Is it necessary to file Form 3115 to claim catch up depreciation on a rental property?
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Yes, it is generally necessary to file Form 3115, Application for Change in Accounting Method, to claim "catch-up" depreciation on a rental property when you are correcting depreciation deductions for prior years due to a change in the method of accounting. This situation commonly arises when a taxpayer did not properly depreciate an asset in prior years, used an incorrect recovery period, method, or convention, or failed to depreciate the property at all. The IRS considers a change in depreciation method, recovery period, or convention for depreciable property to be a change in accounting method that requires the consent of the Commissioner, which is typically obtained by filing Form 3115 under the procedures outlined in Rev. Proc. 2015-13 and the current list of automatic changes (e.g., Rev. Proc. 2019-43, as modified).
1. Legal Framework
Change in Accounting Method
- Treas. Reg. § 1.446-1(e)(2)(ii)(d)(2)(i) provides that a change in the depreciation or amortization method, period of recovery, or convention of a depreciable or amortizable asset is a change in accounting method.
- Treas. Reg. § 1.446-1(e)(2)(iii), Example 9 specifically illustrates that a change in depreciation method, recovery period, and convention resulting from a cost segregation study (or similar reclassification) is a change in accounting method.
- Rev. Proc. 2015-13 and the annual list of automatic changes (e.g., Rev. Proc. 2019-43, as modified) provide the procedures for obtaining automatic consent to make such a change.
Catch-Up Depreciation and Section 481(a) Adjustment
- When a taxpayer changes from an impermissible to a permissible method of accounting for depreciation, the adjustment is made under IRC § 481(a), which requires the taxpayer to take into account those adjustments necessary to prevent amounts from being duplicated or omitted as a result of the change.
- The "catch-up" depreciation is reported as a section 481(a) adjustment in the year of change, which allows the taxpayer to claim the missed depreciation in a single year (or over a specified period, depending on the adjustment amount and circumstances).
Amended Returns vs. Form 3115
- The IRS has a longstanding position that once a method of accounting is adopted for depreciation, a taxpayer may not change the method by amending prior returns. Instead, the taxpayer must file Form 3115 to request consent for the change and claim the catch-up adjustment under section 481(a).
- Amended returns to correct depreciation are generally not allowed unless specific guidance provides otherwise (e.g., for certain recent law changes or within a limited window after the original return was filed and before the next return is filed).
Cost Segregation and Rental Property
- Cost segregation studies, which reclassify property components to shorter recovery periods, are a common reason for filing Form 3115 to claim catch-up depreciation on rental property.
- The IRS Cost Segregation Audit Technique Guide confirms that a change in recovery period, depreciation method, or convention for depreciable property is a change in accounting method, and the adjustment must be made via Form 3115.
2. Practical Steps
- Determine if a change in accounting method is required: If you are correcting prior depreciation errors (e.g., missed depreciation, wrong method, wrong recovery period, or convention), you must file Form 3115.
- Calculate the section 481(a) adjustment: This is the difference between the depreciation that should have been claimed and what was actually claimed in prior years.
- File Form 3115: Attach the form to your timely filed tax return (including extensions) for the year of change, and follow the procedures for automatic consent if eligible.
- Report the section 481(a) adjustment: The catch-up depreciation is included on the tax return for the year of change as an adjustment to income.
3. Exceptions
- If the error is due to a mathematical or posting error, or a change in underlying facts (not a method change), an amended return may be appropriate, but this is rare for depreciation issues.
- For certain recent law changes (e.g., the retroactive change to the recovery period for Qualified Improvement Property), the IRS has provided limited relief to allow amended returns in specific circumstances, but this is not the general rule for rental property.
4. Conclusion
In summary: To claim catch-up depreciation on a rental property due to missed or incorrect depreciation in prior years, you must generally file Form 3115 to request a change in accounting method and report the section 481(a) adjustment. This is the required procedure under IRS regulations and revenue procedures.
If you need guidance on how to complete Form 3115 or calculate the section 481(a) adjustment, additional information about your specific situation (e.g., the nature of the depreciation error, years involved, and property details) would be helpful.
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