Form 3115 is the Application for Change in Accounting Method used to notify the IRS of a change in how you report certain items, and the §481(a) adjustment is a one-time catch-up adjustment that accounts for the difference between the depreciation taken and the amount that could have been taken under the new method. Together, these items ensure you can claim missed or accelerated depreciation without amending prior tax returns.
You will typically need to file Form 3115 and include the §481(a) adjustment when you perform a cost seg study on a property that you have owned for several years. This process allows you to reclassify assets for accelerated depreciation, moving from a standard depreciation method to an accelerated one. This adjustment prevents double counting or missing any depreciation by allowing you to catch up on all missed depreciation in the current tax year. Your CPA or tax adviser will file the Form 3115 along with your tax return.
What is Form 3115?
IRS Form 3115, Application for Change in Accounting Method, is the crucial document required to implement certain advantageous changes in your tax reporting, most notably for real estate investors utilizing cost segregation on previously acquired properties. When a qualified engineering-based cost segregation study is performed on a property that has been owned for one or more years, the investor has effectively discovered they were using an incorrect accounting method by depreciating all assets over the full 27.5-year or 39-year life. Form 3115 serves as the formal mechanism to notify the IRS of this shift to a more accurate method, allowing the reclassification of assets to shorter 5-, 7-, and 15-year recovery periods.
The critical role of Form 3115 in this context is to officially request the change and, most importantly, provide the mechanism for claiming the accumulated, missed depreciation deductions from all prior years in a single, substantial sum. Proper preparation and filing of this form, typically done by a tax professional or an expert firm like Engineered Tax Services (ETS), is essential to ensure compliance and avoid potential penalties related to the adoption of a new tax accounting method.
What is a Adjustment?
The Adjustment is the actual tax deduction amount calculated and claimed when Form 3115 is filed to adopt a new, permissible accounting method—such as accelerating depreciation via a cost segregation study. Specifically, Internal Revenue Code Section 481(a) requires any adjustment necessary to prevent amounts from being duplicated or omitted when a taxpayer changes their accounting method. In the context of accelerated depreciation for rental property, the adjustment represents the “catch-up” depreciation—the total amount of depreciation that should have been claimed in all prior years if the shorter 5-, 7-, and 15-year lives had been used from the property's service date.
This adjustment is recognized entirely in the year Form 3115 is filed, resulting in a significant single-year deduction that drastically reduces the investor's current taxable income. This mechanism effectively allows investors to reap the full benefit of accelerated depreciation without having to amend prior years' tax returns, making it an invaluable tool for maximizing tax savings and improving cash flow on existing real estate investments.
Form 3115 and §481(a): Key Facts
- Form 3115 Role: Used to reclassify assets for accelerated depreciation on properties that are already owned.
- 481(a) Adjustment Role: A one-time adjustment that allows you to catch up on missed depreciation in the current tax year.
- When Needed: When you conduct a Cost Segregation Study on a property that you've owned for several years.
- Filing Method: Your CPA or tax adviser will file the Form 3115 with the tax return.
- Actionable Next Step: Let's ensure you're maximizing your benefits while staying compliant with the IRS rules.
