TaxMamas TaxQuips

Today, TaxMama hears from Susan in Georgia, who tells us, “I am in the process of selling a rental property. The question that I have is in regads to depreciation. I did not depreciate the property. Big mistake, I know. In my capital gains calculation, I understand that I have to account for the depreciation that I did not take. How do I address this depreciation problem?”

Since the answer to her question is identical to one give about a year ago, let’s go look at that answer.

Do you remember the procedure? It comes up often enough.

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Today TaxMama hears from Frank in CT who asks, “I seem to remember you once mentioned that there is a way to correct past depreciation errors in computation or omission by filing a form as opposed to amending prior years. Did I hear correctly or is this wishful thinking on my part?”

Hi Frank,

It became evident to IRS long ago that many people, especially those who prepare their own tax returns, really botch up their depreciation calculations.

The average taxpayer without a tax or accounting education doesn’t understand the concept of allowed or allowable. What does that mean? It means if you’re using a property in business, like your home office, you must take the deduction for depreciation. And when you didn’t claim the deduction for depreciation, since you should have, when you sell the house or property, you will still have to pay tax on the depreciation recapture, just as if you had used it.

That’s the law.

To help people out, early in 2002, IRS issued Revenue Procedure 2002-9 to allow those people who were still using their property to catch up. Then, in 2004 IRS issued Revenue Procedure 2004-11 for those who’ve already sold the property and are just now getting hit with the taxes they didn’t expect. http://www.irs.gov/irb/2004-03_IRB/ar11.html#d0e1923

What does this do for you? It lets you catch up and claim all the missed depreciation at one time, on your most current tax return, so you are not penalized. This is instead of having to amend each and every return for all the open years (usually only limited to three years). And it prevents you from losing the deduction for all those years that are beyond the three-year limit to amend tax returns. Vern Hoven has an explanation of these procedures – “Effective change in the “allowed or allowable”:
http://www.hoven.com/articles/pdf/allowedorallowable.pdf

You’ll be using Form 3115.
http://www.irs.gov/pub/irs-pdf/f3115.pdf

Turn to Schedule E on page 8 of Form 3115 to request approval for the catch-up depreciation. Prepare a depreciation schedule from the inception of the property’s business use. Attach it to the Form 3115 and deduct the missed depreciation on your tax return. Get a tax professional to help you or to review your computations before you send it in.

And remember, you can find answers to all kinds of questions about depreciation and all kinds of other tax issues, free. Where? Where else? At TaxMama.com

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IRS Revenue Procedure 2004-11

Depreciation Catch-Up for sold property

Form 3115

Use Schedule E on page 8 to fix depreciation

Vern Hoven Article

Effective change in the “allowed or allowable” rule