File 3115 for client's incorrect depreciation for leasehold improvements

[David]

Manufacturing S Corp leases a building from the 2 S Corp shareholders. The building is in an LLC owned by the 2 shareholder.

The operations moved to the building in 2015 and incurred leasehold improvement costs. The capitalized leasehold improvements account included non-structural items and repairs & maintenance items. These costs were depreciated on the 2015 and 2016 tax returns using a 39 year recovery period.

Now the owners have given me a detail list of the amounts capitalized as leasehold improvements showing non-structural items, leasehold improvement items and repair & maintenance items. Of course, the changes will be to depreciate non-structural items over 5, 7 or other appropriate years and to expense repair & maintenance items. 

Based on my research, it appears that Form 3115 can be filed to get IRS automatic approval for a change in accounting method. No amended tax returns will be needed for 2015 and 2016.

I'm sure some of you have dealt with this same issue before and can let me know if I am headed in the right direction. 

Is form 3115 the correct way to handle this? Is this considered a change from a permissible method of accounting to a permissible method of accounting?  Or is it a change from an impermissible to a permissible method of accounting?

Thanks for your help. 

 

 

[Lee B]

Yes, filing the 3115 is definitely the right way to handle these issues.

[Edsel]

From where I sit, I see two differences of opinion:

1. Errors in accounting methods, depreciation methods, etc. require a 3115.  If there is simply a data error, no 3115 should be necessary.  Given a list of depreciable assets sufficiently long, there are bound to be errors in the data somewhere.  To issue a 3115 for each one that is discovered means virtually a 3115 every year.
2. If the changes you describe result in no change in taxable income, it would be a freak co-incidence.  An amended return is most likely necessary.  It would appear that Form 1120-S and 4562 (at a minimum) would require amending.

[jklcpa]

37 minutes ago, Edsel said:

From where I sit, I see two differences of opinion:

1. Errors in accounting methods, depreciation methods, etc. require a 3115.  If there is simply a data error, no 3115 should be necessary.  Given a list of depreciable assets sufficiently long, there are bound to be errors in the data somewhere.  To issue a 3115 for each one that is discovered means virtually a 3115 every year.
2. If the changes you describe result in no change in taxable income, it would be a freak co-incidence.  An amended return is most likely necessary.  It would appear that Form 1120-S and 4562 (at a minimum) would require amending.

 

No, ^ this is incorrect for David's client's situation as he described it.  Because incorrect depreciable bases and lives have been reported on 2 or more years tax returns, the proper handling to correct this is by filing Form 3115. They are both considered changes in accounting method.  Amended returns are appropriate only if the error is discovered after only one year's return is filed. 

Please see "Change Your Accounting Method" here for more details: https://taxmap.irs.gov/taxmap/pubs/p946-008.htm

[Catherine]

On 8/25/2018 at 1:25 PM, jklcpa said:

proper handling to correct this is by filing Form 3115

And the procedure is to do it correctly (with all changes incorporated) on the current-year return that will go with the 3115.  ALL changes to income are on the 3115 and added as "other income" or "other expense" (whichever it comes to; I've seen it both ways) to the current-year return.  Don't forget that in Sch C returns, if it's income, that add'l income is subject to SE tax.