Many years of over-reported depreciation (ie. over paid taxes)

[ZWu1]

My CPA probably has filed my many years' tax returns wrong. We just found out this year that for the investment house we have, since we have been doing married filing separate, they have for many years, used 1/4 instead of 1/2 of depreciation for both of us. This resulted in significant over-paid taxes EACH year.

My question is what is the best thing we should do given: 

1. One can only amend returns for the past 2-3 years (depending on when you filed)

2 . For depreciation, this is NOT accounting change, as it is a pure simple mistake, not accounting method or other change. So a special form for depreciation change is not appropriate probably.

Thanks a lot 

[ZWu1]

Forgot to mention, 1/4 is not because of our ownership (I own 50% and got 25% of yearly depreciation), as they did 1/2 calculation TWICE. 

[Mike9241]

you are correct. Amending is not feasible since the error dates back to years for which no amended return can be filed. Best would be to go back to your CPA and have him/her do the work for free of filing form 3115 for both of you because apparently, they messed up as opposed to providing incorrect data. your other choices is to do it yourselves or pay a tax pro.

Explanation of the 2-year rule:
The use of an incorrect method of depreciation, which would include taking am incorrect amount, is considered the use of an incorrect accounting method. Once an incorrect accounting method has been used for two years, a Form 3115 is required to change accounting methods back to a correct method, or in this case, since the depreciation taken was incorrect, a Change in Method form must be filed. To change to the correct method, meaning to take the overlooked or correct depreciation requires the filing of the change in accounting method form, Rev. Proc. 2015-13  in most cases. (Instructions to Form 3115)

[ZWu1]

Thanks a lot. I tried to post a response 2 days ago but it didn't go through.

A friend who is a licensed CPA told me that by filing this Form 3115, etc. for the past many years, a drawback ia all these years will now be open up for audit.  But in normal cases, audits won't happen for filings more than 3 (?) years old.

Is this true? Are there other downsides and reminder to be aware of?

Thanks a bunch. 

[Mike9241]

you don't get to pick and choose the years to correct. it's all of them.

I'll repeat

Once an incorrect accounting method has been used for two years, a Form 3115 is required to change accounting methods back to a correct method, or in this case, since not taking depreciation is incorrect, to begin taking depreciation a Change in Method form must be filed.

Generally, the IRS can include returns filed within the last three years in an audit. If we identify a substantial error, we may add additional years. We usually don't go back more than the last six years.

note that without correction that excess depreciation is subject to section 1250 recapture. so it maybe that when you sell you'll be paying more in income taxes. 

you cannot just change current and future depreciation to correct excess prior depreciation That too can open you to audit. If the iRS audits your returns for any open year and corrects the error not only may you owe taxes but potential penalties and interest. There are no penalties or interest if you correct using form 3115.  

[ZWu1]

Thanks Mike for your quick response.

My message title is misleading but my messages are right. My case is actually I OVER-PAID taxes for many years, as the return filer made math mistakes consistently and reported lower depreciation. So could you please share your views:

1. Filing 3115 will open all these many years for audit, beyond the usual 3 or  years, right? 

2. If we file 3115, is it one form for all these years, or one form for each year?

3. Is what you said about 1250 still true (so far overpaid taxes) for me?

Really grateful for your response.

[Mike9241]

3115 to correct all years. CORRECTION (originally though you took too much actually you took too little) in addition, since this is a negative 481 adjustment you can pick up the entire adjustment in the year of correction.   if you do not correct this your 1250 deprecation recapture, when sold, will be the amount of depreciation you should have taken without ever getting the tax benefit of the missed depreciation. the higher gain in the year of sale can affect many other items on your 1040. For example, this bogus gain could subject you to a 3.8% net investment income tax. The result could be paying more taxes in the long run then the correction had been made. Consult a tax pro to go over the potential results 

[rjs]

To clarify the recapture rule, when you sell the property you will have to recapture the full amount of depreciation that you could have claimed, even if you did not claim it. Since you claimed less than the correct amount of depreciation, you paid more tax than you should have in the earlier years. But when you sell, you still have to pay tax on the depreciation that you did not claim. So if you don't correct the previous years you will, in effect, be paying tax twice on the same depreciation.

[ZWu1]

Now 2 questions to follow up: 

1. The CPA, who made the math errors consistently for years, said I won't be able to adjust/correct all previous year's cumulative over-paid taxes in 2024, due to a cap or limit. Instead, I will have to adjust the cumulative amount over many future years (by filing 3115 each year). Is this right?

2.  Since I converted 1 of the 2 townhouses to self-use, I am no longer to do any adjustment/correction for that townhouse. That is, my over-paid taxes is forever lost. Is this right?

Thanks a lot!!