Catch-Up Depreciation With Form 3115

Many owners learn about cost segregation years after buying a property. A common question is whether it is too late. In many cases it is not, because the tax rules generally provide a procedure for changing the depreciation method for property already in service. That procedure uses Form 3115, Application for Change in Accounting Method. What follows is a general overview. Procedures and requirements change, so verify the current rules with your preparer.

The basic idea

If you have been depreciating a building over 27.5 or 39 years and a study shows that part of the cost belongs in shorter lives, you may be able to change how you depreciate that property. Under the change, the depreciation you should have claimed in prior years, compared with what you actually claimed, is generally accounted for as a single adjustment in the year of change. That is often called a catch-up. It is generally a deduction, and it is generally not spread over several years, though you should confirm the treatment.

Why an accounting method change and not an amended return

Choosing a depreciation classification and using it consistently is usually considered an accounting method. Under the tax rules, once a method has been used on two or more returns, changing it generally requires the IRS's consent through the method change process. For many depreciation method changes, the IRS has published automatic procedures that allow the change without prior advance approval, provided certain requirements are met. A property in only its first year may be treated differently. See Method Change Versus Amended Return for Missed Depreciation.

What you generally file

The change is generally requested by attaching Form 3115 to the timely filed return, including extensions, for the year of change, and sending a copy to the IRS in the manner the procedures require. Details include the applicable designated change number, statements about eligibility, and the computation of the adjustment. Preparers who do these regularly know the mechanics. Rules and forms are updated, so confirm the current instructions.

Eligibility considerations

Certain conditions can limit or complicate a change. Examples in general terms include being under examination on the item, having made the same method change recently, and special rules for particular entities. Ask your preparer to confirm eligibility before you rely on the change.

What the catch-up looks like

Hypothetical only: a building placed in service several years ago has been depreciated straight line. A study shows that some components should have been on shorter recovery schedules. The difference between the depreciation that would have been allowed under the correct classification and what was claimed becomes the adjustment. The larger the shift and the more time has passed, the larger the adjustment. See Hypothetical: Catch-Up on a Property Owned for Years and The Section 481(a) Adjustment Explained Simply.

Interaction with bonus depreciation

Whether accelerated methods including bonus can be part of a catch-up depends on the rules governing the property's placed-in-service date. In general, the rules that applied when the property was placed in service are the ones used. Verify carefully. See Bonus Depreciation: Rules as Currently Understood (Verify) and Used Property and Bonus Depreciation Eligibility.

Costs and paperwork

Expect additional professional fees for preparation. Also expect a more detailed asset schedule and the need to track it going forward. See Cost Segregation Study Fees: General Ranges.

Risks and trade-offs

The deduction may be large in one year, which can create issues if you cannot use it, and it may interact with other limits. The adjustment may cause loss limitations to apply. Coordinate the year of change with your income picture. See Suspended Losses and Carryforwards.

When a catch-up is not attractive

If you expect to sell soon, if your losses would be suspended, or if your property is small, the catch-up may not be worthwhile. See When a Cost Segregation Study May Not Make Sense.

Documentation

Keep the Form 3115 filing, proof of mailing where applicable, the study, and workpapers. See Audit Defense and Documentation for Cost Segregation.

Questions to ask about your specific catch-up

Which years of returns show the depreciation method I used? Has the classification of this property been changed before? Am I under examination for any year that includes this property? Is there any reason the automatic procedure would not be available? How will the adjustment interact with my passive loss position? What state filings are needed? How will the deduction be reported and by whom? Asking these in advance avoids surprises and lets your preparer estimate timing and cost.

A word on statements and forms

Method change filings typically include descriptions of the property, the old and new methods, and the calculation of the adjustment. Preparers rely on the study's schedule to fill these in. If the schedule contains errors, the filing will too. Ask your preparer to review the schedule carefully before filing and to keep a copy of everything submitted, with proof of filing where the procedures require it.

Who typically helps

Method changes are usually handled by a tax professional with experience in depreciation. Some general practitioners do them rarely, so ask about experience. The study provider may supply supporting numbers, while the preparer files. Clear roles avoid dropped tasks.

Next steps

Read The Section 481(a) Adjustment Explained Simply for how the adjustment works, then Hypothetical: Catch-Up on a Property Owned for Years for a labeled hypothetical.