Correcting 20 Years Worth of Mistakes

[mriina]

I need a bit of assistance.  I have a new client who has a 1065 for business real estate rental, and a schedule C for investment sales.  Her past preparer got into big trouble, and all his computers were ceased, but she was able to give me her last two years' returns.  The first thing I noticed is that the 1065 activity is listed on Page 1 of the return and that there are no schedules L, M-1, or M-2.  I know for a fact that there is $1.2mil in real estate in that business, but it doesn't appear to have ever made it on to the balance sheet.  I'm thinking it probably won't hurt to keep the activity on page 1, although it isn't technically correct, but do I need to file Form 3115 to put the assets on the balance sheet and start depreciating them?  Any insight is much appreciated.

[ILLMAS]

Good luck.

[jklcpa]

I think you would need to prepare the 3115 because this spans so many years. If the depreciation that was missed was for the first year in service and caught before the second year is filed, it is possible to simply file an amended return for the first year to start the depreciation and carry on from there, however, once 2 years have passed without taking the depreciation, it is my understanding that that establishes the method (lack of) as an impermissible method and requires the form 3115 to correct that. Plus, there is the potential for missed elections during those prior years, or again the lack of elections, that you'll have to consider.

As far as not having the balance sheet, M-1 or M-2, are you sure that the net assets after the accumulated depreciation deductions would still be over one million?  Are the revenues over $250K that would require those schedules regardless of asset value?

A few other thoughts come to mind on this too:

• First is that you will also have to calculate and show the AMT depreciation also so that the IRS will know that the effects of any AMT have been taken into account.
• Second, I'd be very careful with any amendments since you said that your predecessor was in big trouble to the point of his computers being seized. When you prepare an amended return, you are signing with the jurat stating that to the best of your knowledge and belief, that the return is true, correct and accurate. This is the reason that many preparers will not amend a return that was not originally prepared by them. 
• Third, without having all of the returns affected by the lack of depreciation, are you sure that there weren't, or aren't going to be PALs in any of those prior years at the individual level?
• Fourth, with this being a partnership, unless this is a joint venture with a spouse, are you also handling the other partner(s) returns too, and do you have those returns?

This could be very messy and at the very least time consuming, so make sure you really want to be involved in this.  I'd make sure to have a solid engagement letter and consider getting a retainer up front.

[RitaB]

3 hours ago, jklcpa said:

 

• Second, I'd be very careful with any amendments since you said that your predecessor was in big trouble to the point of his computers being seized. When you prepare an amended return, you are signing with the jurat stating that to the best of your knowledge and belief, that the return is true, correct and accurate. This is the reason that many preparers will not amend a return that was not originally prepared by them.

This one.  Right here.  Nailed it.  I don't know how I'd ever be confident that I could arrive at a correct return.  I would assume other things were missed besides depreciation, and I'm thinking they helped the taxpayer, not the IRS.   I don't think they seize computers because your clients overpaid their taxes.  I think I'd have to start from scratch.  And if the taxpayer can only come up with two tax returns, well, scratch seems unlikely.

 

 

[Randall]

No way I'd take this on.  I'd send to a tax attorney specialist.

[Abby Normal]

So the client has no accounting software? In other words, no books? Send 'em packing. Not worth the trouble.

[Catherine]

6 hours ago, RitaB said:

I don't know how I'd ever be confident that I could arrive at a correct return. 

Over the years, I have fired more than one client when I became convinced that the information I was getting could not be trusted.  I am NOT saying these clients were crooks!  Some of them were in over their heads but refused help; others just overwhelmed.  Also computer crashes with no backups, shaky paper records, and no time/unwilling to take time to re-create.  We've all seen multiple reasons.  (And the ones you just don't trust - the ones where you count the toner cartridges when they leave.)  

You are putting your professional reputation at risk, and taking a chance on nasty preparer penalties.  If you decide to take it on, get a BIG retainer, start from scratch with original records, and work your way forwards.  You might also work with a tax attorney from the start (getting them to hire you to do returns gives *you* privilege as well as protects you; your work will be submitted under the attorney's aegis).  If the prior preparer's machines were seized, starting with an attorney might be a good move even if all the records are pristine.  If they went after the preparer, they are going to scrutinize the returns he prepared.

[Abby Normal]

30 minutes ago, Catherine said:

If they went after the preparer, they are going to scrutinize the returns he prepared.

You really have to wait for the IRS to make changes before you can file current returns, because those changes will affect at least capital and partner's basis. Or, if you can't wait for the IRS changes, file knowing you will have to amend.

And for years the IRS changes, you could respond and add depreciation and any other changes you know need to be made, so you wouldn't want to do a 3115 to include all the depreciation. It's a mess!

[Catherine]

1 minute ago, Abby Normal said:

It's a mess!

One crucial question before your final decision to take this client:  do you have a nice big desk with a goodly and comfy space underneath it?  Big enough to hide in for a while, with your jumbo-sized bag of Skittles (or snack of choice), when it gets overwhelming?  If not, refuse the engagement!

[rfassett]

Is there depreciation expense on page 1?  It could be that the assets are being depreciated - but just not showing up on the Schedule L.  Just a thought.  And the other thought, I agree with others, although I would be inclined to take on the project, it would not be without a very sizable retainer.

