Form 3115 Line-By-Line ihmlisa
This text has been prepared with due diligence. However, the possibility of mechanical or human error does exist and the author accepts no responsibility or liability regarding this material and its use. This text is not intended or written by the practitioner to be used, and cannot be used by a taxpayer or a tax return preparer, for the purpose of of avoiding penalties that may be be imposed. The The text text is is not not intended to address to address every every situation situation that that may may arise. arise. Consult Consult additional sources sources of information, of as needed, as needed, to determine to determine the the solution solution to tax to tax questions. This publication is designed to provide accurate and authoritative information on the subject of federal tax laws. It is presented with the understanding that the author is not engaged in rendering legal or accounting services. Copyright 2017 by Karen Lisa Ihm, Joyner, EA, EA, Coronado, El Cajon, CA. CA Reprinting and Lisa Ihm, any EA, part Coronado, of this text CA. or Reprinting use without any the part express of this written text or permission use without of Lisa the Ihm express is prohibited. written permission of Lisa Ihm is prohibited.
Table of Contents How To Correct Depreciation Errors... 1 When is an amended return appropriate?... 1 When must you file a Change in Accounting Method?... 1 Advantages of Form 3115... 1 481(a) Adjustment... 2 How to calculate adjustment... 2 When to report adjustment... 2 Where to report adjustment... 3 Automatic Change Request Procedures... 3 Automatic Change Not Allowed... 3 Designated Change Number (DCN)... 3 DCN 7 and DCN 107... 3 DCN 8... 3 Filing the Form 3115... 4 8 page form only specific pages required... 4 2 copies must be filed... 4 NEW filing address for copy... 5 Due date... 5 No acknowledgment... 5 Can you still file Form 3115 to make changes relating to new repair regs?... 5 Marked-Up Form 3115... 6 Cessation of Business (Line 4)... 7 Special provision for depreciation corrections... 7 Returns Under Examination (Line 6)... 9 Automatic change request generally not allowed... 9 Allowed in specific circumstances... 9 How to request consent... 9 Under examination defined... 9 Does audit relate to proposed Form 3115 change?... 9 Audit Protection (Line 7)... 10 Audit protection generally applies... 10 DCNs to which audit protection does not apply... 10 Items under exam... 10
3-month window... 10 120-day window period... 10 Method not before director... 10 Change resulting in a negative adjustment... 10 CAP... 10 Other... 11 Audit protection at end of exam... 11 No audit protection if applied new regs prospectively... 11 Changes Within Last 5 Years (Line 11)... 11 Automatic change procedure not allowed... 11 Attachments... 13 Multiple Items & Multiple Businesses (Line 15)... 15 Unrelated business require separate forms... 15 Multiple rental properties are related... 15 DCN list shows permitted concurrent changes... 15 Some increases, some decreases... 15 Designated Change Numbers List... 17 Determining Asset Class - From Pub 946... 19 Form 3115 Shortcuts... 21 Examples... 22 Sample Completed Full 3115... 23 CA Conformity?... 35 Amending Form 3115... 35 Form 3115 Attachment Worksheet for... 36
How To Correct Depreciation Errors When an error is discovered on a prior return, first instinct is to amend the return and make the correction. However, when the error involves depreciation calculations, amending the previously filed return is often not the correct, or most advantageous, way to proceed. 1 When is an amended return appropriate? You can file an amended return (1040X) to correct the amount of depreciation claimed in any of the following situations: You claimed the incorrect amount because of a mathematical error. You claimed the incorrect amount because of a posting error. You have not adopted a method of accounting for property placed in service in tax years ending after December 29, 2003. Generally, you adopt a method of accounting for depreciation by: 1. Using a permissible method of determining depreciation when you file your first tax return, or 2. Using the same impermissible method of determining depreciation in two or more consecutively filed tax returns. When must you file a Change in Accounting Method? If the depreciation correction cannot be made on an amended return (usually because you used the incorrect method on 2 or more returns), the change is made by filing Form 3115. 1 Advantages of Form 3115 Using a Form 3115 rather than a 1040X is generally advantageous for several reasons: 1. It effectively eliminates the statute of limitations for claiming a refund. 2. It eliminates interest on prior year deduction overstatements. 3. It delays payment of tax by allowing corrections of prior year deduction overstatements to be spread out over 4 years. 1 Reg 1.446-1(e)
