No depreciation claimed on rental property that sold in 2022, help with Form 3115

[johnmhtr]

Hello,

Here is my situation:

I had a residential rental property that was in service between 2014 until 2022. It was sold in 2022. No depreciation was ever claimed.

So I need to file form 3115 to change accounting methods from impermissible to permissible for depreciation. This will generate the unclaimed depreciation from 2014-2021 as a section 481(a) adjustment on 3115.

I have a good handle on the form it is question 4 on page 1 that I'm not sure about.

The question reads:

"During the tax year of change, did or will the applicant (a) cease to engage in the trade or business to which the requested change relates, or (b) terminate its existence? See instructions."

Here is what the instructions say:

"Line 4.

If no, check “No.” If yes, check “Yes” and attach a statement explaining why the applicant is eligible to change its method of accounting. For example, specific guidance may permit an applicant to change its method of accounting in its final tax year. See section 5.03(2) of Rev. Proc. 2015-13 and sections 6.01 (DCN 7) and 6.07 (DCN 107) of Rev. Proc. 2018-31.
Ordinarily, the IRS will not consent to a request for a change in method of accounting when an applicant ceases to engage in the trade or business or terminates its existence. Generally, an applicant is considered to cease to engage in a trade or business if the applicant terminates its existence for federal income tax purposes, ceases operation of the trade or business, or transfers substantially all the assets of the trade to another taxpayer. For example, a cessation of a trade or business occurs when a trade or business is incorporated or the assets of the trade or business are contributed to a partnership. See sections 3.04, 5.01, and 5.03 of Rev. Proc. 2015-13."

I'm not sure how to answer this, or if it even applies to my situation. If I have to answer "yes" then I need to justify being allowed to change the accounting method.

Any ideas?

[tagteam · Accepted solution]

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@johnmhtr wrote:

....specific guidance may permit an applicant to change its method of accounting in its final tax year. See section 5.03(2) of Rev. Proc. 2015-13 and sections 6.01 (DCN 7) and 6.07 (DCN 107) of Rev. Proc. 2018-31.

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Those sections in Rev. Proc. 2018-31 address the Section 481(a) adjustment so answer in the affirmative.

As an aside: Read the instructions carefully. Note that you need to include a supporting statement with Form 3115 and it needs to be submitted in duplicate. Since you need to attach a statement you will have to print and mail the return.

[johnmhtr]

Thanks Champ,

I read those sections in the RevProc 2018-31. It  is interesting that the instructions point you to those specific sections that deal with impermissible to permissible depreciation changes, but say nothing about ceasing to engage in business.

[johnmhtr]

I just wanted to post here in case other people are searching for the correct answer.

I just figured out how to handle this correctly. Question 4 should be answered YES because the property was sold. For an automatic accounting change under DCN #7. Section 6.01(2) of Rev. Proc. 2018-31 states that the eligibility rule in section 5.01(1)(d) of Rev. Proc. 2015-13 concerning the final year of trade or business does not apply to this change. It is this eligibility rule which states that the final year of the business cannot be the year of the change.

So the IRS has explicitly allowed changes under DCN #7 (and DCN #107) for cases where the business has been terminated in the year of the change.

[tagteam]

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@johnmhtr wrote:

I just figured out how to handle this correctly. Question 4 should be answered YES because the property was sold. For an automatic accounting change under DCN #7.

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You are 100% correct here and only need to state the specific guidance, which is contained in Rev. Proc. 2018-31.