Depreciation is an annual
income tax deduction that allows
you to recover the cost or other
basis of certain property over
the time you use the property.
It is an allowance for the wear
and tear, deterioration, or
obsolescence of the property.
This chapter discusses the
general rules for depreciating
property. It explains the
following.
What property can be
depreciated.
What property cannot
be depreciated.
When depreciation
begins and ends.
Whether MACRS can be
used to figure
depreciation.
What the basis of
property is.
How to treat
improvements.
When to file Form
4562.
How to correct
depreciation claimed
incorrectly in a
previous year.
Useful Items - You
may want to see:
Publication
534
Depreciating Property
Placed in Service Before
1987
535
Business Expenses
538
Accounting Periods and
Methods
551
Basis of Assets
Form
(and Instructions)
Sch C (Form 1040)
Profit or Loss From
Business
Sch C-EZ (Form 1040)
Net Profit From Business
2106
Employee Business
Expenses
2106-EZ
Unreimbursed Employee
Business Expenses
3115
Application for Change
in Accounting Method
4562
Depreciation and
Amortization
See chapter 7 for information
about getting publications and
forms.
What Property Can Be
Depreciated?
Terms you may
need to know
(see Glossary):
Adjusted basis
Basis
Commuting
Disposition
Fair market
value
Intangible
property
Listed property
Placed in
service
Tangible
property
Term interest
Useful life
You can depreciate most types
of tangible property (except
land), such as buildings,
machinery, vehicles, furniture,
and equipment. You also can
depreciate certain intangible
property, such as patents,
copyrights, and computer
software.
To be depreciable, the
property must meet all the
following requirements.
It must be property
you own.
It must be used in
your business or
income-producing
activity.
It must have a
determinable useful
life.
It must be expected
to last more than one
year.
The following discussions
provide information about these
requirements.
Property You
Own
To claim depreciation,
you usually must be the
owner of the property. You
are considered as owning
property even if it is
subject to a debt.
Example 1.
You made a down
payment on rental
property and assumed the
previous owner's
mortgage. You own the
property and you can
depreciate it.
Example 2.
You bought a new van
that you will use only
for your courier
business. You will be
making payments on the
van over the next 5
years. You own the van
and you can depreciate
it.
Leased
property.
You can depreciate
leased property only if
you retain the incidents
of ownership (explained
below) in the property.
This means you bear the
burden of exhaustion of
the capital investment
in the property.
Therefore, if you lease
property from someone to
use in your trade or
business or for the
production of income,
you generally cannot
depreciate its cost
because you do not
retain the incidents of
ownership. You can,
however, depreciate any
capital improvements you
make to the property.
See
How Do You Treat
Improvements
later in this chapter
and
Additions and
Improvements
under
Which Recovery
Period Applies
in chapter 4.
If you lease property
to someone, you
generally can depreciate
its cost even if the
lessee (the person
leasing from you) has
agreed to preserve,
replace, renew, and
maintain the property.
However, if the lease
provides that the lessee
is to maintain the
property and return to
you the same property or
its equivalent in value
at the expiration of the
lease in as good
condition and value as
when leased, you cannot
depreciate the cost of
the property.
Incidents of ownership.
Incidents of ownership
in property include the
following.
The legal
title to the
property.
The legal
obligation to
pay for the
property.
The
responsibility
to pay
maintenance and
operating
expenses.
The duty to
pay any taxes on
the property.
The risk of
loss if the
property is
destroyed,
condemned, or
diminished in
value through
obsolescence or
exhaustion.
Life
tenant.
Generally, if you hold
business or investment
property as a life
tenant, you can
depreciate it as if you
were the absolute owner
of the property.
However, see
Certain term
interests in property
under
Excepted Property,
later.
Cooperative apartments.
If you are a
tenant-stockholder in a
cooperative housing
corporation and use your
cooperative apartment in
your business or for the
production of income,
you can depreciate your
stock in the
corporation, even though
the corporation owns the
apartment.
Figure your
depreciation deduction
as follows.
Figure the
depreciation for
all the
depreciable real
property owned
by the
corporation. If
you bought your
cooperative
stock after its
first offering,
figure the
depreciable
basis of this
property as
follows.
Multiply
your
cost per
share by
the
total
number
of
outstanding
shares.
Add
to the
amount
figured
in (a)
any
mortgage
debt on
the
property
on the
date you
bought
the
stock.
Subtract
from the
amount
figured
in (b)
any
mortgage
debt
that is
not for
the
depreciable
real
property,
such as
the part
for the
land.
Subtract
from the amount
figured in (1)
any depreciation
for space owned
by the
corporation that
can be rented
but cannot be
lived in by
tenant-stockholders.
Divide the
number of your
shares of stock
by the total
number of shares
outstanding,
including any
shares held by
the corporation.
Multiply the
result of (2) by
the percentage
you figured in
(3). This is
your
depreciation on
the stock.
Your depreciation
deduction for the year
cannot be more than the
part of your adjusted
basis in the stock of
the corporation that is
allocable to your
business or
income-producing
property.
Example.
You figure your
share of the
cooperative housing
corporation's
depreciation to be
$30,000. Your
adjusted basis in
the stock of the
corporation is
$50,000. You use one
half of your
apartment solely for
business purposes.
Your depreciation
deduction for the
stock for the year
cannot be more than
$25,000 (½ of
$50,000).
Change to business use.
If you change your
cooperative apartment to
business use, figure
your allowable
depreciation as
explained earlier. The
basis of all the
depreciable real
property owned by the
cooperative housing
corporation is the
smaller of the following
amounts.
The fair
market value of
the property on
the date you
change your
apartment to
business use.