481(a) Adjustment The amount of the adjustment resulting from correcting the depreciation deduction from prior returns is referred to as a Code Section 481(a) adjustment. 481(a) adjustments represent the aggregate amount of net income or expense that would have been reported in the tax years before the year of change if the taxpayer had used the correct or new method in those earlier years. 2 2 How to calculate adjustment The 481(a) adjustment is generally computed by comparing the amounts reported in prior years and the amounts that would have been reported if the taxpayer had used the correct or new method in those years. 3 The 481(a) adjustment is computed ignoring the statute of limitations on assessment and collection of tax. 4 (Go back to the beginning of time.) When to report adjustment Decrease in income The entire deduction is taken in the year the error is discovered. 5 Increase in income The 481(a) adjustment period is 4 tax years for a net positive adjustment (i.e., increase in taxable income). 1/4 of the adjustment is added to income each year. However, if the increase in taxable income is less than $50,000 6 the taxpayer may elect to include the entire adjustment in the year of change (the year the error is discovered), rather than spread it out over 4 years. (The limit prior to 2014 was $25,000.) Applicant under audit The 481(a) adjustment period is two taxable years (year of change and next taxable year) for a positive 481(a) adjustment for a change in method of accounting requested when a taxpayer is under examination, unless the rules for a change filed in a 3-month window, 120-day window, or method not before the director applies. 7 (See discussion of taxpayers under audit later.) Out of business A taxpayer who ceases to engage in a trade or business must take the remaining balance of any 481(a) adjustment into account in computing taxable income in the tax year of the cessation or termination. 8 Therefore, if a building that was being depreciated is sold, the remaining 481(a) adjustment must be taken into consideration in the year of sale. 2 IRS Letter Ruling 200134005 3 IRS Letter Ruling 200134005 4 Superior Coach of FL, Inc.; Rev Proc 2011-14 5 Rev Proc 97-27 as modified by Rev Proc 2002-19 and 2007-67 6 Rev Proc 2015-13, Section 7.03(3)(c) 7 Rev Proc 2015-13, Section 7.03(3)(b) 8 Rev Proc 2015-13, Section 7.03(4)(a)
Where to report adjustment The adjustment is reported on Line 26 of Form 3115 and on the same form or schedule where the original error occurred. This will generally be Schedule E, but might also be Schedule C or F, Form 2106, etc. 3 Automatic Change Request Procedures In most instances, you use the automatic change request procedures to change the method of accounting for depreciation. 9 There is no fee required by the IRS for an automatic change request. The IRS does not acknowledge receipt or acceptance of your request. Automatic Change Not Allowed The automatic change procedures generally cannot be used, or are subject to special limitations, in the following cases: 1. Taxpayer has returns under audit 2. Filed a Form 3115 within the last 5 years 3. Cessation of business (but special allowance for depreciation deductions) Designated Change Number (DCN) Each change eligible for the automatic change procedures has been assigned a DCN. Those numbers can be found in the chart at the end of the Form 3115 instructions. DCN 7 and DCN 107 These two DCNs will be used most often for depreciation corrections. DCN 7 is a change from an impermissible to a permissible method of depreciation. DCN 107 is the same, but for disposed property. Common depreciation corrections include: 1. Depreciation never claimed (this is not a permissible method, so DCN 7 will be used) 2. Land depreciated (this is not a permissible method, so DCN 7 will be used) 3. Basis in inherited property not adjusted to FMV at date of death (taxpayer is effectively not depreciating part of the basis of the property, which is not a permissible method, so DCN 7 will be used) In all of these examples, if the property was disposed of before the filing of the Form 3115, then DCN 107 is used rather than DCN 7. DCN 8 A change from a permissible method to another permissible method is reported using DCN 8. The most common reason this DCN would be used is to change from item accounting for specific assets to multiple asset accounting (pooling or bulk asset accounts) for the same assets, or vice versa. Some other specific changes are allowed. 10 9 Revenue Procedure 2008-52, Revenue Procedure 2009-39 10 Rev Proc 2015-14, Section 6.02(4)
