Rental depreciation

[Primobabe]

New client.  Sold a rental property during 2020.  Prior accountant never claimed depreciation on Schedule E.  Every year's loss (without depreciation) suspended because of the income limitation.  

My thought -- file Form 3115 to correct the missing depreciation expenses AND add them to the suspended PALs.  Is this ok?

[TaxGuyBill]

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@Primobabe wrote:

My thought -- file Form 3115 to correct the missing depreciation expenses

AND add them to the suspended PALs.  Is this ok?

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Yes.

No, the §481 adjustment from Form 3115 will go on Schedule E as an "other" deduction.

[BobKamman]

Just don't expect anyone at IRS to look at the 3115.  I don't think that is an appropriate form for changing from an unacceptable method to an acceptable one, but I don't want to get into an argument with the Accounting Police.  

[sjrcpa]

I've had them looked at occasionally.

[BobKamman]

Must have been back when IRS had extra people sitting around with little to do.  What is being proposed here is a retroactive change, I suppose under the "automatic" procedures.  But IRS has said  "In the Government’s view, it is in not in the interest of sound tax administration to permit taxpayers from requesting, or otherwise making, a retroactive change in a method of accounting, whether the change is from a permissible or impermissible method."  

If the taxpayer had kept this rental, the 3115 would be needed to start depreciation in 2020.  But since it was sold, there is no going back.  The gain includes recapture of depreciation that was allowable even though not claimed.  The carryover losses are those that exist without depreciation.  The former tax preparer is liable for the additional taxes.  

[Primobabe]

The rental activity began in 2016.  Is amending 2017 - 2019 not allowed, given that "impermissible" was already underway?

[BobKamman]

Revenue Ruling 90-38, which is an IRS version of the debate on how many angels can dance on the head of a pin, says:

A taxpayer may not, without the Commissioner's consent, retroactively change from an erroneous to a permissible method of accounting by filing amended returns, even if the period for amending the return for the first year in which the erroneous method was used has not expired.

https://bradfordtaxinstitute.com/Endnotes/Rev_Rul_90-38.pdf 

Have you asked the taxpayer and/or his previous preparer, why no depreciation was claimed?  Maybe the entire value of the property was in the land -- it would be worth more with the building torn down.  

[sjrcpa]

There's a special rule for this situation that lets you file the 3115 and claim the "missed" depreciation in the year of sale.

I don't have the cite.

[Primobabe]

That's a clever thought about land v. structure value, but no.  Because the property was sold last year, I've already used the Closing Disclosure papers, from the purchase, to calculate the cost basis.  The property is a rather nice rental condo, and depreciation should have been taken.

[Accountant-Man]

I don't have the cite and more either, but it is a Rev. Proc. 2004-ish

[BobKamman]

Rev Proc 2004-11, which said:

SECTION 4. WAIVER OF TWO-YEAR RULE IN REV. RUL. 90-38
.01 In general. Notwithstanding Rev. Rul. 90-38, a taxpayer may file a Form 3115 under Rev. Proc. 97-27, 1997-1 C.B. 680 (or its successor), or Rev. Proc. 2002-9, as applicable, to change from an impermissible method of accounting for depreciation to a permissible method of accounting for depreciation under § 1.446-1T(e)(2)(ii)(d) for any depreciable or amortizable property subject to § 1.446-1T(e)(2)(ii)(d) and placed in service by the taxpayer in the taxable year immediately preceding the year of change (as defined in section 5.02(2) of Rev. Proc. 97-27 or section 5.02 of Rev. Proc. 2002-9, as applicable) (hereinafter, this property is referred to as “1-year depreciable property”), provided the additional term and condition in section 4.02 of this revenue procedure is satisfied. Alternatively, the taxpayer may make the change from the impermissible depreciation method to the permissible depreciation method for the 1-year depreciable property by filing an amended federal tax return for the placed-in-service year prior to the date the taxpayer files its federal tax return for the taxable year succeeding the placed-in-service year.

So that was only when the mistake was caught in the first year. But then it was rescinded by Rev Proc 2007-16, which allows amended returns for earlier years but still requires the filing of a 3115. At least, that’s how I read its Section 3, but I haven’t had any coffee yet this morning.

This whole 3115 shtick is a ridiculous anachronism which should only apply to taxpayers with a net worth of, say, more than $10 million. If anyone at IRS took it seriously, they would deregulate it.