Discussion Archives:Correction of an error in depreciation

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Discussion Forum Index --> Advanced Tax Questions --> Correction of an error in depreciation


Discussion Forum Index --> Tax Questions --> Correction of an error in depreciation

Marnone (talk|edits) said:

August 12, 2010

I'm wondering how to go about correcting depreciation deductions for an input error.

My client tracks Federal depreciation himself using some depreciation software package. We then take his depreciation calculation and inset it into his tax return. Over the course of several years, he inadvertently input a salvage value for several assets causing those assets to retain basis well beyond the end of their useful life. He has no plans to dispose of those assets any time soon, so we would like to take a depreciation deduction for the remaining basis, if possible.

After reading a couple of rev. procs., I'm still not clear on what our options are. I don't know if this is a change in accounting method or a correction of an error. To complicate matters, for many of these assets, the statute has expired on the last year that a depreciation deduction was taken.

I seem to recall a rev. proc. from several years ago that addressed instances where, for whatever reason, an asset had not been fully depreciated. My recollection was that the taxpayer could write off the remaining basis of the asset in the year the error is discovered. Does this ring a bell to anybody? I would like to know what our options are in this case?

Thanks for the help.

Solomon (talk|edits) said:

12 August 2010
"...I don't know if this is a change in accounting method or a correction of an error."

I doubt the latter.

Marcilio (talk|edits) said:

13 August 2010
Pub 946 - Page 14

Changing Your Accounting Method

Generally, you must get IRS approval to change your method of accounting. You generally must file Form 3115 Application for Change in Accounting Method, to request a change in your method of accounting for depreciation. The following are examples of a change in method of an accounting for depreciation.

• 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. • ....

Davidlat (talk|edits) said:

13 August 2010
I was always under the impression depreciation was allowed or allowable. If you didn't claim the depreciation in the year it was allowed or allowable you can not claim the depreciation now. You would also have to reduce the basis in the asset to zero even though the depreciation wasn't claimed.

Captcook (talk|edits) said:

13 August 2010
I think you can file Form 3115 and pick up the untaken depreciation. I seem to remember a seminar I took where they said this was one of the newer automatic change in accounting methods for which IRS permission was not required. Good luck!

Marcilio (talk|edits) said:

13 August 2010
Allowed or allowable is an old concept. The law now provides a more enlighted view. If you were entitled to the deduction, but didn't take it, you can make up for it. Also, if someone doesn't deduct depreciation to which they are entitled (allowable), it no longer affects basis upon sale of the asset.

I remember unhappy conversations in the old days when people found out they owed taxes based on deductions they didn't take.


Szptax (talk|edits) said:

30 August 2010

I have a correction to make to an asset acquired by an S Corp in 2006. From the client notes it appears that the price of some software was renegotiated down to less than half of the original purchase. The amount in the GL is 59K 5/15/2006 and 26K 2/1/2007. It appears that he continued to depreciate the full amount through 2008. I have been engaged to prepare 2009's return by the estate. The sole shareholder died a couple of months ago.

Since I am only preparing 2009, I think that I can correct the beginning balance sheet and prepare 2009 correctly. I will advise the executor about the error but since it does not effect the reported income for 2009 (I will take no depreciation for the item), then it will have no effect on the return I am completing.

Am I missing anything?

Kevinh5 (talk|edits) said:

30 August 2010
My favorite waitress at the local Waffle House asks the same question "I have your waffle, 2 eggs over easy, side of bacon; scrambled eggs with rye toast, hash browns smothered, covered, topped, chopped, diced, and chunked, two coffees, 1 orange juice. Am I missing anything?"

I haven't the nerve to tell her 'Yes, most of your front teeth.'

I try not to smile, for fear she will smile back. I won't be able to eat my breakfast if she does.

Harry Boscoe (talk|edits) said:

30 August 2010
"...if someone doesn't deduct depreciation to which they are entitled (allowable), it no longer affects basis upon sale of the asset."

Ooooh. How long was I asleep? I *totally* missed that change. Can you cite the *new* rule for us, Marcilio?

Kbairtax (talk|edits) said:

30 August 2010
SZptax...I would NOT suggest changing the beginning balance sheet. YOu are stuck with it unless you amend prior years.

Szptax (talk|edits) said:

30 August 2010
ok - so I am stuck with an erroneous balance sheet showing negative fixed assets, negative total assets and negative liabilities? Well, it does balance....Seriously, not an option.

Kevinh5 (talk|edits) said:

30 August 2010
exactly, tell the client you must amend prior returns, or not prepare this year's return

Szptax (talk|edits) said:

30 August 2010
got it. I was hoping someone smarter than me know of some authority where I wouldn't have to amend returns 2006, 2007 & 2008. I remember another discussion on the subject of amending and there were differing opinions of when there could be a correction without an amendment.