Filing the Form 3115 11 8 page form only specific pages required When the IRS modified the Form 3115 at the end of 2015, they did not shorten it, but they did add some reference charts making it clear that a taxpayer is only required to complete the parts of the form that relate to their specific change. 4 We will usually file Form 3115 using the automatic change procedures, so Parts I, II, and IV must be completed. Part III can be skipped. Depreciation corrections require completion of only Schedule E. All other schedules can be skipped. 2 copies must be filed A second copy must be sent by mail to Covington, KY. That copy cannot be filed electronically. 11 Form 3115 revised December 2015 instructions
NEW filing address for copy For 2015 the address for automatic change requests delivered by mail has changed from Ogden, UT to 201 West Rivercenter Blvd., PIN Team Mail Stop 97, Covington, KY 41011-1424. Forms sent by private delivery service should be sent to the same address. 5 Due date Form 3115 has the same due date as the tax return to which it relates. An automatic extension of 6 months from the due date (excluding any extension) is granted to file a Form 3115 under the automatic change procedures provided the taxpayer: 12 a) Timely filed (including extensions) its original federal income tax return. b) Files an amended return within the 6-month extension period, c) Attached the original Form 3115 to the amended return, d) Files a signed copy of the Form 3115 with the IRS in Covington, KY no later than the date the original is filed with the amended return, e) Attaches a statement to the Form 3115 that it is being filed pursuant to 301.9100-2(b) of the Procedure and Administration Regulations. No acknowledgment The IRS does not send an acknowledgement of receipt for a Form 3115 (original or copy) filed under the automatic change procedures. 13 No news is good news! Can you still file Form 3115 to make changes relating to new repair regs? If a taxpayer made the election under Rev Proc 2015-20 to apply the new repair regs only in taxable years beginning on or after January 1, 2014, then they cannot file a Form 3115 (after 2014) to apply the new regs to old items (prior to 2014) on their depreciation schedules. There was no formal election statement required to make the election under Rev Proc 2015-20, so there is debate about whether the taxpayer automatically made the election by failing to file a Form 3115 in 2014; if they did, then they cannot file a Form 3115 in a year after 2014 to clean-up their pre-2014 depreciation schedule. Some argue that if no election statement was attached to the 2014 return, then no election was made, and the taxpayer would be able to file a 3115 in a year after 2014 to clean-up pre-2014 depreciation schedules. 12 Rev Proc 2015-13, Section 6.03(4) 13 Rev Proc 2015-13, Section 6.03(1)(c)
Marked-Up Form 3115 6
Cessation of Business (Line 4) Cessation of a business generally disqualifies a taxpayer from requesting a change in accounting method using the automatic change request procedures. 14 7 Special provision for depreciation corrections However, this provision does not apply when the requested change is a correction in depreciation. 15 If the taxpayer is terminating his business, answer the question Yes and attach a statement explaining why he can still use the automatic change request procedures. A sample statement could state: Revenue Procedure 2015-14 Section 6.01 states that the eligibility rule in section 5.01(1)(d) of Rev Proc 2015-13 does not apply to DCN 7 or DCN 107. (DCN 7 is a change from an impermissible to a permissible method of depreciation. DCN 107 is the same, but for disposed property.) 14 Rev Proc 2015-13 Section 5.01(1)(d) 15 Rev Proc 2015-14 Section 6.01(2)
