Depreciation errors are corrected by either filing an amended return or filing a change in accounting method form. Depreciation errors that are NOT subject to the accounting method change filing requirements require amended returns and include:
Amending returns will only correct depreciation errors that have occurred in the last three years. Errors that have occurred before that cannot be “caught up” on current or amended returns and will only be “caught up” when the asset is sold using a Form 3115 and Code 107 as discussed below.
Change in Accounting Method Form 3115:
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. When changing methods of accounting from not taking depreciation (incorrect method) to taking depreciation (correct method) use Code 7 on Form 3115 if the asset is still in use, code 107 if disposed.
The IRS’s automatic consent procedures for taxpayers who have adopted an impermissible method of accounting for depreciation (or amortization) and have either claimed no allowable depreciation, less depreciation than allowable, or more depreciation than allowable is provided in the guidance at Rev. Proc. 2015-13 and 2018-31.
Generally, Form 3115 must be attached to the taxpayer’s tax return for the year of change by the original due date (including extensions). A copy must also be filed with the IRS no later than when the original is filed with the taxpayer’s return.
Taxpayers who qualify under the automatic procedure are permitted to change to a method of accounting under which the allowable amount of depreciation is claimed. The unclaimed depreciation from years prior to the year of change is taken into account as a net negative (taxpayer favorable) adjustment in the year of change, generally effective for tax years ending on or after December 31, 2001 and are deducted in full on the return for the year of change.
Changes that are considered to be a change in accounting method are:
Rev. Proc. 2015-13 is also to be used to correct depreciation after an asset has been sold and the 12/30/03 regulation changes correct other depreciation errors. The Procedure’s additional primary value is to recover depreciation deductions mistakenly overlooked, for which, under the “allowed or allowable” rule the taxpayer had to reduce basis in the asset. This Revenue Procedure effectively makes the “allowed or allowable” penalty disappear! Code 107 on Form 3115 is to be used to “catch up” omitted depreciation on an asset when it is sold.
Changes that do not require Form 3115 because they are not considered changes in a method include, and which may only be made on an amended return:
Other depreciation corrections still qualify for the automatic change provisions of Rev. Proc. 2015-13.
Explanation of the 2-year rule:
The use of an incorrect method of depreciation, which would include taking no depreciation, is considered the use of an incorrect accounting method. Once an incorrect accounting method has been used for two years, a Form 3115 is required to change accounting methods back to a correct method, or in this case, since not taking depreciation is incorrect, to begin taking depreciation a Change in Method form must be filed. To change to the correct method, meaning to take the overlooked or correct depreciation requires the filing of the change in accounting method form, Rev. Proc. 2015-13 in most cases. (Instructions to Form 3115)
If no depreciation had been taken and only one year has passed the return may be corrected via amendment because the incorrect method had only been used for one year.
Examples of depreciation change in accounting methods:
Form 3115 will have to be filed, with the entire amount of incorrect or overlooked depreciation deducted in full in the year of correction via this Form 3115. The total depreciation adjustment is called a Section 481(a) adjustment, which, if negative may be deducted in full in the year of change.
If positive, it may be added in ratably over 4 years, or if positive but less than $50,000 in total the taxpayer may elect to add it in to income in full in the year of change.
The form may be filed at any time for any year, and if for a prior year sale, is accompanied by an amended tax return, effective for a Form 3115 filed for taxable years ending on or after 12/30/2003.
Rev. Proc. 2015-13 requires that a signed copy of Form 3115 be filed to the IRS office. No advance approval is required to correct the error, as this is an automatic approval change in most cases. There is no user fee.
An original of the Form 3115 should be included with the tax return filed for the year of change. The original must be filed by the due date of the return, plus extension. There is a 6-month automatic extension of this due date providing the return was timely filed, and an amended return (with this change) is filed within 6 months.
When filing Form 3115, the additional statements listed below must be attached:
On Form 3115 at the top of the page make sure of this notation:
Filed Under Rev. Proc. 2015-13