Missed Depreciation Before You Sell: Catch It Up in the Sale Year With Form 3115

Why missed depreciation costs you at sale

The tax code reduces the basis of rental and business property by depreciation "allowed" but "not less than the amount allowable" (IRC 1016(a)(2)). If you never claimed depreciation on a building, a roof, a parking lot or an addition, the IRS still treats your basis as if you had. At sale, that lower basis means more gain, and you never got the deduction that is supposed to come with it.

It happens more than people expect: a rental converted from a personal residence and never put on Form 4562, an improvement expensed by nobody, a land and building split that left the building undervalued, a farm building or well that a preparer missed, or a property inherited with a stepped-up basis that nobody started depreciating. The longer the hold, the bigger the number.

The fix: Form 3115 instead of amended returns

Using the wrong depreciation (including none) on two or more filed returns is an accounting method. You change it prospectively with Form 3115 under the automatic change procedures, not by amending old years. Rev. Proc. 2025-23 section 6.01 (designated change number 7) covers a change from an impermissible to a permissible depreciation method when:

• the impermissible method was used on at least two returns immediately before the year of change, and
• you own the property at the beginning of the year of change.

The whole difference between the depreciation you claimed and what was allowable comes in as a single Section 481(a) adjustment. A negative (taxpayer-favorable) adjustment is generally taken in full in the year of change (Rev. Proc. 2015-13 section 7.03). If the error is on only one filed return, the usual fix is an amended return instead (Rev. Proc. 2025-23 section 6.01(1)(b) for property placed in service the year before).

Timing around a sale: own it on January 1, or use DCN 107

Because DCN 7 requires ownership at the start of the year of change, a calendar-year owner who sells in 2026 can file the change with the 2026 return: the property was owned on January 1, 2026. Waiting until 2027 to deal with it fails that test.

For property already disposed of, Rev. Proc. 2025-23 section 6.07 (designated change number 107) lets you claim the unclaimed depreciation for the year of disposition. That change can be made on the timely original return for the disposal year, or on an amended return for that year filed before the assessment period for the disposal year expires, with the full Section 481(a) adjustment taken in that year. It is the backstop if the sale has closed and the error is found at return time.

Either way, the change belongs in the sale-year planning, before the return is filed, because the deduction and the gain should land in the same year.

Worked example: $150,000 never claimed

Our Texas couple sells a rental with $1,200,000 of total gain. They claimed $300,000 of depreciation over the years but missed $150,000 on an improvement. Basis is still reduced by all $450,000. Without a fix, the sale costs $274,201 in 2026 federal income tax and net investment income tax.

With a Form 3115 filed for 2026, the missed $150,000 becomes one ordinary deduction in the sale year. It also becomes depreciation "allowed," so that slice of gain moves from the 15% or 20% layer into the 25% unrecaptured Section 1250 layer. Net, the sale-year tax falls to $217,903, saving $56,298, because the deduction comes off income at ordinary rates while the gain shifts only from a 20% rate to a 25% cap (Rev. Proc. 2025-32 brackets, 2026). Numbers are illustrative engine output from labeled assumptions.

How the missed amount is taxed if you do nothing

Recapture follows what you can prove you deducted. For both Section 1245 property and Section 1250 property, if you can establish by adequate records that the depreciation allowed was less than allowable, recapture counts only the amount allowed (IRC 1245(a)(2)(B); IRC 1250(b)(3)). The rest of the extra gain is ordinary long-term capital gain. That is why the example's no-fix case taxes the $150,000 at capital gain rates: you lose the deduction but avoid the recapture layer on it. Keep the records, the returns and the depreciation schedules that show what was claimed.

Look-back cost segregation is the same change

A cost segregation study on a building you have owned for years also runs through DCN 7: moving components from 39 or 27.5 years to 5, 7 or 15 years is a change from an impermissible to a permissible method, and the catch-up is a negative Section 481(a) adjustment. Bonus depreciation follows the rates for the year each component was originally placed in service, not today's 100% rate (IRS Notice 2026-11 applies the 100% rate to property acquired after January 19, 2025).

In a sale year, though, a look-back study mostly converts gain into recapture: depreciation on 5- and 7-year components is ordinary Section 1245 recapture, and recapture is taxed in year one even on an installment sale (IRC 453(i)). The missed-depreciation catch-up above is a clearer win than a new study, because without it you are taxed on deductions you never took. See cost segregation before a sale.

Questions to settle before the sale-year return

1. Has every improvement, addition and land improvement been on the depreciation schedule since it was placed in service? (your CPA)
2. Was the property owned on January 1 of the sale year? If not, does DCN 107 fit? (your CPA)
3. Was the wrong method used on two or more returns, or just one? (your CPA)
4. Is the property in a passive activity, and is the sale a fully taxable disposition of the whole activity under IRC 469(g)? (your CPA)
5. For California and other states, does the state follow the federal method change and basis? (your CPA)

Get the Big Sale Tax Analysis to model the catch-up, the gain and the deferral options together.

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Frequently asked questions