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Returns Under Examination (Line 6) Automatic change request generally not allowed Generally, if a taxpayer s return is under audit, they do not qualify to use the automatic change request procedures, unless the IRS director consents to the filing of an application to change. 9 Allowed in specific circumstances The director will consent to the filing of the application under the automatic change request procedures unless, in the director s opinion, the method of accounting to be changed would ordinarily be included as an item of adjustment in the year(s) for which the taxpayer is under exam. 16 For example, the director will consent to a filing of an application for a change from a clearly permissible method of accounting, or for an asset placed in service after the year under exam. The director s consent is limited to consent to file the application, and does not constitute the director s agreement to, or approval of, the requested change. How to request consent The request is made by requesting technical advice, and because technical advice is issued to assist field offices, it is the field office (auditor) that determines whether to request technical advice. While a case is under the jurisdiction of a Director, a taxpayer may request an issue be referred to the Associate (Chief Counsel) office for technical advice. The request may be oral or written and should be directed to the field office. If denied, appeal procedures are available. 17 Under examination defined The applicant is under examination if they have received any contact in any manner by a representative of the IRS, for the purpose of scheduling or conducting any type of examination of the return. 18 (If the exam has been scheduled but has not yet begun, the applicant is considered under examination. If a letter has been received asking the taxpayer to contact the IRS to set up the exam, the applicant is under examination. If a CP 2000 letter has been received and has not yet been reconciled, the taxpayer is under examination.) Does audit relate to proposed Form 3115 change? Generally, the applicant s method of accounting (the reason for filing the Form 3115) is an issue under consideration if the examining agent has given the taxpayer written notification specifically citing the treatment of the item as an issue under consideration. If no adjustment is proposed for the item during the exam, and the auditor does not put the issue in suspense for later review related to another year, then the item is no longer considered to be an item under examination. 16 Rev Proc 2011-14, Sec 6.03 17 Rev Proc 2014-2, Section 5 18 Rev Proc 2015-13, Section 3.18
10 Audit protection generally applies Audit protection generally applies when an application for change in accounting method is granted. Audit Protection (Line 7) DCNs to which audit protection does not apply Those changes to which audit protection does not apply are noted in the chart of DCNs provided at the end of the Form 3115 instructions. If that chart does not specifically say that audit protection is not provided, then audit protection is provided. Items under exam Special rules apply to taxpayers under exam, but they may still qualify for audit protection in specific circumstances. 3-month window The 3-month window is the period from the 15 th day of the 7 th month (usually July) to the 15 th day of the 10 th month (usually October) following the close of the applicant s tax year. Audit protection applies if: A. Taxpayer has been under exam for at least 12 months as of the first day of the 3- month window, and B. The change being requested is not an issue under consideration. 120-day window period The 120-day window is the 120-day period following the date an exam ends, regardless of whether a subsequent exam has commenced. An applicant qualifies for audit protection if: A. They file Form 3115 during the 120-day window, and B. The change being requested is not an issue under consideration. Method not before director The present method is not before the director when it is: A. A change from a clearly permissible method of accounting, or B. A change to property placed in service after the year under exam. Change resulting in a negative adjustment If the change results in additional income being reported, then audit protection generally applies. (This would be the case if depreciation adjustments were overstated in prior years.) CAP CAP applies only to consolidated group members participating in the compliance assurance process (CAP).
