It is true you could legally avoid depreciation. However, if you depreciate every year it will put yourself at a disadvantage and lose the opportunity to claim tax benefits. Depreciation will not be avoided and when you sell the property you must “recapture” all the depreciations regardless whether or not you took it. This can lead to a major headache.
Depreciation allowed is depreciation which is actually deducted and from which the taxpayer receives a tax benefit.
Depreciation allowable is deprecation the taxpayer is entitled to deduct, whether or not actually deducted. If the taxpayer fails to claim allowable deprecation, the basis of the property must still be reduced by the full amount of the allowable depreciation, even though no tax benefit was realized.
Here is a scenario to describe how to fix the missing depreciation in prior years.
Question: A client owns rental property they purchased over ten years ago. They are planning to sell it but have not previously claimed depreciation on the property. When we report the sale on Form 4797, the form requests the depreciation allowed or allowable since acquired. Do we calculate the depreciation they should have claimed in the past and include it on Form 4797 to report the sale, or do we report $0 depreciation since none was ever claimed?
Answer: In the year of sale, report on Form 4797 all depreciation that should have been claimed in the past plus any for the current tax year being filed. The key here is that you also need to complete Form 3115, Change in Accounting Method, to report the missed depreciation discovered at the time of sale. The Form 3115 results in a negative §481(a) adjustment for missed depreciation that is taken in the current tax year in which the rental is sold. Show the “§481(a) adjustment” on the other expense line of their Schedule E.
If you need help with depreciation or other business transactions, feel free to contact me.
