What Is the IRS Forced Depreciation Rule?

Depreciation is an accounting method for spreading a tangible asset’s cost over its useful life. When a business buys an asset like a building or vehicle expected to last more than one year, they cannot deduct the entire cost in the year of purchase. Instead, they deduct a portion of the cost each year. This process applies to property used in a business or for an income-producing activity.

The Allowed or Allowable Rule

The Internal Revenue Service (IRS) has a regulation regarding depreciation known as the “allowed or allowable” rule. This rule dictates how an asset’s basis, which is its original cost, must be adjusted. Your property’s basis must be reduced by the amount of depreciation you were entitled to claim, regardless of whether you took the deduction. The IRS requires you to reduce your basis by the greater of the “allowed” depreciation (what you claimed) or the “allowable” depreciation (what you were entitled to claim).

This rule prevents taxpayers from avoiding depreciation deductions and then using the original cost basis to calculate the gain or loss when selling the asset. Failing to claim a depreciation deduction you were entitled to means you lose the tax benefit for that year and are still required to reduce your basis as if you had taken it. This results in a higher taxable gain when the asset is sold.

Consider a rental property purchased for $300,000. Over five years, the allowable depreciation under the Modified Accelerated Cost Recovery System (MACRS) might be $50,000. If the owner fails to claim any depreciation and sells the property for $350,000, they cannot use the original $300,000 cost to calculate their gain. The IRS requires the basis to be adjusted by the allowable depreciation, making the adjusted basis $250,000 ($300,000 – $50,000) and the taxable gain $100,000 ($350,000 – $250,000).

The IRS views the failure to claim allowable depreciation as an incorrect method of accounting. This classification dictates the specific procedure required to correct the error. Simply amending prior tax returns is not the correct approach for fixing multiple years of missed depreciation; instead, the taxpayer must follow a formal process to change their accounting method.

Information for Correcting Unclaimed Depreciation

Correcting unclaimed depreciation involves filing for a change in accounting method with the IRS using Form 3115, Application for Change in Accounting Method. This form notifies the IRS that you are changing from an impermissible accounting method (not claiming depreciation) to a permissible one. This allows a taxpayer to make up for all previously missed depreciation in a single tax year.

Before completing Form 3115, you must gather specific information about the asset, including its description, original cost basis, and the date it was placed in service. This information is needed to calculate the total depreciation that should have been claimed over the years.

The main part of the correction is calculating the cumulative depreciation that was allowable but not taken. This total is known as a Section 481(a) adjustment. You must compute the proper depreciation for each past year according to the appropriate method, like MACRS, and sum these amounts to find the total adjustment.

On Form 3115, you must identify yourself as the taxpayer and provide details about your business activity. You must describe the impermissible method used, such as “Failure to claim allowable depreciation,” and the proposed permissible method, like “MACRS depreciation.” The calculated Section 481(a) adjustment must be entered accurately on the form.

Filing for an Accounting Method Change

For an automatic change request, which covers correcting unclaimed depreciation, the process involves submitting two copies of Form 3115. One original, signed copy must be attached to your timely filed federal income tax return for the year of the change.

A second, duplicate copy of the signed Form 3115 must be mailed separately to the IRS address specified in the form’s instructions. This dual-filing requirement is necessary for the automatic change to be approved.

The Section 481(a) adjustment, representing all missed depreciation from prior years, is reported as a one-time deduction on your tax return for the year of the change. This allows for a full catch-up of the deductions that were previously overlooked. This corrects the asset’s basis and ensures future depreciation is claimed properly.