When you make a major purchase for a small business or you own a rental property, you deduct its value over time through depreciation. Once the Internal Revenue Service figures out that you have something that can be depreciated, they assume that you depreciate it. If you don't, you could end up throwing a valuable tax deduction away, and potentially even being double-taxed.
If you forgot to take a depreciation in a previous tax year, the IRS can subtract it from the tax basis if you take the time to file an amended return within three years.
How Depreciation Works
Major purchases of assets aren't expenses in the IRS' eyes. To them, you just converted money, which is valuable, into a piece of equipment or property which is equally valuable. The asset costs you money when it gradually wears out. Depreciation is how you write off the estimated cost of its aging. The IRS defines recovery periods for various depreciable assets and you get to deduct a portion of its cost every year during its recovery period. For example, a rental house lasts 27.5 years while a computer that you buy for your business has a 5-year recovery period.
Depreciation and You
Depreciation is primarily a business tax concern. If you don't engage in any business activities, you'd never have to depreciate anything. However, it's easier to be in business than you think. For example, if you buy a camera to shoot stock photography on the weekend, you can depreciate it to offset your stock income. A home office that your employer requires you to maintain is also depreciable, and if you own a rental house, you can depreciate it as well.
If you legitimately forgot to claim depreciation on an asset to which you were entitled to claim it, the IRS is going to assume that you depreciated it anyway. They won't retroactively give you the value of the deduction, but they will subtract it from the tax basis, increasing your exposure to capital gains taxes when you sell it.
For example, if you spend $3,000 on a high-end computer monitor for your graphics arts business, you'd be entitled to write off $600 per year if you claim straight-line depreciation. If you sold it after three years for $1,500 and forgot to claim one year's depreciation, you'd look at it as a $300 loss, based on getting $1500 for an $1800 monitor ($3,000 minus two years at $600). The IRS, however, would classify it as a $300 gain, based on their calculated basis of $1,200 (three year's worth of depreciation).
If you forgot to claim depreciation to which you were entitled, you have up to three years to fix the problem by filing an amended return. Amended returns, like the 1040X for personal taxes or 1120X for the corporate income tax, let you go back and correct errors on your original return. Refiling the return on which you forgot to claim the depreciation should actually net you a refund, since you're increasing your expenses by adding the depreciation back in.
Filing the 1040X
To file the 1040X, you'll need a copy of your original 1040 form and the supporting documentation, like your Form 4562 and Schedule C or E, depending on whether you're going to fix the depreciation on a business asset or a rental property. On the 1040X, you fill in the incorrect information from your 1040, show the changes and then explain them. For example, if you forgot to claim $300 in depreciation on a computer you bought for your home-based business, you would reduce your Adjusted Gross Income by $300 on line 1 of your 1040X, adjust your taxable income down on line 5, reduce your tax liability on line 6 and reduce your total tax on line 10.
By the end of the front of the form, you'd have documented that you deserve a refund of the tax on the $300. On the back of the form, you write why you're making the adjustment in Part 3 and attach a corrected Form 4562 showing the depreciation for the computer and a corrected Schedule C showing that your business claimed $300 of additional depreciation and, as such, made $300 less profit.
- IRS: Publication 946 - How to Depreciate Property
- IRS: Form 1040X - Amended U.S. Individual Income Tax Return
- IRS: Form 1120X - Amended U.S. Corporation Income Tax Return
- IRS: Form 4562 - Depreciation and Amortization
- IRS: Schedule C (Form 1040)
- Internal Revenue Service (IRS). "Topic No. 704 Depreciation." Accessed July 26, 2020.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.