So you think you may have missed some depreciation deductions on your prior tax return? Well you shouldn’t worry too much. In this post, we will walk through your options.
If you missed the deduction in the last three years or less you can simply amend the returns. If you missed any depreciation and have owned the property for three years or less, then get it back by filing a separate amended return for each year you are amending as follows:
- Individuals – File IRS Form 1040X to the IRS service center where you live now (not the address on the original return if this were different.) It often takes 2 to 3 months to process the 1040X.
- State Returns – If your state or local returns are affected, file an amended return with them.
- Corporations – C-Corporations file form 1120X. For S-corporations, file an amended 1120S and follow the instructions for form 1120S. An amended K-1 schedule (form 1120S) must also be filed with the amended 1120S and given to the shareholders.
- Partnerships\LLC’s – For partnerships\LLC’s, file an amended 1065 and check box 5 on form 1065. An amended K-1 schedule (form 1065) must also be filed with the amended 1065 and given to the partners.
- Before three years (closed years) – IRS Form 3115. If you missed any depreciation, and have owned the property for more than three years, then get it back all in one year without having to file amended returns.
- Cumulative catch-up depreciation – Instead you can do “catch-up” depreciation and claim the understated deductions (including closed tax years) as a current year deduction. It is called a “Section 481(a) adjustment”.
- You take the entire catch-up depreciation deduction all in the year of change. Any such catch-up depreciation reduces the basis of the property and would therefore increase any gain on the disposition of the property. It would anyway because you still have to reduce the basis of the property by the accumulated depreciation, which in effect, is adding back to gain depreciation allowed or allowable. Moreover, don’t forget the tax savings from the catch-up deduction and that a 1031 exchange can defer all of the taxes on your gain!
- Form to file\tax law cites – Do this by filing for automatic IRS consent via IRS Form 3115 – Application for Change in Accounting Method. Revenue Procedures: 2008-52; 2002-19; 2002-9; 97-37; 96-31.
- How to file\tax law cites – Form 3115 can be filed by at any time during the year, not just during the first 180 days [Reg. 1.446-1T(e)(3)(i)(B); Rev. Proc, 97-37]. Not all of the lines of the form have to be filled in. At the top of form 3115, insert “Automatic Method Change under Revenue
Procedures 2008-52, 96-31 and 97-37”. Also see Revenue Procedure 9949. For directions refer to Section 5 of Rev. Proc. 96-31 which can be obtained from your tax advisor or the Freedom of Information Reading Room at IRS Headquarters, Box 795, Ben Franklin Station, Washington, DC 20044; or call, (202) 512-1716 (“fax watch”); (202) 512-1800, (202) 622-1658 or 1-888-293-6498.
Alternatively you can have a competent specialist complete the form for you.
- Where to file – See the form’s instructions where to mail. Send certified. Also, attach a copy of the completed 3115 to your own tax return where you are claiming the catch-up depreciation.
- Do the election before you sell the property — This option only pertains to property held by the taxpayer at the time of the change. If the taxpayer sells or disposes of the property and no 3115 election has been made by December 31, the catch-up depreciation is not available. But you have to still add back to gain all depreciation allowed or allowable, which includes any missed depreciation. In this case you can do an amended return (1040X) to recoup missed depreciation for the past three years only.
- Amended return versus 3115. Some may take the position that even for three years or less, file form 3115. But in this scenario of three years or less, many tax experts prefer the amended returns of number 1 above.