Correcting missed depreciation using Form 3115

Depreciation is one of the most powerful and frequently misunderstood tools in the tax code. It can quietly reduce taxable income year after year, rewarding taxpayers for investing in income-producing property. When depreciation is calculated correctly, it works in the background as intended. When it is missed or miscalculated, however, the consequences can follow a taxpayer for years and land squarely on a tax professional’s desk.

Missed depreciation most often surfaces when a new client comes on board or when an existing client mentions, almost in passing, that they purchased a rental property or business asset several years ago. In many cases, depreciation was never started, used an incorrect method or just stopped altogether. Rental real estate is especially vulnerable to these errors, given the complexity of cost allocations, placed-in-service dates and improvement tracking. The Internal Revenue Service does not view missed depreciation as optional. Whether claimed on the tax return or not, depreciation is considered “allowable,” meaning it still reduces basis when calculating gains or recapture. 

Why depreciation errors raise red flags 

From the IRS’s perspective, depreciation is not merely a tax benefit; it is an accounting method. Once a taxpayer begins depreciating an asset, that method is expected to be applied consistently. According to Treasury Regulations, using an impermissible method of depreciation for two or more consecutive tax years formally “adopts” that method.

Failing to claim allowable depreciation does not preserve it for later years. Instead, it creates an error that must typically be corrected by filing for a change in accounting method. Continuing to ignore the issue can distort income, affect the calculation of gain or loss on disposition, and complicate audits. For tax professionals, missed depreciation is more than a math problem; it is a compliance issue. Correcting it properly protects both the taxpayer and the preparer. That is where Form 3115, Application for Change in Accounting Method, enters the conversation.

Understanding when Form 3115 is required

A common misconception is that missed depreciation can always be fixed by filing amended returns. In reality, amended returns are only appropriate in limited circumstances. For example, a simple mathematical or posting error can be fixed on an amended return. Likewise, if an impermissible method was used for only one year, a preparer can amend that return to make the change.

However, when depreciation was never claimed or was calculated using an incorrect method over two or more years, the IRS generally requires a change in accounting method. That change is requested on Form 3115. This form allows taxpayers to correct cumulative depreciation errors in a single year rather than reopening multiple prior returns. This approach brings the taxpayer into compliance while minimizing administrative burden and providing a clear audit trail.

The role of the §481(a) adjustment

At the heart of most depreciation corrections is the §481(a) adjustment. This adjustment accounts for the cumulative difference between the depreciation that should have been claimed and what was actually claimed in prior years.

A negative §481(a) adjustment, which occurs when prior depreciation was understated, results in a favorable one-time deduction in the year of the change. This can significantly improve a client’s cash flow and reduce their current tax liability. 

A positive adjustment, which occurs when depreciation was overstated, is less welcome but still necessary for compliance. These unfavorable adjustments are typically spread over four years, softening the immediate tax impact. A de minimis rule also permits taxpayers to elect to recognize positive adjustments of less than $50,000 entirely in the year of change.

Mastering Form 3115 benefits your practice

Tax professionals who are comfortable with Form 3115 add measurable value to their services. Most depreciation changes qualify for automatic consent from the IRS, meaning the process is streamlined and does not require a user fee. Identifying these opportunities demonstrates technical competence and opens the door to advisory conversations about recordkeeping and long-term tax planning.

Proper use of Form 3115 also reduces risk by helping clients potentially avoid penalties, interest and uncomfortable questions during an examination. It positions the tax professional as a proactive problem-solver.

For a deeper look at correcting depreciation errors, preparing Form 3115 and calculating the §481(a) adjustment in real-world scenarios, join us for our May 5 webinar, Correcting Missed Depreciation, also available on demand after the live event.