Kevinh5 (talk|edits) said:

30 August 2010
those discussions probably all mentioned IRS Form 3115, you could look at the instructions to see if that would apply here.

Szptax (talk|edits) said:

30 August 2010
I don't see this as a change in accounting method - it was just flat out wrong in my opinion, but I will check.

Solomon (talk|edits) said:

30 August 2010
""...if someone doesn't deduct depreciation to which they are entitled (allowable), it no longer affects basis upon sale of the asset."

Ooooh. How long was I asleep? I *totally* missed that change. Can you cite the *new* rule for us, Marcilio? "

I must have been snoozing as well - may be just us, HB.

Szptax (talk|edits) said:

30 August 2010
rev proc 2007-16

Szptax (talk|edits) said:

30 August 2010
here it is Rev._Proc._2007-16

Solomon (talk|edits) said:

30 August 2010
I am aware of that RP, Sz, but could not deduce the "...it no longer affects basis upon sale of the asset. " statement from the RP.

Marcilio (talk|edits) said:

31 August 2010
1245(a)(2)Recomputed basis.—For purposes of this section—

1245(a)(2)(A)In general.—The term “recomputed basis” means, with respect to any property, its adjusted basis recomputed by adding thereto all adjustments reflected in such adjusted basis on account of deductions (whether in respect of the same or other property) allowed or allowable to the taxpayer or to any other person for depreciation or amortization.

1245(a)(2)(B)Taxpayer may establish amount allowed.—For purposes of subparagraph (A), if the taxpayer can establish by adequate records or other sufficient evidence that the amount allowed for depreciation or amortization for any period was less than the amount allowable, the amount added for such period shall be the amount allowed.

1250(b)(3)Depreciation adjustments.—The term “depreciation adjustments” means, in respect of any property, all adjustments attributable to periods after December 31, 1963, reflected in the adjusted basis of such property on account of deductions (whether in respect of the same or other property) allowed or allowable to the taxpayer or to any other person for exhaustion, wear and tear, obsolescence, or amortization (other than amortization under section 168 (as in effect before its repeal by the Tax Reform Act of 1976), 169, 185 (as in effect before its repeal by the Tax Reform Act of 1986), 188 (as in effect before its repeal by the Revenue Reconciliation Act of 1990), 190, or 193). For purposes of the preceding sentence, if the taxpayer can establish by adequate records or other sufficient evidence that the amount allowed as a deduction for any period was less than the amount allowable, the amount taken into account for such period shall be the amount allowed.

Solomon (talk|edits) said:

31 August 2010
Well yes. But this would apply to a disposition of property for which depreciation was taken by an employee under miscellaneous on Schedule A would it not. That is to say, the amount allowed was zero because of the 2% limitation.

This would not apply to "...if someone doesn't deduct depreciation to which they are entitled (allowable), it no longer affects basis upon sale of the asset." but rather §1016(a)(2) and allowable are still alive.

Marcilio (talk|edits) said:

31 August 2010
I made a mistake. Allowable is still alive, but only to the extent that the taxpayer doesn't have records to prove that the depreciation taken was less than the amount allowable. The government's position is that they will use the allowable amount to reduce basis; however they will use the allowed amount if there is sufficient evidence to document that less than the allowable amount was deducted.

I've only seen this one time in the last 20 years.

Harry Boscoe (talk|edits) said:

31 August 2010
Marcilio, the two Code cites you gave us are for determining how much of the gain from the sale or exchange of a depreciated asset will be taxed as ordinary income rather than Section 1231 gain under the "depreciation recapture" mechanisms. They have nothing to do with the adjusted tax basis of the asset being sold.

They have been in the IRC for a long long time. They may be older than you are. Show us your research chops - find out when these two provisions were put into the Code.

You won't find the *real* allowed or allowable concept in Section 1245 or 1250. You know where to find it. Solomon just told you.

POP QUIZ: Is it the greater of, or the lesser of, the allowed or allowable amount?

Does anybody else think there's been a recent change in IRS's application of the "allowed or allowable" thing in determining the adjusted tax basis of depreciated property? If so, please raise your hand!

Szptax (talk|edits) said:

31 August 2010
Can we back track a little... regarding the amended returns that need to be done to correct for depreciation in my situation:


2006: purchased asset for 59,000

2007: (feb) adjusted purchase price of asset to approx 26,000

Client self prepared 2006, 2007 & 2008 corporate returns.

I dug into the 2006 and discovered the following: 1 -client did not expense their COGS (about 92K)

2 -client used straight line for some assets and 200DB for others

Do I amend 2006, 2007 & 2008 using the depreciation methods used by client...and carry forward to 2007 & 2008 and then amend these years or - do I amend AND prepare a 3115 for change in accounting method for depreciation, though I suspect its too late for that.

