Repairs, Capital Improvements and Depreciation

When a prior accountant never claimed depreciation on a rental property, the IRS treats that as an "impermissible method" of accounting, and Form 3115 (Change in Accounting Method) is the correct tool to catch up all missed deductions in one year as a Section 481(a) adjustment. Taxpayers sometimes wonder whether they can intentionally hold off filing the 3115 until a cost segregation study is done, so both the catch-up and the reclassified components hit the return at the same time. There is no IRS rule that forces you to file the 3115 in the very first year you discover the error - but the automatic change procedure includes a five-year restriction on changing the same accounting method item more than once, which affects the timing calculus in a specific way: sometimes the reason to act sooner is not to bunch up losses, but to avoid burning that five-year window before the cost seg is ready. Readers should confirm current procedural rules and automatic change eligibility under the latest Revenue Procedure governing accounting method changes on the IRS website or with qualified counsel.

When property is used for both personal and business or rental purposes, depreciation must be allocated to the business or rental portion - and the IRS does not forgive the portion you failed to claim. Under the "allowed or allowable" rule in IRC Section 1016(a)(2), your cost basis is reduced by the greater of depreciation actually taken or the amount you were entitled to take, whether you claimed it or not. Skipping depreciation on mixed-use property does not preserve basis - it creates a phantom gain on sale. The mechanics and the recovery options are worth understanding before a disposition forces the issue.