Fair Market Value (Form 3115)

Family child care providers can use Form 3115 Application for Change in Accounting Method to recapture previously unclaimed depreciation, according to a recently settled Tax Court case in Minnesota.

Many providers have not depreciated items used for their business that they are entitled to deduct. Such items can include the home, home improvements, furniture, appliances, computers, play equipment, etc. If you have not depreciated such items going back more than three years, you can use Form 3115 to claim them on your current tax return. For example, if you went into business in 2003 and did not depreciate the furniture and appliances you owned at that time, you could calculate the amount of depreciation you were entitled to claim from 2003-2010 and deduct this on your 2010 tax return by filing Form 3115 with your tax forms.

The original IRS auditor disallowed a family child care provider from using this form to claim thousands of dollars in depreciation deductions that she had not taken in earlier years. The auditor gave no authority for his position and would not allow these deductions despite the provider's tax preparer's explanation that this form commonly allows such deductions.

There were two additional issues in this case. Some of the items listed on Form 3115 had been previously depreciated and were therefore disallowed. (Note: If you who are using Form 3115 be careful to exclude depreciation deductions claimed in earlier years.) Secondly, the Tax Court appeals officer challenged the "fair market value" of some of the items submitted by the child care provider. These items included a fence, patio, piano, desk, chair, and other items.

In denying the deduction for these items, the appeals officer argued that the provider had not produced any evidence of their cost or fair market value. Without some evidence to back up the claim, the officer was not willing to accept the provider's position.

An IRS officer will often accept a "reasonable" estimate of an item without much backup evidence. In one audit, I presented the auditor with photographs of the furniture in a provider's living room, dining room, and kitchen. These items had been purchased before the business began, so we had no receipts, canceled checks, or credit card statements as evidence of their value once the business had begun. The provider had estimated that the three rooms of furniture were worth $3,000. At a meeting with the auditor, he said, "My family is in the used furniture business, so I know the value of used furniture." I replied, "What do you think of our estimate?" He said, "Yeah, your estimate is about right."

On the other hand, I represented a provider in another Tax Court case where the IRS appeals officer would not allow the provider to deduct 100% of the cost of cleaning her heating/air conditioning ducts. (This was a minor issue in a case involving thousands of dollars about other matters.) The provider argued that she only had them cleaned because she was about to care for a child with asthma. Eventually, the IRS officer allowed her to deduct the Time-Space Percentage of the cost of the cleaning. After the case was settled, I asked, "What additional evidence could we have presented that would have made a difference in our case?" The officer replied, "I would have wanted to see a letter from a doctor saying that the child has asthma and that the cleaning of the ducts was important for this child's health.

Here are some suggestions for how to establish a fair market value for purchases. We'll use the example of a backyard fence that was installed before a provider was in business.

The Tax Court appeals officer did allow these deductions, citing IRS Revenue Procedure 2004-11. As a result, the provider saved about $5,300 in taxes and penalties.

  • Are there photos that show the backyard before and after the fence was installed? 
    If so, a dated photo may help prove what year the fence was installed.
  • Get a letter from one or more neighbors testifying as to the year the fence was installed.
  • Take a picture of the fence now that shows the brand and style of the fence.
  • Go to the store where the fence was purchased and look up the brand and style in the store's catalog to show its current price.
  • Talk with the salespeople at the store to see if they can give you information about the price of the fence in the year it was installed. Ask them to sign a statement of their estimate or get a copy of a previous year's catalog.
  • Look for credit/debit card statements for a record of the purchase.
  • See if the fence was included in the homeowner's property insurance coverage. A value of the fence may be included in an insurance rider.

When discussing fair market value estimates with the IRS, always ask what other records might make a difference.

Photo Credit: Patrick Fitzgerald

Return to Taxes and the IRS