A client who self-prepared returns "forgot" to depreciate her rental. The property was placed in service in 2018. Should I amend or file Form 3115?

[George4Tacks]

Amend

[itonewbie]

I have a different take on this but I'm sure George has his reasons for the position.

If your client did not claim any depreciation on an asset, that, in itself, is an impermissible method.  Since your client has used that impermissible method for two or more years (i.e. 2018 and 2019), consistent tax treatment is established and a method of accounting is deemed to have been adopted.  To start claiming depreciation on the asset, your client should file a F.3115 for the change of accounting method and the catch-up depreciation will be a negative §481(a) adjustment allowable as an expense on the Sch E of the year of change (presumably 2020 in this case).

Had your client discovered the omission when the 2019 return was prepared, she could have simply filed an amended 2018 return to correct the depreciation prior to filing the 2019 return, which would then show the proper depreciation based on the amended 2018 return.

[IRonMaN]

Hopefully the client doesn't "forget" to pay you.

[BobKamman]

@itonewbie 

I always want to ask those who live in the fantasy world where ordinary people can understand Form 3115 or afford to hire someone who does:  What's the penalty, for not filing it and just using @George4Tacks 's common-sense solution?

[PhoebeRoberts]

Being stuck with no depreciation deduction until they accept the consequences of their initial error. Preparers can't advise them to knowingly prepare an incorrect return, and can't sign the return themselves.

Plenty of people in jail for not understanding the law and not affording a lawyer to do it for them. This is just money.

[puravidapto]

I would like to add two additional questions to the thread:

1. When consistent tax treatment has been established, is form 3115 the only option or amending is also accepted solution? In this case, amending two years is not too bad technically.
2. Suppose the client also "forget" to carryover the rental loss in 2019 from loss from 2018 to 2019 (or something else), what is the solution in this scenario?

[PhoebeRoberts]

1) Yes, once you've adopted a method of accounting, even if it's an incorrect / impermissible method, a 3115 is the only technically correct way to change your method of accounting. Not every decision constitutes a method of accounting, but using the same depreciation method ("no depreciation" is a method) for the first two years an asset is placed in service constitutes adopting a method of accounting with respect to that asset.

2) The client can choose to amend 2019, or not. The amount carried forward into 2020 is required to be the "as if prior returns had been prepared correctly" amount, whether the client chooses to amend 2019 or not. "Correctly" in this case includes "using the taxpayer's adopted method of accounting," so isn't a workaround for the depreciation issue.

Caveat that if the client got an impermissible benefit in a prior year, you can't double-dip. So if your client had taken an impermissible rental loss in 2019, the amount carried forward to 2020 would be reduced by that impermissible loss unless the client amended 2019. 

[itonewbie]

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@PhoebeRoberts wrote:

Being stuck with no depreciation deduction until they accept the consequences of their initial error. Preparers can't advise them to knowingly prepare an incorrect return, and can't sign the return themselves.

Plenty of people in jail for not understanding the law and not affording a lawyer to do it for them. This is just money.

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Agree with Phoebe.  The authority is in §446(f) and tax preparers are bound by Circular 230 in conjunction with §6694.  In any case, reduced filing for F.3115 is available to qualified small taxpayers.

May be academic to some but there's no reason for me to advise my clients to not follow the rules, which are clearly established, and risk being sanctioned.

[BobKamman]

@PhoebeRoberts 

O.. C.  D.  

[BobKamman]

@itonewbie   "May be academic to some but there's no reason for me to advise my clients to not follow the rules,"

And lots of rea$on$ for you to do so.  On the other hand, my ethics require not charging an unreasonable fee.  

[IRonMaN]

"and risk being sanctioned"

Not to stir the pot and I am a rule follower, but when was the last time someone was sanctioned over an instance of amending a return similar to the situation in this post?

[itonewbie]

But $ is not what determines one's filing requirements or reporting position, is it?  Unfortunately, incorrect reporting most often comes with a cost, in one way or another.  The only way to avoid that is to have the return done right the first time (and, often times, with proper planning ahead of a significant transaction). 

There is nothing unethical about billing a client for the fair amount of work that needs to be undertaken (unless the additional work was the result of one's own fault) but that also doesn't negate the discretion a practitioner has in setting one's fees under different circumstances.

