or from their accountants which are not proper. If you have a list of (for example) 25 assets purchased over the last 10 years, chances are 1/3 of them are incorrect, when you consider improper lives, bonus depreciation, quarterly and half-year conventions, class life designation, and the fact that the rules for all the above have changed many times over the last 10 years.

I have encountered an enormous workload of this stuff, and sad to say, some of the mistakes were even my own, if this qualifies me to be the winner of a "humble pie" award.

Is the "right thing" to refile back 10 years on such a client? That might be the "right thing" but I'll guarantee you the IRS does not want you to do this, and you shouldn't want to do it either.

How do I handle these situations when I encounter them? I'll guarantee you I don't pursue the "pure" solution unless there is a compelling economic reason to do so. But I take the cumulative effect of all such errors and adjust them PROSPECTIVELY over the remaining life.

Example: Bush-Hog was purchased for $10,000 when class life was 7 years. 3 years have passed, and $6500 has been depreciated, whereas the correct depreciation would be only $5000. There are 3.5 years left to depreciate the item, and I would take the remaining $3500 over 3.5 years, meaning $1000 in yrs 4,5,6 and $500 in yr. 7. If an auditor raised an issue, I would concede and invite him to make the corrections. Most auditors would walk away and wouldn't waste their time recalculating the effect of refiling three years' tax returns.

My position might be different if the item was a $500,000 combine. But there must always be some prostration to common sense, and you have to be the best judge of that.

[tacks]

Excellent response, Nashville. Thanks for sharing.