Depreciation Error on Rental RE - how to amend after 3 years?

Since your depreciation base is limited to the LESSER of your basis or FMV when you converted the property to business/rental use, and in 2003-2004, real estate prices were generally increasing, I don't see the need for a change in depreciation method for form 3115. You would NOT be changing the base number that depreciation is computed on. However, as you took a year that you're not entitled to and cannot amend that year, then you may execute a corrective option of ending the depreciation one year early. Regardless, the amount will be recaptured when you sell the property and the error will wash out then.

"Disallowed" passive losses: They aren't disallowed but carried forward. In most cases, you get them anyway, some year.

I'm not sure I follow you so I'd like to ask a clarification question (or several) please.

Does your 2003 return include a Schedule E for a rental property and is there depreciation included on that return?

If I read your post one way I get - our 03 return incorrectly included a rental property. If this is correct then you certainly can amend your 03 return BECAUSE it will result in your PAYING more in taxes. The three statute of limitations to amend is mostly about getting more refund money back. You can always amend to pay more taxes.

If I read it another way I get - 04 was the first year our returns included a rental property but the placed in service date is listed as 03. If this is correct it should be a simple matter to just change the date placed in service for future calculations.

Depreciation of rental property is mostly a straight line calculation. If you're entitled to a full year's depreciation then you get a full year. If the property was rented for all of 04 then you're entitled to all of the 04 depreciation. The difference in depreciation because of a wrong in service date will only matter if the first year was incorrectly reported as a full year when it was really supposed to be a partial year - and the closer to the beginning of the year it was actually placed in service, the lesser the variance.

Form 3115 can be used to correct incorrect depreciation claimed in prior years but is not to be used ONLY to change an in service date. With the caveat that neither I nor anyone else here can tell you exactly what to do without first seeing all the paperwork, I doubt that you have any requirement to amend any of the years in questions to correct the depreciation, it should be sufficient to simply calculate the correct amount of depreciation "ALLOWED OR ALLOWABLE" and adjust your basis in the property so that when you finally sell the house you pay tax on the correct amount of gain.

As for the prior accountant not allowing the passive losses, I'm curious as to why he did NOT allow them. His assessment may have been correct if you were not actively involved in them. But in my experience even the most remote of owners still keeps a hand in the operations sufficiently to make Active Participation so that the losses are allowable.

As a side note - because the original losses were treated as suspended they do get carried forward until you dispose of the property so you'll need to keep the records related to the rental activity until you sell the house. You will need to report the suspended losses on that return along with the recapture of depreciation claimed as well as any gain from appreciation.

Good luck, Gene E. Utterback, EA, RFC, ABA

The IRS doesn't always accept these. Back in the mid-1990's, I was a sub-contractor to a criminal defense attorney whose client got caught for tax fraud (and illegal insurance kickbacks). As part of his deal with the U.S. Attorney's office, he had to file amended returns, reporting his (higher) tax due to fraud. The IRS REJECTED the balance due returns because they were more than 3 years late. "We smiled" as we fulfilled our part of the deal and the client didn't have to pay after all. ;-)

In the immortal words of Artie Johnson - VERY INTERESTING!

As most of us pros know, there is no statute of limitations on fraudulent returns - once a fraud always a fraud and the IRS can go back to the day of conception if they want to. AND a fraudulent return cannot normally be corrected by amending the return (unless the amended return is filed prior to the original due date NOT including extensions).

Normally when one is convicted of tax fraud (civil or criminal) just how is the tax collected?

That being said, I've picked up clients who insisted on filing amended returns that were a year or two past the statute date and the IRS has accepted them. It's been many years ago and perhaps they have changed things.

Reminds me of the taxpayer who wrote to the IRS and confessed - "I've been cheating on my tax returns and now I can't sleep at night. Enclosed please find a check for $10,000. If I find that I still cannot sleep I'll send another $10,000."

Gene E. Utterback, EA, RFC, ABA