[Medlin Software, Dennis]

Thank you to the OP for posting.  While I cannot add to what the others have responded, I appreciate the reminder we are not alone with these types of things - that sometimes saying no and suggesting seeking someone who specializes in the issue (without giving a specific referral) is the best course.

[OldJack]

If I was guessing I would say all the assets had been fully depreciated in prior years right or wrong but fully deducted.  If I did his taxes it would only be current and forward from current information.  Let the past be the past.

[mriina]

On 8/28/2017 at 2:02 PM, OldJack said:

If I was guessing I would say all the assets had been fully depreciated in prior years right or wrong but fully deducted.  If I did his taxes it would only be current and forward from current information.  Let the past be the past.

The assets aren't old enough to be fully depreciated.  The only assets there are the buildings that they rent out, so they are S/L, 39-yr assets.  My biggest worry is that I am going to complete schedule L and list depreciation on page 1, and it is going to trigger an audit.  That is why I was considering the 3115 to acknowledge the mistake, and move forward.  My understanding is that the 3115 does offer some audit protection.

[mriina]

On 8/24/2017 at 11:23 PM, jklcpa said:

I think you would need to prepare the 3115 because this spans so many years. If the depreciation that was missed was for the first year in service and caught before the second year is filed, it is possible to simply file an amended return for the first year to start the depreciation and carry on from there, however, once 2 years have passed without taking the depreciation, it is my understanding that that establishes the method (lack of) as an impermissible method and requires the form 3115 to correct that. Plus, there is the potential for missed elections during those prior years, or again the lack of elections, that you'll have to consider.

As far as not having the balance sheet, M-1 or M-2, are you sure that the net assets after the accumulated depreciation deductions would still be over one million?  Are the revenues over $250K that would require those schedules regardless of asset value?

A few other thoughts come to mind on this too:

• First is that you will also have to calculate and show the AMT depreciation also so that the IRS will know that the effects of any AMT have been taken into account.
• Second, I'd be very careful with any amendments since you said that your predecessor was in big trouble to the point of his computers being seized. When you prepare an amended return, you are signing with the jurat stating that to the best of your knowledge and belief, that the return is true, correct and accurate. This is the reason that many preparers will not amend a return that was not originally prepared by them. 
• Third, without having all of the returns affected by the lack of depreciation, are you sure that there weren't, or aren't going to be PALs in any of those prior years at the individual level?
• Fourth, with this being a partnership, unless this is a joint venture with a spouse, are you also handling the other partner(s) returns too, and do you have those returns?

This could be very messy and at the very least time consuming, so make sure you really want to be involved in this.  I'd make sure to have a solid engagement letter and consider getting a retainer up front.

This is neither the first or second year that the assets were left out, and no depreciation was recorded.  They are 8 years down the road on this now, and the prior preparer was a family friend who really didn't know what he was doing, not a CPA. The assets are 39-yr, straight line assets, so I wouldn't need to worry about AMT.  The rental qualifies as active instead of passive, so we are good there.

[jklcpa]

4 minutes ago, mriina said:

This is neither the first or second year that the assets were left out, and no depreciation was recorded.  They are 8 years down the road on this now, and the prior preparer was a family friend who really didn't know what he was doing, not a CPA. The assets are 39-yr, straight line assets, so I wouldn't need to worry about AMT.  The rental qualifies as active instead of passive, so we are good there.

Well, that makes it a little easier anyway. I mentioned the AMT because you didn't say how long ago the assets were put in service.  It's anecdotal, I know, but it's been my experience that if no mention of AMT or its calculations are shown on an amended return, the IRS will put processing on hold until the AMT calculations are provided, whether it applies to the return or not.

I had this with amended returns for an individual's NOL carryback on a 1045, and I had included a statement that there were no adjustments in any years for AMT depreciation or other AMT adjustments, and that the AMT could not have any impact based on the level of income of the original and amended, but the IRS didn't reason any of that out.  The IRS wanted the 1045 schedules all recomputed on the AMT basis as proof before it would finish its processing.

If I were doing this, I'd make sure that the amended K-1s have -0- printed in the AMT adjustments/preferences box, and include the form 6251 on the individual amended returns too, even if that form comes down to -0- adjustment, but that's me. You may choose to do otherwise and hope that you get agents that don't question the returns, but at this point I'd think you and your client would want to leave as little open to interpretation or questions as possible.

[mriina]

20 hours ago, jklcpa said:

Well, that makes it a little easier anyway. I mentioned the AMT because you didn't say how long ago the assets were put in service.  It's anecdotal, I know, but it's been my experience that if no mention of AMT or its calculations are shown on an amended return, the IRS will put processing on hold until the AMT calculations are provided, whether it applies to the return or not.

I had this with amended returns for an individual's NOL carryback on a 1045, and I had included a statement that there were no adjustments in any years for AMT depreciation or other AMT adjustments, and that the AMT could not have any impact based on the level of income of the original and amended, but the IRS didn't reason any of that out.  The IRS wanted the 1045 schedules all recomputed on the AMT basis as proof before it would finish its processing.

If I were doing this, I'd make sure that the amended K-1s have -0- printed in the AMT adjustments/preferences box, and include the form 6251 on the individual amended returns too, even if that form comes down to -0- adjustment, but that's me. You may choose to do otherwise and hope that you get agents that don't question the returns, but at this point I'd think you and your client would want to leave as little open to interpretation or questions as possible.

That's a good recommendation.  I will make sure I get the AMT calculations in there.  Thank you!