11 The List of Automatic Changes may provide audit protection in specific cases. Attach a Other statement citing the guidance providing audit protection. Audit protection at end of exam If none of the other categories applies, this box should generally be checked. The applicant may receive audit protection at the end of the exam, provided the examining agent does not propose an adjustment for the same item and the method of accounting for that same item is not an issue under consideration. No audit protection if applied new regs prospectively A small business taxpayer choosing the option of calculating a 481(a) adjustment that takes into account only amounts paid or incurred, and dispositions, in taxable years beginning on or after January 1, 2014, does not receive audit protection for taxable years beginning prior to January 1, 2014. 19 Changes Within Last 5 Years (Line 11) Automatic change procedure not allowed An applicant generally is not eligible to file under the automatic change procedures if they made or requested a prior item change (for the same item) or a prior overall method change within the five tax years ending with the requested year of change. The national office will consider the taxpayer s explanation for requesting consent to again change its method of accounting for that same item in determining whether to grant consent for the current request. 20 19 Rev Proc 2015-20, Section 2 20 Rev Proc 2015-13, Section 11.02(2)
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13 Throughout the Form 3115 there are lines that ask for detailed information about the change. Most of the requested information is already on your depreciation schedule, so save substantial time by simply typing See Statement Attached into every one of those lines, and attach the current correct depreciation schedule to the return, with the following added notations: Attachments A. Attach copy of new current correct depreciation schedule 1. Above the Prior Depreciation column, add the word Correct. (Since this is the correct current year depreciation schedule, you should have entered the prior depreciation as if it had been correctly claimed. 2. Make another column titled Actual Prior Dep. In that column enter the depreciation actually claimed by the taxpayer in prior years. 3. Cross out Current Depreciation and make the title of that column Section 481(a) adjustment. Do the math and enter the amount of the correction for each asset in that column. 4. To the left of the asset name, make a column titled Asset Class. Enter the asset class from Pub 946. (Applicable pages are reproduced later in this text.) Real estate does not have an asset class, so enter None, or if your property header does not state the type of property, enter the type of property (i.e. residential rental, commercial, etc.). B. Attach a statement including the information requested. A fillable Excel version of the Form 3115 Attachment Worksheet can be downloaded from my website at www.lisaihm.com.
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15 Unrelated business require separate forms A taxpayer may ordinarily request only one change in method of accounting on a Form 3115, but if changes are related, they may appear on the same form. As an example, if the rental building was depreciated using the wrong basis, and the land was also depreciated, both changes can appear on the same Form 3115 (as can all other changes related to that property and other rental properties that are a part of the same business). Separate Forms 3115 are required if changes are made in 2 businesses that are separate and distinct. 21 Multiple Items & Multiple Businesses (Line 15) Multiple rental properties are related Several rental properties do not constitute several businesses even though the rental properties are each reported on a separate Schedule E, so if the land was depreciated on 2 separate rental properties, both corrections can be reported on one Form 3115, but detail must be provided to show how much of the adjustment goes to each of the properties (that detail is already on the depreciation schedule you created). DCN list shows permitted concurrent changes The List of Automatic Changes describes particular changes in method of accounting that a taxpayer is required or permitted to request on a single Form 3115. 22 Some increases, some decreases If corrections are being made to 2 or more depreciable items, and some of the changes result in increases to income and some result in decreases to income, 2 adjustments are made: 1. All increases to income are added together 2. All decreases to income are added together The decreases to income are all included in the year the error is discovered. The increases to income are spread over 4 years (unless the total is less than $50,000 and an election is made to report the entire adjustment in the current year). 21 Rev Proc 2014-1, Section 9.05 22 Rev Proc 2015-13, Section 6.03(1)(b)
16 Form 3115, pages 5, 6, & 7 intentionally deleted because they are not required for a change in depreciation.
Designated Change Numbers List 17
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19 Form 3115 requires that you enter the asset class for each item changed. The asset class is NOT the recovery period (3, 5, 7, 27.5, 39 years). The asset classes are listed in the depreciation publication, Pub 946 (which you haven t opened since 1987 when you memorized all the class lives). Determining Asset Class - From Pub 946
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21 This 8 page form contains question after question that does not apply to typical taxpayers requesting an automatic change in accounting method to correct depreciation, and the technical language used makes it impossible to quickly read the questions to determine which ones apply, and the instructions are even worse. Form 3115 Shortcuts The marked-up Form 3115 provides a quick and easy-to-follow guide for completion of the form. Use a simpler worksheet attachment Using a standardized worksheet to provide the detail required in several areas of the form eliminates the need to read through 8 pages of forms and enter the same information in several different formats. Simply type See Statement Attached into the Form 3115 anywhere that it asks for typed-in information. The example to follow includes a worksheet for this purpose. An Excel version of the worksheet can be downloaded free of charge from my website at www.lisaihm.com. Create a Template Complete a Form 3115. Take screen shots of the completed input, and you or support staff can use that as a guide to quickly enter the required information into your software program for any client needing a Form 3115.
