Form 3115: catching up missed depreciation on a rental before you sell (2026)

Why missed depreciation matters even if you did not claim it

The hard rule is in IRS Publication 946: "You must reduce the basis of property by the depreciation allowed or allowable, whichever is greater." Even if you never deducted a dollar of depreciation on your Schedule E, the IRS will treat you as if you did when you sell. Your adjusted basis drops by the full allowable amount, which inflates your capital gain and your Section 1250 unrecaptured gain (taxed up to 25%).

For an Indian owner who kept a US rental during a sabbatical, moved back and never claimed depreciation because the property "didn't make money anyway", the shock arrives at sale: the IRS calculates recapture as if you had taken every allowable deduction, so the choice is either (1) take the recapture without ever having had the tax benefit, or (2) file Form 3115 before you sell and recover the deductions through a §481(a) adjustment.

When does missed depreciation become a method of accounting?

The two-year rule. If you used an impermissible method — including no depreciation at all — for two or more consecutive tax years, you have adopted a method of accounting. Rev. Proc. 2019-43 §6.01(1)(a) applies to a taxpayer who "used the impermissible method of accounting in at least two taxable years immediately preceding the year of change" (Rev. Proc. 2019-43 §6.01).

Once that happens, you cannot fix the problem by amending prior-year returns. The IRS treats the switch as a change in accounting method, which requires Form 3115 — not Form 1040-X.

The exception is "1-year depreciable property": property placed in service only in the tax year immediately before the year of change. For that, Rev. Proc. 2019-43 §6.01(1)(b) lets you either file Form 3115 or file an amended return for the placed-in-service year before you file the return for the following year.

For every typical NRI rental scenario — a condo bought in 2019 and still owned in 2026, no depreciation ever claimed — you are well past the two-year line and Form 3115 is the only correct path.

Form 3115 at a glance

How the Section 481(a) adjustment works

The adjustment is the difference between what you depreciated under your old (impermissible) method and what you should have depreciated under the correct method, totalled across every prior year the property was in service — open years and closed years alike.

Rev. Proc. 2019-43 §6.01(5): "This § 481(a) adjustment equals the difference between the total amount of depreciation taken into account in computing taxable income for the property under the taxpayer's present method of accounting… and the total amount of depreciation allowable for the property under the taxpayer's proposed method of accounting… for open and closed years prior to the year of change."

For a rental where you took zero depreciation, the §481(a) adjustment equals the full depreciation you should have taken, as a negative number (a deduction).

A negative §481(a) adjustment is taken into income in full in the year of change — one tax year, one big deduction. A positive §481(a) adjustment (where you took too much depreciation) is spread over four years. See the Form 3115 instructions for the four-year rule on positive adjustments.

Worked example: a condo you forgot to depreciate

Priya bought a condo in Austin in December 2019 for $400,000, with $350,000 allocated to the building (the land is not depreciable; your closing statement or tax assessor split tells you the land vs building portion). She rented it on Schedule E but her CPA never set up depreciation. She wants to sell in 2026 before she moves back to India permanently.

Allowable depreciation on $350,000 of residential rental property, 27.5-year straight-line MACRS GDS, placed in service in December 2019:

• 2019 (half-month convention, 0.5 months at 1/27.5 ÷ 12): about $530
• 2020-2025 (6 full years at $350,000 ÷ 27.5): about $12,727 per year, so $76,364
• 2026 (year of change, from Jan 1 to the first part of 2026 under the convention): calculated for the year of change on her 2026 Schedule E, not in the §481(a) adjustment

The §481(a) adjustment for all prior years is approximately -$76,894. Priya files Form 3115 (DCN 7) with her 2026 Form 1040, deducts $76,894 on her 2026 Schedule E, and the adjusted basis of the building drops by the same amount, raising the gain she will report when she sells. The two numbers roughly offset at ordinary rates vs long-term capital gain rates — but the rate arbitrage, plus the Section 1250 unrecaptured gain being capped at 25%, often leaves her ahead by a meaningful amount.

Numbers are approximate; use your own closing-statement land/building split and your placed-in-service month. The real win is that none of the deduction expires with closed years — you capture 2019-2025 entirely in 2026.

