The Tax Form Every Business Owner & Real Estate Investor Needs to File


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Form 3115Before I even start with what the form is, or why you need to know about this, let me tell you what the IRS has said about Form 3115 “Application for Change in Accounting Method.” A US Treasury Official has stated that they expect that every single business owner and real estate investor will need to file at least one with their 2014 tax return. After all 2014 tax returns are filed, they will look for business returns that do not have the forms and from those, start selecting for audit. That’s like winning the world’s worse lottery.

Let’s start with what has happened and why you suddenly may need to file Form 3115. This form is for an application for change in accounting method. It’s an 8 page form that is rarely used by most business owners. If you change your method of accounting, say from cash basis to accrual, then you have to ask the IRS Commissioner if it’s okay to do so. Normally, you would also pay a fee to make the change.

The IRS has waived the fee for application this time and has streamlined the application process. If you follow the strict rules for the 2014 filing, it will be accepted.

IRS Repair Regulations

The big change came about as part of the “Repair Regulations” that the IRS issued a few years ago. There are over 100 pages of changes regarding how you calculate what can be expensed as a repair and what has to be capitalized and depreciated. Plus, there are elections you need to make when you buy materials or supplies so that you can immediately expense them. Otherwise, they also get capitalized and then depreciated over time. If you have a service business, you’re not going to be impacted much, if at all. But personally, I’m concerned about the fact that the IRS has already written an audit procedure for businesses that don’t make the filing. It may make sense to file one no matter what, just to state that you are in compliance with the repair regulations (TD 9636).

Because of the final property regulations, there is a required accounting change. In fact, the regulations say this directly at Reg Section 1.446-1(e)(2)(ii)(d)(2) “a change in the treatment of an asset from nondepreciable … to depreciable ….. or vice versa, is a change in method of accounting.” The final tangible property regulations (for instance at Reg Section 1.263(a)-3(q)) states, “a change to comply with this section is a change in method of accounting.

IRS Form 3115And if you have an accounting change, you have to file Form 3115. The Form 3115 is actually filed separately from your regular business income tax return and should be filed first. You then attach a copy of the form to your business return.

Each business must have at least one Form 3115 attached. If you have 10 single member LLCs for your real estate, even if they are disregarded and just reported on your Schedule E, you’ll need to have at least one Form 3115s for each LLC.

It’s important to note that filing the Form 3115 is just part of what you’ll need to do. You also need to go back through your past depreciation schedule. This is, in essence, a retroactive change. So, if you have something that you haven’t properly depreciated in accordance with the new rules, you’ll need to figure out how you should have treated it. In most cases that means you’ll have less of a deduction and more income. The IRS will give you 4 years to pay that tax, provided to file everything right in 2014.

One change could create more of a tax loss for you, though. One change (provided you properly report this on your Form 3115s) will allow you to expense portions of your real or personal property if there is a repair. For example, let’s say you have to replace the roof on your rental property. That replacement is a capital improvement that you then have to depreciate over 27.5 years. However, your old roof is now gone. The new regulations allow you to deduct the value of that old roof immediately. That would mean more of a write-off.

When you (or more likely your CPA) has gone through and corrected the past depreciation, there will be a net increase or decrease in expenses. That will mean an adjustment that is more or less tax for 2014. That is also reported on Form 3115.

There are additional annual elections that you may decide to make related to depreciation and write-offs. For example, there is a de minimis safe harbor election under Section 1.162-3(f)(1) that will allow you to directly write-off materials and supplies under $500 per item. You need to show that you make this election every year.

These new tax regulations are a very complicated addition to our tax law. There are hundreds of articles online right now for tax professionals, explaining what they need to do. I did a ‘cheat sheet’ for our USTaxAid Service CPAs and the condensed version was 7 pages long!

Unfortunately, this is a change you can’t escape. But, the IRS is all geared up, hoping you try. Bottomline: File your Form 3115s! Don’t believe me? Take a look at the audit program the IRS has sent out to all auditors, instructing them to wait until 2014 filings are done and then commence with the audits! http://www.irs.gov/Businesses/UPDATEDLBIDIRECTIVEforTPsIRC263a

In the next blog posts, I’ll go over more of the details on what has changed in expensing versus capitalizing repairs, the annual elections you need to consider and more details on the Form 3115.

Got more questions about this? Give Richard a call at 888-592-4769 to set up a consultation.



5 Comments

  1. Tony Sileo says:

    Hi Diane,

    Thanks for your response and input, yes i’m a tax preparer, i did find an upcoming webinar on form 3115 which i will take.
    My only questions left are basically the 481(a) calculations and trying to figure out when schedule E on form 3115 needs to be completed.

    I can’t remember a topic that has caused so much confusion among tax professionals. Form 3115 is supposed to be a voluntary filing not demanded due to potential threat of audit.

    Then of course try to explain to a $300 1040 client with a small schedule C how the tax return fee will practically double will be another headache we do not need.

    I’ve attached the following link if you wish to read. The information here is great.

    https://www.linkedin.com/pulse/20141003225401-313328628-faq-implementing-tangible-property-regulations-tpr-s

  2. Diane Kennedy says:

    Hi Tony:

    The best seminar I’ve seen on this was given by CCH. From your question, I’m guessing you’re a tax practitioner so I recommend looking at some of those CPE courses.

    It’s definitely not easy! I bet our firm has put 40 hours or more collectively coming up with the standard procedures for how we will do it.

  3. Tony Sileo says:

    Hello Ms Kennedy,
    Thanks for all the helpful information your website provides, its much appreciated.
    I have read numerous articles and attended a couple seminars on this topic and about form 3115 requirements for 2014 however not one explains how to compute the computation for the 481(a) taxable income adjustment.
    Many say “the depreciation schedule needs to be examined then scrubbed”, ok how exactly?
    If i capitalized a residential rental unit lets say 5 years ago over 27.5 years per tax laws, what exactly am i supposed to do as of
    12-31-14?
    My original thinking is wouldn’t actual repairs and maintenance expenses for prior years have to be analyzed since possibly a lot of items should have been capitalized?
    Do you know where i could find example of these computations?
    Thanks

  4. Diane Kennedy says:

    Mary, thanks for your questions. I have a new book coming out this summer “Real Estate and Taxes”. I’d be a little worried about information that is more than a year old. There have been SO MANY tax changes.

    The Form 3115 is used if you have property and depreciate it. If you have a business without a lot of assets you depreciate, technically you don’t need to file the form. The problem is that the IRS has said they are putting all businesses without Form 3115s on a list for possible audit. So, it might be worth it to file to get off the list.

  5. Mary says:

    Hi Diane, Thank you for providing this forum. Would I have to file the form 3115 if I have my real estate license but haven’t used it in any sales for 2014 (I only have expenses so far)? I have my license so that I can access the MLS in my RE investment endeavors for 2015. Also, do you recommend the advice of Al Aiello for RE Investors structuring of the LLC? Here is a link to a webinar. It is old and it probably is out of date with the current regulations. http://www.reiclub.com/authors/aiello/2014webinarllc.php. Do you offer a guide for RE investors to set up their LLC for maximum tax advantage and protection? If so, would it be helpful for someone in NY State?

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