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Automatic Accounting Method Changes for Depreciation and Amortization

What happens when an unintentional error is discovered on a prior year tax return?

What if past depreciation was not calculated correctly, or an incorrect method or life was used, or the total cost basis of fixed assets according to the depreciation schedule does not agree to the balance sheet? While there is a temptation to do a “quiet catch-up,” this article describes the circumstances of an acceptable accounting method change, what is not acceptable and the requirements to properly make an accounting method change.

Taxpayers can request an automatic method change for depreciation and amortization if the requirements are met to do so. Taxpayers may change from an impermissible method of accounting to a permissible method of accounting or from one permissible method of accounting to another permissible method of accounting.

The following items are appropriate accounting method changes for depreciation and amortization:

  1. A change in the treatment of an asset from non-depreciable or non-amortizable to depreciable or amortizable, or vice versa;
  2. A correction to require capitalization and depreciation or amortization instead of a deduction for the cost of depreciable or amortizable assets that had been consistently treated as an expense in the year of purchase;
  3. A change in the depreciation or amortization method, period of recovery, or convention;
  4. Under certain circumstances, a change from not claiming to claiming additional first year depreciation if the taxpayer did not elect out of taking such deduction in the year of purchase;
  5. Under certain circumstances, a change from claiming to not claiming additional first year depreciation for a non-qualifying asset;
  6. A change in salvage value to zero for an asset for which salvage value is zero as expressly stated by the Internal Revenue Code; and
  7. A change in the accounting for assets from a single asset account to a multiple asset account or vice-versa, or from/to different types of multiple asset accounts.
For more information or questions on appropriate accounting method changes, please contact a member of the Real Estate Services Group.

The following items are NOT accounting method changes for depreciation and amortization:

  1. An adjustment to the useful life of a depreciable or amortizable asset, unless such change is from/to a useful life or recovery period specifically assigned by the Internal Revenue Code or regulations;
  2. Change in use;
  3. Late depreciation or amortization elections or the revocation of timely valid depreciation or amortization elections;
  4. A change in salvage value; and
  5. A change in the placed in-service date.

An IRC Section 481 adjustment will be required for changes from an impermissible method to a permissible method as well changing an asset from non-depreciable or non-amortizable to depreciable or amortizable and vice versa, or for a change from expensing to depreciating or vice versa. Generally, no IRC Section 481 adjustment is appropriate changing from one permissible method of accounting to another permissible method of accounting.

When an accounting method change qualifies as an automatic change for purposes of filing IRS Form 3115, Application for Change in Accounting Method, there is no user fee. Form 3115 must be filed in duplicate. One copy is due with the filer’s timely-filed Federal income tax return (including extensions) for the year of the change. The other copy must be sent to a specific IRS address no earlier than the first day of the year of change and no later than the date of filing the Federal income tax return for the year of change.

Author: Thomas McCormick | tmccormick@withum.com

Real Estate Services

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