Where the balance sheet goes awry is with 2007 so, is it even necessary to amend 2006...Do I just carry through the change in RE with an explanation of the prior year error (did not allow for COGS).

I had concluded that 2006 needed to be amended to change the value of the Fixed Asset (from 59K to 26K) and that fact has not changed.

Harry Boscoe (talk|edits) said:

31 August 2010
Don't amend anything for the depreciation error. Use IRS Form 3115 - if it applies - to avail your client of IRS's automatic permission to change some things in some ways when certain conditions are met. It may be a lot of reading but you'll be able to bill your next client for some of it, and the next one and the next one...

Where did the $33,000 go that the client got back from the reduced purchase price?

One thing at a time: we'll discuss the failure to deduct COGS in another thread, OK?

Szptax (talk|edits) said:

31 August 2010
ok. I didn't think 3115 applied but I will read on some more. This is a Computer & IT company. He used SL for software and MACRS/200DB for everything else. Why would I not amend for the error in the value of the asset? I had read in my research that this was a reason to amend rather than use 3115.

The 33K didn't really go anywhere. The asset was for software licensing/programs. The cost of the license decreased as did the amount due to the company from which it was purchased (amount payable).

Szptax (talk|edits) said:

31 August 2010
Harry - to further complicate matters, I determined the need to correct the prior years returns because the 12/31/08 & 12/31/07 balance sheets were negative, yes minus when prepared and filed by the client. I looked into it further and determined the reason was due to mistakes made regarding the fixed assets, including this 33K overstatement of the asset value for depreciation. Of course I also noticed a change in the 12/31/06 inventory value with no cost of goods sold.

If I were only correcting the depreciation calculation I would be inclined to agree, but I an correcting the asset value itself and for this I think I need to amend. Why would you do the 3115? I don't think it will solve all of the problems.

Szptax (talk|edits) said:

31 August 2010
Additionally, since the shareholder died June 2010 and the company is now closing, I don't think they would qualify for the 3115 under section 5.04(3)(c) ceasing to engage in the trade or business or terminating existence. I think I am stuck with amendment.

Does anyone wish to comment?

Kevinh5 (talk|edits) said:

31 August 2010
I thought we already had.

Szptax (talk|edits) said:

31 August 2010
Thanks Kevin - I was looking at the 3115 again based upon Harry's comments and I was hoping he would enlighten me regarding the COGS issue. I don't think 3115 is applicable - what a mess, there are so many issues! I guess there is really no option but to amend 2006 through 2008. I can use it as an example of why an entity should use a qualified preparer! Are we having fun yet?

Harry Boscoe (talk|edits) said:

1 September 2010
I hope I didn't give you the idea that Form 3115 was being recommended as a cure-all for the several problem areas on this engagement. Initially I was suggesting that Form 3115, if it applies, can be the appropriate solution to a depreciation "misapplication" over several years.

Then there's the COGS thing, also, and then there's the adjustment to the balance sheet, also, and .. and .. don't look again or there'll be more *stuff* to deal with.

I am intrigued by the "failed to deduct COGS" situation. Do you have a Sept 15 deadline to get an amended return filed?

Szptax (talk|edits) said:

1 September 2010
I have a Sept 15 deadline for 2009's return. Unfortunately the problem is reflected in the prior year 2008 balance sheet. The 2008 Balance sheet shows -69309 in fixed assets and -70917 total assets & total liabilities.

In the end the balance sheet is less than 250,000, so the easy solution (if you could call it that) is to not report the balance sheet at all, and go forward and prepare the 2009 with a 3115, except that I believe the 3115 doesn't apply in this case so the only alternative is to amend. The assets went awry in 2006 with the incorrect amount being depreciated for the renegotiated software price (the 33K difference above).

When all of this is said & done there will be losses from year to year. Getting it right benefits no-one except that I cannot proceed with 2009 without the corrections.

My initial question was over the need to amend to do the 2009. Knowing the incorrect amount was used for depreciation and not having the 3115 available due to the termination of the entity in 2010, I think my only solution is to amend 2006, 2007 & 2008.

It just gets better & better. There are suspended losses that I would bet were deducted by the shareholder on his return. I do not know whether or not the estate wants to proceed with the amendment of the prior year individual returns. I suspect that the outcome (overall tax due) wouldn't change in the end and I think they might take a wait and see approach.

As far as the CoGS, they just weren't on the return. He billed the client for equipment procured on their behalf. The sale is reported in income, but the payment to the vendor for the equipment is not in COGS on the return - it is in CoGS in the general ledger. I wonder if he just didn't know what to do with it so he did nothing?

Szptax (talk|edits) said:

5 September 2010
I am also thinking the following: The purchase price for the asset was adjusted 2/2007. So maybe I could make the argument that the correction should be made in 2007? 2006 is a closed year, so I would rather not amend the 2006 return.
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