Triplex Owner Recovers $169K of Missed Depreciation With Form 3115
How the owner of a three-unit building held for 7 years used a Form 3115 change in accounting method to claim $169,000 of previously missed depreciation in a single year, reducing tax by approximately $54,000.
Client Profile
| Asset | Long-term rental, a three-unit building |
|---|---|
| Purchase price | $1,110,000 |
| Years held before study | 7 years |
| Owner's other income | $300,000 |
| State | Florida |
| Section 481(a) adjustment | $169,000 |
| Tax reduction | $54,000 |
The Situation
The client had owned a three-unit building for 7 years, purchased for $1,110,000. From the beginning it had been depreciated on a single 27.5-year straight-line schedule with no component analysis, producing roughly $214,000 of cumulative depreciation over the holding period.
The Challenge
The client assumed that fixing 7 years of understated depreciation would require amended returns, and that the three-year statute of limitations capped any recovery. That belief had kept them from acting for several years. Meanwhile the property was generating taxable income each year that could have been sheltered.
What We Did
1. Reframed the correction as a method change, not an amendment
Depreciation is a method of accounting. Because the original method had been used for more than two consecutive years, correcting it is a change in method of accounting rather than an error correction. That is made on Form 3115 with a Section 481(a) adjustment capturing the entire cumulative difference back to the placed-in-service year, with no statute of limitations cap and no amended returns.
2. Performed an engineering-based cost segregation study
With $270,000 allocated to land, the depreciable basis was $840,000. The study reclassified $227,000, or 27%, into 5-, 7-, and 15-year categories covering appliances, flooring, cabinetry, fixtures, and site improvements including paving, landscaping, fencing, and exterior lighting.
3. Computed the Section 481(a) adjustment
Recomputed under the correct classifications, cumulative allowable depreciation through the beginning of the year of change would have been $383,000 against $214,000 actually claimed. The favorable adjustment of $169,000 was deducted in full in the year of change, since negative adjustments are not spread.
4. Filed under automatic consent with the required duplicate copy
The change was filed under the automatic consent procedures with no user fee, using the designated change number for depreciation method and recovery period changes. The original accompanied the timely filed return and a duplicate was filed separately with the IRS in Ogden. We also evaluated late partial disposition elections for components replaced during the holding period.
The Result
The $169,000 catch-up deduction reduced tax by approximately $54,000 at a 32.0% combined marginal rate, all in a single filing year, without amending a single prior return. Going forward the property depreciates on the corrected component schedule.
Key Takeaways
- A Form 3115 reached back all 7 years, well beyond the three-year amendment window.
- The catch-up was a negative Section 481(a) adjustment, deducted entirely in the year of change.
- Automatic consent meant no user fee and no advance IRS approval.
- The duplicate Ogden filing is mandatory and is the most commonly missed step.
Frequently Asked Questions
Why not just amend the prior returns?
Depreciation used for two or more consecutive years is an established method of accounting, so correcting it is a method change rather than an error correction. The method change is also better: it reached all 7 years at once, while amendments would have been limited to the open statute period.
Is the catch-up deduction spread over several years?
No. A negative Section 481(a) adjustment, which is what a cost segregation lookback produces, is deducted in full in the year of change. Only positive adjustments that increase income are spread, generally over four years.
Does this trigger an audit?
Form 3115 is a routine filing made under automatic consent. What draws scrutiny is a large adjustment with no engineering study behind it. This filing included a full cost segregation report meeting the standards in the IRS Cost Segregation Audit Techniques Guide.
Could this be done in the year of sale?
Generally no. A change in accounting method is not available in the year the property is disposed of, which is why waiting until you are selling forfeits the opportunity entirely.
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