Tax Professionals are facing an increasingly common error made by rental and business owners - incorrect asset depreciation. Most clients are unaware of the error’s disastrous consequence until it arrives as a giant tax bill when they sell the property.

Unsurprisingly, landlords have become the most common victims of depreciation mistakes. Why? For several reasons: First, rental-owning has skyrocketed over the past decade. Second, many owners attempt to prepare their tax returns and overlook or misunderstand the requirements. And finally, many tax preparers they hire do not understand the nuanced regulations governing depreciation.

We created the Correcting Depreciation Errors course to help professionals assist clients and grow their businesses. It takes students step-by-step through the correction process, including line-by-line instruction and detailed examples of attached statements. It also includes a resource library containing a completed Form 3115 with attachments, form instructions, and rulings and procedures highlighted in the course.

  Here are a few scenarios professionals regularly encounter:

• Failure to Depreciating Residential and Commercial Rentals, Including Short-Term Rentals 
• Failure to Separate Land from the Asset’s Value, Resulting in Depreciation of Land, which is not allowed
• Failure to Adjust the Basis of an Inherited Asset Later Used in Business
• Incorrect Depreciation Methods
• Impermissible Recovery Periods for Depreciable Assets

Costly Mistake: Each of these errors can generate significant tax liability.  However, the one we see the most often, failure to depreciate rental property, is often the most expensive.  Why?  It generates a HUGE tax liability when the property gets sold because the law considers the asset depreciated even if it wasn’t.   The rules work this way: The owner deducts (or carries over) zero depreciation expense, but the depreciation (which did not happen) still reduces the property’s basis and generates taxable gain when sold. 

Example: Sally purchased a residential rental property on January 1st, 2013 for $250,000.  As many do, Sally believed that taking depreciation was an option, and she chose not to deduct it.  Exactly ten years later, Sally sells the property for the same price - $250,000 (an unrealistic assumption, but I’m illustrating a point).  In Sally’s mind, she broke even and owes no tax on the sale.   

Unfortunately, this belief is a fallacy.  According to the Tax Code, Sally depreciated the rental.  Since the value of the land at the time of purchase was $50,000, Sally expensed the remaining cost, $200,000, over 27.5 years using straight-line depreciation.  In the eyes of the law, $9,091 was deducted each year for ten years, a total of $90,910!  

As an employee at a local tax business tried to explain, Sally’s “basis” (cost minus depreciation) in the rental was $150,090 on the sale date ($200,000 minus $90,910 depreciation + $50,000 for the land).  As a result, her taxable gain from the sale equals the unclaimed depreciation, $90,910 ($250,000 minus $150,910)!  According to the tax preparer, they could recoup a small portion of lost depreciation by amending a few years’ returns, but it would make little difference in the outcome. 

Sally is panicked by this unimaginable injustice.  Without a fix, she owes tax on income she did not receive!  Worse yet, because straight-line depreciation generated the phantom gain, she must pay a 25% rate on this phantom profit, nearly $23,000!

To the Rescue - Form 3115 and a Knowledgeable Professional: Sally desperately sought a solution and, after several calls, contacted Jeff, the attorney who handled the property sale.  Jeff told Sally he’d had several clients in the same predicament over the years and believed there was a way to correct her mistake.  He referred Sally to a tax pro (an EA or CPA) those clients hailed as a “miracle worker.”  

Sally immediately contacted the professional who fixed her mistake and eliminated her $23,000 tax bill.  But it was not a miracle; the Tax Pro knew a procedure few others in her town understood: Using Form 3115, Application for Change in Accounting Method, to Correct Depreciation Errors.

Correcting Depreciation Errors Using Form 3115 to Fix Common Mistakes

Form 3115, Application for Change in Accounting Method, is confusing and overwhelming.  Its eight pages encompass nearly every possible change an individual and entity can make (there are 250 Designated Change Numbers (DCNs)).  Fortunately, however, with some guidance, correcting common depreciation errors is not as difficult as it may seem, especially compared to other challenges tax professionals face.  

We created the Correcting Depreciation Errors course to help professionals assist clients and grow their businesses.  It takes students step-by-step through the correction process, including line-by-line instruction and detailed examples of attached statements.  It also includes a resource library containing a completed Form 3115 with attachments, form instructions, and rulings and procedures highlighted in the course.

Best of all, you own it once you purchase Correcting Depreciation Errors!  Use it repeatedly as needed for yourself, employees, and staff!

The example utilized in the course is related to the failure to depreciate a rental property, but the principles covered apply to most of the following scenarios:

• Failure to Depreciate Residential and Commercial Rentals, Including Short-Term Rentals 
• Failure to Separate Land from the Asset’s Value, Resulting in Depreciation of Land, which is not allowed
• Failure to Adjust the Basis of an Inherited Asset Later Used in Business
• Incorrect Depreciation Methods
• Incorrect Recovery Periods for Depreciable Assets

Important Considerations Regarding this Course:

• Correcting Depreciation Errors is designed for tax preparers and professionals.  It assumes a level of knowledge and understanding that exceeds some other courses.  We do not recommend it for non-professionals.
• The video version of this course does not qualify for CPE.
• The instructor will not be available to answer questions for this course.  Students should be knowledgeable enough to perform research if necessary.