Rental -- no depreciation

[appelman]

What to do with a new client who owns a duplex, has been renting out half of it since 2002, and has NEVER taken any depreciation? Start now? Carry on without?

[Lion]

Form 3115

Form 3115 and then continue correctly going forward.

[appelman]

What do you do with prior years' depreciation?

And what about the state (CA in this case)?

[Questionguy101]

I would claim the correct amount of depreciation for him this year.

I would also calculate the total amount of depreciation that he had been allowed through the years and put it under "prior depreciation". Whether he has claimed it or not, he will have to recapture all the depreciation expense that he has been allowed since day 1 that he has rented out the duplex.

I would also explain to him that he can amend his last three years (the open years) tax returns to claim the depreciation expenses.

[snowshine]

Figure out the prior years of depreciation and put it on Form 3115, it is line 25 IIRC.
Then enter that number as an adjustment on this year's SCH-E under the "other" expense line with the description, "Form 3115 adjustment". Keep normal depreciation in future years.

[appelman]

This seems very nice, but...

Is it really legitimate? The only directly relevant citation I've found is:

http://www.irs.gov/irb/2004-03_IRB/ar11.html#d0e1923

which only speaks of doing this when you dispose of the property.

[FEDUKE404]

However...

For some reason the phrase "allowed or allowable" seems to creep into my mind....

This whole thing reminds me of an employee (three-year experience?) at a "big" firm who had this nasty habit of treating Sch E depreciation et al as "optional." I spent a lot of time later correcting her errors with 1040X and having to make some unpleasant client calls. She came across to the clients quite well, but was generally devoid of great, and at times rudimentary, tax skills.

I would somewhat take the approach to calculate the correct allowable depreciation (from time of purchase) and use the current year amount. As for the prior years, some perhaps cannot be repaired. If I/my firm had exposure to anything that could still be amended then I would likely correct those.

As for any use of Form 3115, I'm not quite sure that is its underlying purpose. There is no "change" to accounting methods but rather the implementation of such.

BTW: I wonder if she still works there???

FE

[Bill Tubbs]

Form 3115

I've done F3115 like this a couple times and haven't had any issues with the IRS -- they were filed 2 & 3 years ago (different clients).

Bill

[AJsTax]

By rule,

changes in depreciation after the first 2 (I believe it is 2) requires the change in accounting methods form(3115) be prepared. Correcting depreciation for amounts not taken is a change in methods.
You can correct on the year following the first, but after that you must jump through the hoops.

[appelman]

Someone found this on the IRS site FAQs

It is really a pops version of Rev. Proc. 2004-11:

11.4 Sale or Trade of Business, Depreciation, Rentals: Sales, Trades, Exchanges

Q.: We are selling rental property and have never claimed depreciation. What do we do about this when we file our taxes?

A.: When reporting the sale of or computing gain or loss on rental property, you are required to make an adjustment to your basis for allowable depreciation regardless of whether the deduction was taken. For more information refer to Publication 544, Sales or Other Dispositions of Assets, and the Form 4797 Instructions, Sales of Business Property.

You can claim the depreciation not taken for the rental property in the years before the year of sale. How to do this depends on when you placed in service the rental property. If you placed in service the rental property before calendar year 2003, you may amend your income tax returns for the years before the year of the sale by using Form 1040X (PDF), Amended U.S. Individual Income Tax Return, to take the depreciation deductions for the rental property that should have been taken. Or, you may file a Form 3115 (PDF), Application for Change in Accounting Method, to claim the depreciation for the rental property that should have been taken for the years before the year of the sale. The Form 3115 must be timely filed for the same tax year in which you sell the rental property.

If you placed in service the rental property after calendar year 2002 and you have unclaimed depreciation for two or more years before the year of sale, you must use Form 3115 (PDF), Application for Change in Accounting Method, to claim the depreciation for the rental property that should have been taken for the years before the year of the sale. The Form 3115 must be timely filed for the same tax year in which you sell the rental property.

If you placed in service the rental property after calendar year 2002 and you have unclaimed depreciation for only the year immediately preceding the year of sale, you may amend your income tax return for that prior year by using Form 1040X (PDF), Amended U.S. Individual Income Tax Return, to take the depreciation deduction for the rental property that should have been taken. Or, you may file a Form 3115 (PDF), Application for Change in Accounting Method, to claim the depreciation for the rental property that should have been taken for the prior year. The Form 3115 must be timely filed for the same tax year in which you sell the rental property.