Benefits of filing Form 3115 include IRS audit protection and valuable tax savings from prior-year repairs and dispositions.
To file Form 3115 or not. That is the question of the week.
Our answer: Owners of commercial property should continue to file a Form 3115 with their 2014 tax returns with limited exceptions (see sidebar), even though it may require filing extensions to allow adequate time to complete and file a Form 3115.
Sure… on its face, Rev. Proc. 2015-20 appears to be a reason to celebrate. Small taxpayers can now choose to make changes in accounting methods for tangible property without filing a Form 3115, as long as they use a “cut-off” method (i.e., for tax year 2014 and going forward).
Whew! Tax preparers can breathe a huge sigh of relief as a looming mountain of paperwork disappears in a puff of smoke. Right? Not really.
Filing a Form 3115 actually provides a number of protections that your client is waiving by taking advantage of this so-called “relief.”
- IRS examination protection. When taxpayers file Forms 3115, they receive IRS examination protection for their accounting method treatment for all prior tax years. By taking advantage of the exception for small taxpayers, your client waives that protection. For clients who may have aggressively expensed items in prior years under their old methods, that protection is likely worth the cost of preparing the Form 3115 (at most a couple of hours of your time). You still need to perform the work and documentation as to the methods and elections that apply to the 2014 tax year.
- Current deductions of previously capitalized items. Your client could be missing out on some taxpayer-friendly provisions within the Tangible Property Regulations if they choose to use the “cut-off” method. Many owners of commercial real estate actually have been fairly conservative in the past with regard to capitalization of costs in prior years. They could have tens or even hundreds of thousands of dollars in remaining tax basis that, under the new unit of property rules, are now eligible for current deductions. Without a method change filing, those deductions are off limits.
- Late partial disposition. As we’ve said in prior posts on "late" partial dispositions, taxpayers have a one-time opportunity to recognize partial dispositions of property that occurred in prior years on 2014 tax returns—and only if they file a Form 3115. Your client is waiving this opportunity if they file their return without a Form 3115.
- Recognize an unfavorable section 481(a) adjustment over a four-year period. If you have a commercial real estate client who aggressively expensed items in prior years that now must be capitalized and depreciated, then that client will be better off by coming into compliance now and spreading the hit over a four-year period. If the IRS finds those issues upon examination, they will require an immediate increase in income.
Resistant Clients? Have Them Sign a Waiver
What if your client has heard about this so-called good news from the IRS and demands to skip the Form 3115? We recommend that you ask your client to sign a written acknowledgement of the following:
- They waive IRS exam protection for the item for all prior tax years.
- They forego any tax benefits associated with a method change for repairs or for dispositions—including the expiring “late” partial disposition election.
- Filing the return without a Form 3115 is irrevocable once the return is filed.
Of course, we believe that your commercial real estate clients will see the light when you present all the benefits that can come from digging into their fixed asset and depreciation schedules to uncover tax savings while bringing them into compliance with the Tangible Property Regulations. If you have questions about whether filing Form 3115 is right for your client, contact us to learn how our accounting method change specialists can help.