Change in Method or Error Correction

[ACCLIGHT]

Hello all-

I have two advisor CPA's which have a difference of opinion and frankly I am not sure which call is correct. On is of the opinion the issue is a method change which requires filing of a 3115 in the next current tax year. The other feels it is correction of an error, not a change in method of accounting.  

Here are the facts. All knowledgeable  "weigh in's" appreciated. In 2019 (still open for correction) an item which should have been capitalized as 39 yr property was instead expensed. It is not eligible for any safe harbor, 179 or bonus depn. 2020 and 2021 are being amended  also so it is not an issue to correct by capitalizing and adding to depreciation as it should have been in the first place. The company has a written capitalize policy which this entry did not adhere to and is not reflected by other entries in the year. The question is for tax purposes should this be viewed as a change in method, left incorrect and untouched and corrected in the current year with a 3115, or corrected in the year of the issue and rolled forward through the following years? Thanks!

[Norman2001]

You're changing from an expensed asset to a depreciable asset. It seems that requires a 3115. Read §1.446-1(e)(2)(ii)(d)(2). 

Additionally, a correction to require depreciation or amortization in lieu of a deduction for the cost of depreciable or amortizable assets that had been consistently treated as an expense in the year of purchase, or vice versa, is a change in method of accounting. 

[ACCLIGHT]

Thanks ever so much. That was my feeling also as it involves timing and affects income. I have reviewed Treas. Reg. 1.446-1 and some case law. I guess my concern is going against the advice of a paid advisor with deep experience as a IRS auditor, revenue agent and appeals officer. I made the changes but I just couldn't shake the feeling it was not proper so I reached out to the community and really appreciate your input. Is your advice simply to amend around the error? Can I certify in signing that amended return  is accurate and correct even though it is not but because it conforms to IRS code?

[sjrcpa]

Norman is saying this is a change in accounting method requiring Form 3115.

[sjrcpa]

Did this former IRS employee specialize in accounting methods? Just because you work for the IRS doesn't mean you know everything.

[Terry53029]

Here is a link from "The Tax Advisor" which is easier reading, and agrees with Norman that it is a change in accounting methods, and needs 3115.

https://www.thetaxadviser.com/issues/2007/may/depreciationmethodchanges.html#:~:text=Regs.%20Sec.%20....

[ACCLIGHT]

🤗Understood, but I do have respect for place a respect on a significant career in both private practice and with the IRS as well as several law firms. I have found that there are times when a deeply experienced professional can be wrong or cut corners, but many other times that they simply understand something well past my knowledge. This the advisor makes some excellent points I can't easily drive past. For example:

There is no Designated Change Number in the various IRS revenue procedures and in the Form 3115 instructions that allow a taxpayer to change from deducting an expenditure as an expense to treating it as a capital expenditure with depreciation deductions.  There is no automatic change for this.

Changing from expensing a single item to capitalizing the item and claiming depreciation is neither a change in method of accounting nor a change in depreciation that is mentioned in the regulations.  In fact, in the thousands of court cases where the IRS has capitalized an expense in an audit, I couldn’t find a single instance where the taxpayer argued that such a change was a change in method of accounting. This instance appears to be a capital expenditure that is a correction of an error, not a change in method of accounting.  Although it is a timing issue, that’s not enough to constitute a change of accounting.

So I have to take those points seriously. But I also recognize that this is neither correction of mathematical or a posting errors as outlined by 1.446-1(e)(2)(ii)(b) of the regulations. 

And further seems to meet the definition of “Method of accounting change” which includes not only the overall method of accounting of the taxpayer but also the accounting treatment of any item. Treas. Reg. 1.446-1(a)(1). An accounting practice that involves the timing of when an item is included in income or when it is deducted is considered an accounting method. (1) Section 1.446-1(e)(2)(ii)(a) provides that a change in method of accounting includes a change in the treatment of any item that involves the proper time for the inclusion of the item in income or the taking of the item as a deduction. In determining whether a taxpayer's accounting practice for an item involves timing, if the practice does not permanently affect the taxpayer's lifetime income, but does or could change the taxable year in which income is reported, it involves timing and is therefore a method of accounting. See Rev. Proc. 91-31, 1991-1 C.B. 566. The treatment of a material item in the same way in determining the gross income or deductions in two or more consecutively filed tax returns (without regard to any change in status of the method as permissible or impermissible) represents consistent treatment of that item for purposes of § 1.446- 1(e)(2)(ii)(a). 

As I mentioned I am inclined to go with the 3115 but I need to be sure that in certifying the prior year amendments that this has been handled correctly. 

Thanks for your time and input. 

[ACCLIGHT]

Thanks Terry,

That is a good article and inline with what I have gathered. Would you mind reviewing my comments in my reply to another community member above and sharing your thoughts? My only hesitation in going the 3115 route is the points the advisor has made (outlined above) and my discomfort at certifying the amendments to be true and accurate if they contain a know error that I am not in fact precluded for correcting. 

[Terry53029]

This is taken from Sec. 1.446-1(e)(2)(ii)(d)(2) "a change in the treatment of an asset from nondepreciable or nonamortizable to depreciable or amortizable, or vice versa, is a change in method of accounting".

You stated earlier that the asset was originally expensed, and should have been depreciated. The regs are quiet clear that is a change in method of accounting which requires a 3115

[ACCLIGHT]

Thanks Terry. Any idea on what DCN to use? In making his case the advisor stated there was no code for an automatic change. I have looked through the codes and am not seeing a clear match for Expensed (non permissible) to capitalized. Finally are you willing to weigh in on certifying a return which contains a known issue as accurate and correct. Is it accurate and correct not because it is error free but because it conforms to IRS principal/code?

Really appreciate it. 

[Terry53029 · Accepted solution]

The full list is in the 3115 instructions (https://www.irs.gov/pub/irs-pdf/i3115.pdf) at the bottom of the instructions, and there are 233 numbers. and you are looking for "Expense to Capitalize". It is definitely there, and used as a sample on page 5 of the instructions You can use form  8275  to disclose your position, if you are concerned about penalties

[ACCLIGHT]

Good input Terry. An 8275-R will do the trick. I do see the method change in Table B and searched all DCN's. The only one I can see that should work is Schedule E Code 7. Given the input of yourself and others I think it is the right call. Thanks for your assistance. 

[PhoebeRoberts]

8275-R means "I'm doing something the regs say I shouldn't." You want a regular 8275 if you feel the need for disclosure.

[ACCLIGHT]

 Thanks for your attention to that. My thinking was related to the prior year return which contains the mistake and I am amending for other reasons. Since I know it contains a position contrary to regulation (expense that should be cap.) I was thinking -R version. However your comment caused me to reconsider since we all seem to agree that correcting as part of the amendment would be inappropriate and impermissible. Does that make it incorrectly correct?  (  :