What to do when a new client comes to you with a "wrong" depreciation schedule.

[DebitThatCreditThis]

Have a new client for the 2022 tax year. They sold a rental property in 2022.

Looking at their depreciation schedule to determine basis and I see that they have been depreciating closing costs over 360 YEARS.

This poses 2 questions from me:

- How do you go about correcting depreciation schedules from year to year? What does the IRS do when you change horses in the middle of a stream.

- Would it be ok to leave things as is (keep it as 360 years)? Since they sold the house, it will only help their cause, no? Or will this leave them open to scrutiny since they should've taken more depreciation and have accidentally skirted some depreciation recapture tax here.

[TaxGuyBill]

Have you done the math to confirm it is 360 years? Loan fees are usually amortized, and that is over months. So it would be common for the depreciation/amortization schedule to show "360" to indicate the number of months.

If it was wrong, you first need to look at the FIRST year it was "placed in service". Was it wrong then?

Closing costs? Was this for a refinance? Most closing costs to originally purchase the property are included in the Basis of the property itself.

How much are we talking here? What was the total amount? How many years has it been since it was "placed in service"?

[DebitThatCreditThis]

Yep, I can confirm it was wrong based on the math.

Closing costs were 10,318

Placed in service 9/2009

A.D. = 325
CY Depr = 28 (10,318 / 360)

Seeing as the property was sold in May of 2022, I wonder how to go about this.

It seems like 3115 is necessary at this point. I am just unsure if I should select the code for depreciable or amortization (impermissible) (7) or Change for disposed depreciable or amortizable (107) or something completely different.

[Beersheba]

I believe the 360 represents 30 years X 12 months. I would check the year purchased and see if the 30 year election was a valid election at the time of purchase. If so, the Accumulated Depreciation is probably not wrong. Closing costs are amortizable over the course of the loan.

3115 is for a change in method, if indeed this is what is going to happen. Even a 3115 won't allow amended returns beyond the prescribed period.

[DebitThatCreditThis]

I believe the 360 represents 30 years X 12 months. I would check the year purchased and see if the 30 year election was a valid election at the time of purchase. If so, the Accumulated Depreciation is probably not wrong. Closing costs are amortizable over the course of the loan.

3115 is for a change in method, if indeed this is what is going to happen. Even a 3115 won't allow amended returns beyond the prescribed period.

While it’s possible the 30 year election was allowable at time of purchase, the math still suggests taking one months worth of depreciation a year for 12 years.

Thinking about this further, I feel like since it’s in the year of sale that this was caught, combined with the fact that it’s a small amount, I want to just tack on the allowed depreciation onto the 4797 calc and move on.

If the IRS comes back and tells me to fill out the 3115 then so be it but at least they won’t reassess the taxes owed on the sale.

[TaxGuyBill]

Have you confirmed that the amount is actually the "closing costs" to purchase the property? Those should have been added to the Basis of the property itself, not be depreciated separately.

Or was it loan fees, either from the original purchase or from a refinance?

Have you looked at the 2009 tax return to confirm it was incorrect in 2009 on the 4562?

[DebitThatCreditThis]

Have you confirmed that the amount is actually the "closing costs" to purchase the property? Those should have been added to the Basis of the property itself, not be depreciated separately.

Or was it loan fees, either from the original purchase or from a refinance?

Have you looked at the 2009 tax return to confirm it was incorrect in 2009 on the 4562?

The client cannot locate their 2009 tax return so I'm in a tight spot regarding any additional info.

[Uncle Sam]

What was the depreciation deduction claimed and the accumulated depreciation shown on the last available tax return?
I really believe you're making more of this issue than really exists - you've got Form 3115 and the availability of a ? 481a adjustment to make on the tax return when the error was first discovered.

[DebitThatCreditThis]

What was the depreciation deduction claimed and the accumulated depreciation shown on the last available tax return?
I really believe you're making more of this issue than really exists - you've got Form 3115 and the availability of a ? 481a adjustment to make on the tax return when the error was first discovered.

I uploaded the 2021 depr schedule and sch E here: https://imgur.com/a/UYrD7CG

Believe me, I want to be as pragmatic as possible in this situation and don't want to spend more time than necessary on a depreciation mistake of about $4,000 lol.

I've just never done a 3115 before and after looking into some examples, it looks like it will be at least a half day project citing codes, writing out explanations, etc. So if I can get away with not doing the 3115, I'd gladly take that route.

[Uncle Sam]

Some years ago I represented a client who self-prepared his own return via Turbo Tax and got audited.
He had 3 different rental properties and never picked up depreciation - all 3 units were coops. He never picked up depreciation on any of the properties.
In order to bring things in line I took the time (and billed him accordingly) to prepare Form 3115 which has a section on it for unclaimed depreciation charges he was entitled to claim and
followed the instructions on claiming a ?481a deduction for the unclaimed depreciation.
When depreciable property is sold, you must recapture the depreciation that was claimed OR AVAILABLE whether you claimed it or not.
So it's in your client's best interest to pick up an accumulated adjustment so the calculation on Form 4797 upon sale is correct.
Don't forget you've got ethical considerations under Circular 230 in correcting mistakes of prior filed returns.

[Lion]

https://brasstax.com/ has a course/on-demand/something plus maybe a booklet and definitely some spreadsheet templates for your attachments re Form 3115 at a really reasonable fee. (Years ago it was maybe $20 for the booklet and free spreadsheets.) Charge your client accordingly.

[DebitThatCreditThis]

Some years ago I represented a client who self-prepared his own return via Turbo Tax and got audited.
He had 3 different rental properties and never picked up depreciation - all 3 units were coops. He never picked up depreciation on any of the properties.
In order to bring things in line I took the time (and billed him accordingly) to prepare Form 3115 which has a section on it for unclaimed depreciation charges he was entitled to claim and
followed the instructions on claiming a ?481a deduction for the unclaimed depreciation.
When depreciable property is sold, you must recapture the depreciation that was claimed OR AVAILABLE whether you claimed it or not.
So it's in your client's best interest to pick up an accumulated adjustment so the calculation on Form 4797 upon sale is correct.
Don't forget you've got ethical considerations under Circular 230 in correcting mistakes of prior filed returns.

You are right. Thank you, I appreciate the thoughtful responses.

[DebitThatCreditThis]

https://brasstax.com/ has a course/on-demand/something plus maybe a booklet and definitely some spreadsheet templates for your attachments re Form 3115 at a really reasonable fee. (Years ago it was maybe $20 for the booklet and free spreadsheets.) Charge your client accordingly.

Found it! Sweet, thanks for the rec: It's here if anyone is interested.