Step by step: filing Form 3115 for missed rental depreciation

Step 1. Confirm the two-year rule applies. Pull your prior Schedule Es. If depreciation was zero (or under the wrong method or recovery period) for the two tax years immediately before 2026, you are in Rev. Proc. 2019-43 §6.01(1)(a). If the mistake is only in 2025, see §6.01(1)(b) (1-year depreciable property) and consider amending 2025 instead.

Step 2. Reconstruct the correct depreciation schedule. Determine the placed-in-service date (the date the property was first available for rent), the land/building split, the recovery period (27.5 years for residential rental under GDS; 30 years under ADS for property placed in service after 2017 for electing real property trades or businesses), the method (straight-line), and the convention (mid-month for real property). Compute allowable depreciation for every year the property was in service, up to the end of 2025.

Step 3. Compute the §481(a) adjustment. For each year, actual depreciation taken minus allowable depreciation. Sum across all years before 2026. If you took zero and the correct amount is positive, your §481(a) adjustment equals the negative of total allowable depreciation.

Step 4. Fill in Form 3115. Part I: automatic change, DCN 7. Part II: the questions on prior accounting method changes (usually "no" if this is your first), §263A, and so on. Schedule E of Form 3115: the depreciation details — property type, placed-in-service date, recovery period, method, convention. Part IV: the §481(a) adjustment amount on line 26. Sign under penalties of perjury (the Form 3115 instructions state the signature must be by someone "with authority and personal knowledge of the facts").

Step 5. Attach a §481(a) adjustment schedule. Show the year-by-year depreciation that should have been taken, the amount actually taken, and the running total. This becomes the audit trail. Keep it with your records.

Step 6. File the original with your 2026 Form 1040. Attach the completed Form 3115 to your 2026 return. On your 2026 Schedule E, enter the §481(a) adjustment as "Other expenses — Section 481(a) adjustment" or as a line labeled "Form 3115 §481(a) adjustment".

Step 7. Mail the signed duplicate copy to Ogden. The Form 3115 instructions require a signed duplicate "no earlier than the first day of the year of change and no later than the date the original is filed" to the Ogden, UT address listed in the instructions. The automatic consent is not valid without the duplicate copy.

Step 8. Reset your basis. As of the first day of 2026, reduce the building's basis by the full allowable depreciation (Rev. Proc. 2019-43 §6.01(6): "the basis of depreciable property to which this section 6.01 applies must reflect the reductions required by § 1016(a)(2) for the depreciation allowable"). Carry this corrected basis forward for the sale calculation.

When Form 3115 is not the right fix

• One missed year only. Amend the 2025 return before you file the 2026 return; §6.01(1)(b) explicitly allows amendment for 1-year depreciable property.
• Property already sold. §6.01 "does not apply to any item of depreciable property disposed of by the taxpayer before the year of change" — so if the sale happened in 2025 and you want to catch up, you are generally outside §6.01's scope. There is a separate section 6.07 of the Rev. Proc. for disposed property; talk to a CPA before filing.
• Property held by a tax-exempt organisation. §6.01(1)(c)(i) excludes property to which §1016(a)(3) applies.
• The property is not depreciable. Land, personal-use second homes before conversion, and property held for personal use are not depreciable. See IRS Pub 527 for what counts as rental property.

If you own US real estate from abroad and have been filing a 1040-NR or your spouse's joint return without depreciation, the same mechanics apply, but the basis step-up on sale and the FIRPTA withholding on the sale also need to be factored in. We cover the moving-back-to-India sale planning in sell RSUs moving back to India; the US exit-tax context for green-card holders selling US property is in US exit tax for green-card holders moving to India; and if you are still in the "where should I report Indian rental income" stage, start with reporting India income on a US return.

Does Form 3115 trigger an audit?

The IRS has publicly treated DCN 7 as a routine automatic-consent change. It is designed to be filed by taxpayers who have fixed their own errors — the §481(a) mechanism exists so that the Service does not have to reopen closed years. In practice, Form 3115 for missed rental depreciation is one of the most commonly filed automatic changes. There is no formal correlation between filing it and audit selection in published IRS statistics.

That said, the attached §481(a) schedule needs to be clean. The depreciation calculations need to be defensible against the property's basis, placed-in-service date and land allocation. If any of those inputs is wobbly, that is where to spend the review time.