Recapture of Depreciation

[RJK0308]

Good morning everyone. 

I had someone come to me yesterday and told me that they purchased a home in 2005 and did some capital improvements shortly thereafter. 

In 2016, their old tax preparer gave the return to someone else in their office and the new preparer stopped depreciating the property. The property hasn't been depreciated since then on the Schedule E. 

What is the best practice to recapture the depreciation and receive the missed savings?  

[IRonMaN]

Has the property been rented since 2005, or just depreciated?  I'm not really clear on that based on how your post reads.

[RJK0308]

From my understanding, it was originally purchased as a primary residence. However, it's a 3-family residence. Therefore, it's always been rented (at least partially).

Approximately in 2007 or 2008, the owner moved out and it became an investment property since then. 

[abctax55]

You'll need to do some research regarding Form 3115.

It's not 'recapture' of depreciation; it's depreciation not taken.

Also research "allowed" vs allowable depreciation.

[TaxGuyBill]

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@RJK0308 wrote:

In 2016, their old tax preparer gave the return to someone else in their office and the new preparer stopped depreciating the property. The property hasn't been depreciated since then on the Schedule E. 

 receive the missed savings?  

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The old office should amend 2020, 2021 and 2022 for free.  And the old tax office should pay the client for the missed tax savings from 2016-2019.

Unfortunately, Form 3115 does not apply because this was just a "mathematical or posting error".

[RJK0308]

I completely agree with you. However, based on my conversation with the person, the old preparer hasn't offered to do so. Furthermore, they don't have confidence in the old preparer anymore to do it correctly. 

[abctax55]

Thanks, Bill.  I knew you would know the specifics.  I always have to look it up.

And I agree about the 'go back to the prior preparer'.  Hopefully, they have E&O insurance.

[TaxGuyBill]

The old tax office is responsible for their mistake and need to compensate your client for it (they may file an E&O claim with their insurance for their mistake).

Even if they don't want to amend, they need to pay your client the amount of the 'extra' tax your client had to pay due to the preparer's mistake.  Your client may want to insist that the old preparer reimburse them for that 'extra' tax, or file a lawsuit (probably small claims court).

[TaxGuyBill]

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@abctax55 wrote:

Thanks, Bill.  I knew you would know the specifics.  I always have to look it up.

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You are welcome.  I usually need to look up many of the specifics too.  There can be so much involved with Form 3115, it is a headache to try to remember things about it.

[sjrcpa]

Old preparer should also pay the fees for the new preparer to fix this.

[rbynaker]

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@TaxGuyBill wrote:

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The old office should amend 2020, 2021 and 2022 for free.  And the old tax office should pay the client for the missed tax savings from 2016-2019.

Unfortunately, Form 3115 does not apply because this was just a "mathematical or posting error".

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I agree with Bill (on all counts).  We don't have the full timeline but it sounds like a permissible method of accounting for depreciation was adopted and then later arbitrarily changed to an impermissible method.

If your client is lucky, the rentals were all operated at a loss and you might be able to just adjust the PAL carryovers to include depreciation.  But any way you slice it, you're looking at hours of time spent across multiple tax years just to ascertain the extent of the damage.

Another alternative is for your client to die so the heirs get a step-up in basis without having to deal with prior "allowed or allowable" depreciation.  I don't recommend this strategy due to the side effects.

[TaxGuyBill]

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@rbynaker wrote:

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I don't recommend this strategy due to the side effects.

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🤣

[PATAX]

@sjrcpa For myself, before passing judgment on any prior accountant, I think it is prudent to hear his or her side of what transpired directly from him or her. Also the last time I checked, when any client signs a tax return, he or she is responsible for the data therein.

[IRonMaN]

The tax liability was there whether the old tax preparer did it right or not.  The tax preparer isn’t responsible for paying the tax but he is responsible for any interest or penalties incurred.

[PATAX]

@IRonMaN I don't believe anything that any of my clients say negatively about a prior accountant until I can verify it myself. I had a client who ripped me off and didn't pay me. The rodent told one of my clients that "I messed up its taxes". I guess this was the roach's excuse for not paying me. So I can just imagine what the worm told its new accountant about me. So  I am skeptical of what my clients say about their prior accountant until I can verify it myself. 

[sjrcpa]

@PATAX Good point.