Form 3115 and §481(a) adjustments: what they are and when you need one

What is Form 3115?

Form 3115, Application for Change in Accounting Method, is how a taxpayer tells the IRS it is changing the way it treats an item of income or expense, and asks for (or, for automatic changes, reports) the IRS's consent to do so. Businesses use it for inventory, revenue timing, repairs versus capital improvements and much else. For real estate owners the common case is depreciation: which recovery period a building's components use, whether bonus depreciation applied, or whether depreciation was claimed at all.

Depreciation counts as an accounting method once a treatment has been used on two or more consecutively filed returns. From then on, changing it, even to fix something that was wrong, is a change in method rather than an error to amend away. That is why a look-back cost segregation study, which moves part of a building from 27.5- or 39-year property into 5-, 7- and 15-year property, runs through Form 3115.

Changes come in two kinds. Automatic changes are on the IRS's published list, need no advance approval and carry no user fee; the one used for depreciation of property you still own is designated change number (DCN) 7, filed under the procedures of Rev. Proc. 2015-13. Non-automatic changes need a ruling from the IRS before they take effect and do carry a user fee. Nearly every cost segregation catch-up is automatic, subject to eligibility rules (for example, restrictions while the item is under IRS examination) that your CPA checks.

What is a §481(a) adjustment?

When you change a method, the years already filed under the old method do not get reopened. Instead, IRC §481(a) requires a single adjustment in the year of change that trues everything up: the deductions you would have had, through the start of that year, under the new method, minus the deductions you actually took under the old one.

• A negative adjustment reduces taxable income. Missed depreciation produces one, and it is generally deducted in full in the year of change.
• A positive adjustment increases taxable income, for example if too much depreciation was claimed. It is generally spread over four years.

Bonus depreciation inside the adjustment follows the rules for the year each asset was placed in service, not the rate in the year of change, and it assumes you did not elect out of bonus for that class in that year.

Worked example: a 2019 rental, caught up in 2026

An illustrative single-family rental, placed in service in June 2019, with $332,880 of depreciable basis after land. It has been depreciated as one 27.5-year asset. A look-back cost segregation study in 2026 finds about 15.5% of that basis is 5- and 15-year property: appliances, cabinetry, flooring, site improvements and similar components. Property placed in service in 2019 qualified for 100% bonus depreciation.

The remaining $281,284 keeps depreciating on the original 27.5-year schedule, so nothing changes there. The reclassified components are fully depreciated, so their share of the annual straight-line deduction stops from 2026 on. What the $39,322 is worth in tax depends on your bracket and on whether the passive loss rules let you use it that year. The numbers are illustrative; a study replaces the assumed percentage with the property's actual components, and your CPA computes the filed figure.

For the line-by-line computation, including property placed in service in years when bonus was below 100%, see the §481(a) catch-up worksheet.

When do you need Form 3115?

The short version: when the property was placed in service in an earlier year, the depreciation on it has been filed at least twice, and the treatment needs to change. Common situations for rental and commercial property owners:

• Depreciation was missed entirely. A rental that was never depreciated can generally catch up through Form 3115. Depreciation you were entitled to but did not claim still reduces your basis when you sell, so leaving it unclaimed costs twice.
• The wrong recovery period or method was used. For example, residential property depreciated over 39 years, or a land improvement left inside the building.
• A look-back cost segregation study. The property was bought in a prior year and depreciated as a single building; a study now splits out the shorter-life components.

Timing: there is no deadline to catch up, but there is one for each year of change

You can make the change in any year you still own the property, and the §481(a) adjustment reaches all the way back to the placed-in-service date. The deadline attaches to the year you choose. Under an automatic change:

• The original Form 3115 is attached to your timely filed original return for the year of change, including extensions.
• A signed copy goes separately to the IRS, no later than the date the original is filed, at the address in the Form 3115 instructions (currently the IRS in Ogden, Utah, for automatic changes).
• If the return went in on time without the form, Treas. Reg. §301.9100-2 may allow an automatic six-month extension to add it. Relief beyond that generally means a private letter ruling request with a user fee, which is why most CPAs build the study into the extended return rather than leaving it late.

Form 3115 or an amended return?

The IRS's Cost Segregation Audit Techniques Guide treats a reclassification of property already in service as a change in accounting method, which is the reason a look-back study goes through Form 3115 rather than amended returns.

How Form 3115 works with a cost segregation study

A study bought in the year the property goes into service needs no Form 3115; its classifications go straight onto Form 4562. A look-back study, on a property you already own, follows this path:

1. The study. You provide the purchase price, property type, placed-in-service date and any major improvements since. The study assigns each component a recovery period and produces depreciation schedules under both methods.
2. The §481(a) schedule. From those schedules, the catch-up is computed year by year from the placed-in-service date. Every Cost Seg Smart look-back study includes these schedules and workpapers.
3. Eligibility and year of change. Your CPA confirms the change qualifies as automatic (DCN 7), picks the year of change, and checks how much of the deduction the passive loss rules let you use.
4. The form. Form 3115 is completed: Part I identifies the automatic change, Part IV reports the §481(a) adjustment, and Schedule E of the form describes the old and new depreciation methods. The study or a summary of it supports the figures.
5. Filing. The original goes with the year-of-change return and a signed copy goes to the IRS. For an individual owner the adjustment is generally reported with that property's rental income and expenses; current-year depreciation under the new method goes on Form 4562 as usual.

Two things to weigh before you file

Passive loss limits. The catch-up is a deduction of the rental activity. If that activity is passive for you, some or all of the loss it creates may be suspended and carried forward rather than used against wages or other income that year.

Recapture on sale. Accelerating depreciation changes when you take it, not the total. When the property is sold, depreciation on the shorter-life components is generally recaptured, and a 1031 exchange can defer that. The case for a catch-up is the value of the deduction now against tax that may be due later, which your CPA can weigh for your situation.

Estimate your catch-up

Purchase price, year placed in service and property type are enough for a first pass at the §481(a) figure. A study replaces the assumed reclassification with the property's actual components. The same estimate lives on the §481(a) catch-up calculator.

Want the Form 3115 prepared for you?

Every look-back study includes the §481(a) schedules and workpapers. If you would also like us to complete and sign the Form 3115 filing package, that is a paid add-on priced per form, with a lower charge for each additional property on the same form. Your CPA still files it with your return and makes the final call on the change.

See Form 3115 add-on pricing Order a look-back study →