[itonewbie]

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@IRonMaN wrote:

"and risk being sanctioned"

Not to stir the pot and I am a rule follower, but when was the last time someone was sanctioned over an instance of amending a return similar to the situation in this post?

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I don't know.  May be never.  That's why I said this may be academic. 😁

[Dan Dan the Tax man]

Doo a 481a adjustment.  This is an automatic fix on the 3115 change of accounting.  Fairly straightforward fix.  

[laval650]

Thank you all for your input.  I was hoping for an easier solution (amendment).   

Yes, I know that technically she was supposed to file F. 3115, but I remember reading somewhere that for property placed in service in 2018 the IRS allowed to amend 2 years to correct depreciation not previously claimed (CARES Act?).  However, with the strong support in favor of filing Form 3115 I am going to do just that.

[BobKamman]

@IRonMaN 

Form 3115 is an embarrassing anachronism in many cases, like Form 2063.  I wonder how often our colleague advises non-U.S. citizen clients to comply with that silliness.  

[puravidapto · Accepted solution]

@PhoebeRobertsTruly appreciate your answer, suppose:

1. there was missed depreciation in both 2018 and 2019
2. there was no rental loss carryover from 2018 to 2019
3. we know that there were other errors (overstated deduction) that may or may not change rental income

My questions are:

1. Are we permitted by the law to correct depreciation via form 3115 ignoring the other errors that we know?
2. Suppose we need to amend the returns for the other errors, can we correct the depreciation at the same time or we have to use form 3115?
3. Similarly, can we just carry forward the rental loss to 2020 as filed originally ignoring the other errors that we know?
4. Can we choose not to file amended return for 2018 and 2019 but to use the correct rental loss amounts in 2020 as if the amended return correcting the other errors were filed?
5. Can we mail the amended returns correcting the other errors to clients and assume they were filed and proceed with the assumption?

In the other words, what are the correct options for us to take in above scenario?

PS: I believe your previous answer:

The amount carried forward into 2020 is required to be the "as if prior returns had been prepared correctly" amount, whether the client chooses to amend 2019 or not.

is correct, but can you provide the reference document for me to study more?

[IRonMaN]

I think this would be about the time that our favorite lovable dearly departed curmudgeon would post -------- CAGMC.

[PhoebeRoberts]

1) Form 3115 only pertains to the depreciation issue, and is the only permissible method for changing the amount of depreciation. You get a 481(a) adjustment in the current year (2020) for the 2018 and 2019 amounts, plus 2020 depreciation under the newly-adopted method. 

2) The depreciation taken in 2018 and 2019 was correct under the taxpayer's adopted method of accounting. The accounting method change isn't retroactive; the prior-year adjustment is handled under 481(a).

3) No, the return has to be "true, correct, and complete" to "the best of [your] knowledge and belief." You can't start with an incorrect number (unless the client has already gotten a benefit from taking a larger deduction, in which case the prohibition on double-dipping wins). Note also that the statute of limitations for the IRS to examine the carryforward runs concurrent with the year in which the loss is eventually used, not the year in which it arose. 

4) Yep. If it were an NOL, the statutory authority would be Rev Rul 81-88; I don't happen to have a Form 8275 handy for one in which a passive loss carryforward was involved. 

5) The answer to "can I wink and nudge so my client can cheat" is "no." The answer to "can I make a good-faith reliance on my client's reasonable representation that they file the amended returns I prepared" is yes.

In the simple scenario in which both 2018 and 2019 were loss years, and that there was no current tax benefit from the losses (due to the AGI > $150k passive loss limitation, for instance), document the right amounts and carry the correct amount to 2020. I personally might file a Form 8275, particularly if the client is likely to change preparers before using up all the loss carry fowards, because there's nothing worse than a client coming along with all their back returns and there's no documentation as to why the carry forward coming out of the 2019 return isn't the same as the one coming into the 2020 return, and 10 years from now the client isn't going to have any idea.

In the complex scenario in which amending 2018 and/or 2019 resulted in a change in tax for one or both of those years, amend the years that change and carry the correct amount to 2020.

Reference document: http://www2.csudh.edu/rmalamud/tn083099.PDF is pretty readable, and has good footnote citations. There have been no substantive changes in the last 20 years; you may note that the references in the document go back to the 1960s, so this is pretty old stuff. It's just obscure.