Examples The following are examples of a change in method of accounting for depreciation. 22 Example 1 Missed Deduction A change from an impermissible method of determining depreciation for depreciable property, if the impermissible method was used in two or more consecutively filed tax returns. Wanda Widow is a new client Errors discovered before return prepared Rental property was fully depreciated Husband died 6 years ago Step-up in basis was overlooked FMV of building at date of death was $275,000 FMV of land at date of death was $200,000 File Form 3115 The statute of limitations does not apply. Calculate the correct depreciation, back to the beginning of time. The 481(a) adjustment is the difference between the depreciation actually claimed and what the correct depreciation should have been.
Sample Completed Full 3115 23
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Pages 5, 6, & 7 were intentionally omitted, as they would be blank. 26
27 The $59,583 will be deducted in full in the year the error is discovered. Put the adjustment on Schedule E on the Other Expenses line. Use Section 481(a) adjustment as the description. Mail additional signed copy of Form 3115 to KY address.
28 Example 2 Deducted Too Much Depreciation Larry Landlord Owns 20 unit residential rental building Purchased for $1.4 million Depreciated entire cost Did not take out land Land was $84,000 Form 3115 makes correction all the way back to date of purchase even though older returns are out of statute. Larry Landlord s 3115 would be almost identical to Wanda Widow s, except that the amount entered in Part IV would be different and since the total amount of the positive adjustment is less than $50,000, Larry can elect to include the entire adjustment in the current year. If he made that election, he would answer Yes to Question 27 instead of No.
29 The excess depreciation claimed must be included in income, even though the statute of limitations for assessment of tax is closed for many of these years! The $27,877 of additional income is reported over 4 years, beginning in the year the error was discovered. He can elect to report all the income in one year because the amount is under $50,000 (limit increased from $25,000 by Rev Proc 2015-13(3)(c)).
Example 1 Continued 2 Corrections. 30 Wanda Widow bought the lot next door to rental 3 years ago Paid $100,000 and depreciated it How would the 2 adjustments appear on Form 3115? Depreciated Land Did not depreciate building
31 Negative adjustment portion The $59,583 of missed deductions will all be deducted in the current year. Positive adjustment portion The $8,636 of overstated deductions on the land results in additional income. The income is reported over 4 years (the current year and the next 3 years), unless the additional income is less than $50,000 and the taxpayer elects to report all of the income in the current year.
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Example 1 Continued 33 What if Wanda is in a $0 tax bracket? She should elect to report the entire positive 481(a) adjustment in the current year, as she will pay no tax in the current year and reporting the income in future years might result in tax. On Page 4 of Form 3115, check the box for Line 27 Yes and check the box for the $50,000 de minimis election. On the attached worksheet, be sure to answer the questions at the bottom appropriately.
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35 Yes, but no CA Form 3115 CA generally allows the same adjustments under section 481(a) that are allowed on the federal return, does not have a separate Form 3115. If there are basis differences that result in a different CA 481(a) adjustment amount, make an adjustment on the California Schedule CA for the Schedule C, Schedule E, etc. CA Conformity? Amending Form 3115 If a taxpayer submits additional correspondence regarding its Form 3115 filed under the automatic change procedures (for example, a revised 481(a) adjustment or power of attorney), it must attach a copy of the additional correspondence behind a copy of page 1 of the previously filed Form 3115 and submit it to the IRS at the current address for submission of original Forms 3115.
Form 3115 Attachment Worksheet for 36 An Excel fill-in version of this worksheet can be downloaded from my website at www.lisaihm.com.