Unused Depreciation

[Christian]

I took on a client some ten years back who had some four rental houses. Three had established schedules for depreciation set up by his former wife. One did not and on asking him "Where is the schedule for this one?" there was none or my wife did not set one up. Now he is selling the house and recalls he paid some $17,00 for it and added $60,000 in improvements over time. I thought we had settled on the house having been fully depreciated but no it apparently was not. I am having him go back and find when he bought it and will simply add his improvements to arrive at a cost as he kept no records of when he made the improvements. He realized no benefit from  the depreciation and would look to me to simply have lost it. My thought is to simply take the year of purchase using his $17,00 cost plus improvements and arrive at what would have been the depreciation over that time period arriving at a depreciated basis which I will deduct from the received amount he gets and he pays capital gains tax on that. Frankly I know of no other way to handle this as in point of fact I have never run into it in my years of practice. If he gets checked by the Service he will simply have to pay on the full amount which I will clearly explain to him. He has a check he paid for the house for years back and a number of receipts for cash payments he made on improvements with no darn date on them. I will make copies of it all. It is not a large sale so it likely will pass muster. He will pay tax on about 87% of the received price. 

[Lee B]

If depreciation was never deducted then a Form 3115 needs to be filed correcting the depreciation

which would allow the deduction of the combined years of depreciation in the current year.

Then the sale of the house could be recorded using the correct accumulated depreciation.

"Form 3115, Change in Accounting Method, is used to correct most other depreciation errors, including the omission of depreciation. If you forget to take depreciation on an asset, the IRS treats this as the adoption of an incorrect method of accounting, which may only be corrected by filing Form 3115."

[JohnH]

I've never done this, but recently walked through the process with a colleague (they did the work - I only looked up instructions and  made suggestions).  At first glance it looks complicated, but the process is fairly straightforward once you get the "allowable" depreciation calculation finished and determine the exact codes to use on the Form 3115.  IMO, you should charge the client well for this work - if you haven't done this before it will require some intensive study, but the client will benefit greatly from your extra effort.

[mcb39]

Depreciation equals allowed or allowable; which everyone seems to realize.  These seem to be coming up fairly frequently lately; perhaps because of the housing market.  

Did you set up a depreciation schedule for him ten years ago, when he first came to you?  I would consider all aspects when deciding on the pricing.

[Christian]

In a word "Good Grief". i will need to start on it now and hope it's done by April 15th.  

[Lee B]

Just go through the 3115 step by step. You only have to do it once. The total depreciation will be deducted only once in the tax year to be filed.

It won't be that bad.

[Lion EA]

The best $20 you'll ever spend:

https://brasstax.com/shop/ols/products/form-3115-line-by-line-correcting-depreciation

Add your cost to your invoice to your client. He should pay your $20 Research Fee.

[JohnH]

Thanks for that link. I approached the research the hard way. Sure would have liked to have this about a month ago.  Guess I should have asked on this forum, eh?

Will certainly save the link just in case I ever run across one myself.  

[DANRVAN]

On 12/1/2023 at 2:47 PM, Christian said:

I thought we had settled on the house having been fully depreciated but no it apparently was not.

Just curious how you have now determined it had not been depreciated either in full or part?

Also, how are you going to determine if the improvements (either in full or in part) have not been written off as expenses over the years?

On 12/1/2023 at 2:47 PM, Christian said:

He has a check he paid for the house for years back and a number of receipts for cash payments he made on improvements with no darn date on them.

In order to include the improvements in the 481(a) adjustment, you will need the date placed in service to determine the amount of depreciation allowed or allowable.

[Corduroy Frog]

This may sound bizarre, but I think at a recent seminar, a new form was introduced, whereby all of the prior depreciable amounts are added to income, but the accumulated amounts plus current year is allowed as a deduction.  There were pre-qualifiers.  Sorry, I'm having trouble remembering the special form.

[DANRVAN]

On 12/22/2023 at 10:05 PM, Corduroy Frog said:

but I think at a recent seminar, a new form was introduced, whereby all of the prior depreciable amounts are added to income, but the accumulated amounts plus current year is allowed as a deduction. 

I think you are confused.  That does not make any sense at all.

[Corduroy Frog]

I am confused.  Looking back at the seminar materials, apparently what I had reference to was a 481(a) Adjustment, where the recapture of "allowable" depreciation can be minimized by the use of Form 3115 to change methods retroactively.  The 481(a) adjustment could also be used to increase recapture and add to taxable income, if circumstances benefit the taxpayer having more income.

[DANRVAN]

It is not a new form or concept, been around for as long as I can remember doing taxes; and referred to in multiple replies to the OP above.

[Christian]

Not having ever had to deal with this let me say this. An allowance for formerly unused depreciation going back fifteen or so years would be a deduction for 2023 right ? Of course, it would also reduce his basis and he would pay a resulting larger capital gain tax. And yes Danrvan a receipt with no date is essentially worthless as I have no date to assign for depreciation.

[Lee B]

47 minutes ago, Christian said:

Not having ever had to deal with this let me say this. An allowance for formerly unused depreciation going back fifteen or so years would be a deduction for 2023 right ? Of course, it would also reduce his basis and he would pay a resulting larger capital gain tax. 

Yes, it would all be deducted in 2023.

No, remember depreciation is allowed or allowable, so not submitting the 3115 would be a failing to do your due diligence.

[Christian]

I understood that I would need to submit a Form 3115 with the return. It looks a bit complicated but I'll need to do some reading for sure.

[Lee B]

The self study class from Brass Tax that Lion posted about sounds like a good investment for only $20