This is
considered to be
the same as the
corporation's
adjusted basis
minus straight
line
depreciation,
unless this
value is
unrealistic.
The
corporation's
adjusted basis
in the property
on that date. Do
not subtract
depreciation
when figuring
the
corporation's
adjusted basis.
If you bought the
stock after its first
offering, the
corporation's adjusted
basis in the property is
the amount figured in
(1), above. The fair
market value of the
property is considered
to be the same as the
corporation's adjusted
basis figured in this
way minus straight line
depreciation, unless the
value is unrealistic.
For a discussion of
fair market value and
adjusted basis, see
Publication 551.
Property
Used in Your
Business or
Income-Producing
Activity
To claim depreciation on
property, you must use it in
your business or
income-producing activity.
If you use property to
produce income (investment
use), the income must be
taxable. You cannot
depreciate property that you
use solely for personal
activities.
Partial
business or investment
use.
If you use property
for business or
investment purposes and
for personal purposes,
you can deduct
depreciation based only
on the business or
investment use. For
example, you cannot
deduct depreciation on a
car used only for
commuting, personal
shopping trips, family
vacations, driving
children to and from
school, or similar
activities.
You must keep
records showing the
business, investment,
and personal use of your
property. For more
information on the
records you must keep
for listed property,
such as a car, see
What Records Must Be
Kept in
chapter 5.
Although you can
combine business and
investment use of
property when figuring
depreciation deductions,
do not treat investment
use as qualified
business use when
determining whether the
business-use requirement
for listed property is
met. For information
about qualified business
use of listed property,
see What Is the
Business-Use Requirement
in chapter 5.
Office in the home.
If you use part of
your home as an office,
you may be able to
deduct depreciation on
that part based on its
business use. For
information about
depreciating your home
office, see Publication
587.
Inventory.
You cannot depreciate
inventory because it is
not held for use in your
business. Inventory is
any property you hold
primarily for sale to
customers in the
ordinary course of your
business.
If you are a
rent-to-own dealer, you
may be able to
depreciate certain
property held in your
business. See
Rent-to-own dealer
under
Which Property Class
Applies Under GDS
in chapter 4.
In some cases, it is
not clear whether
property is held for
sale (inventory) or for
use in your business. If
it is unclear, examine
carefully all the facts
in the operation of the
particular business. The
following example shows
how a careful
examination of the facts
in two similar
situations results in
different conclusions.
Example.
Maple Corporation
is in the business
of leasing cars. At
the end of their
useful lives, when
the cars are no
longer profitable to
lease, Maple sells
them. Maple does not
have a showroom,
used car lot, or
individuals to sell
the cars. Instead,
it sells them
through wholesalers
or by similar
arrangements in
which a dealer's
profit is not
intended or
considered. Maple
can depreciate the
leased cars because
the cars are not
held primarily for
sale to customers in
the ordinary course
of business, but are
leased.
If Maple buys
cars at wholesale
prices, leases them
for a short time,
and then sells them
at retail prices or
in sales in which a
dealer's profit is
intended, the cars
are treated as
inventory and are
not depreciable
property. In this
situation, the cars
are held primarily
for sale to
customers in the
ordinary course of
business.
Containers.
Generally, containers
for the products you
sell are part of
inventory and you cannot
depreciate them.
However, you can
depreciate containers
used to ship your
products if they have a
life longer than one
year and meet the
following requirements.
They qualify
as property used
in your
business.
Title to the
containers does
not pass to the
buyer.
To determine if these
requirements are met,
consider the following
questions.
Does your
sales contract,
sales invoice,
or other type of
order
acknowledgment
indicate whether
you have
retained title?
Does your
invoice treat
the containers
as separate
items?
Do any of
your records
state your basis
in the
containers?
Property
Having a
Determinable
Useful Life
To be depreciable, your
property must have a
determinable useful life.
This means that it must be
something that wears out,
decays, gets used up,
becomes obsolete, or loses
its value from natural
causes.
Property
Lasting More
Than One Year
To be depreciable,
property must have a useful
life that extends
substantially beyond the
year you place it in
service.
Example.
You maintain a
library for use in your
profession. You can
depreciate it. However,
if you buy technical
books, journals, or
information services for
use in your business
that have a useful life
of one year or less, you
cannot depreciate them.
Instead, you deduct
their cost as a business
expense.
What Property Cannot
Be Depreciated?
Terms you may
need to know
(see Glossary):
Amortization
Basis
Goodwill
Intangible
property
Remainder
interest
Term interest
Certain property cannot be
depreciated. This includes the
following.
Land
You cannot depreciate the
cost of land because land
does not wear out, become
obsolete, or get used up.
The cost of land generally
includes the cost of
clearing, grading, planting,
and landscaping.
Land
preparation costs.
Although you cannot
depreciate land, you can
depreciate certain costs
(such as landscaping
costs) incurred in
preparing land for
business use. These
costs must be so closely
associated with other
depreciable property
that you can determine a
life for them along with
the life of the
associated property.
Example.
You constructed a
new building for use
in your business and
paid for grading,
clearing, seeding,
and planting bushes
and trees. Some of
the bushes and trees
were planted right
next to the
building, while
others were planted
around the outer
border of the lot.
If you replace the
building, you would
have to destroy the
bushes and trees
right next to it.
These bushes and
trees are closely
associated with the
building, so they
have a determinable
useful life.
Therefore, you can
depreciate them. Add
your other land
preparation costs to
the basis of your
land because they
have no determinable
life and you cannot
depreciate them.
Excepted
Property
Even if the requirements
explained in the preceding
discussions are met, you
cannot depreciate the
following property.
Property placed
in service and
disposed of in the
same year.
(Determining when
property is placed
in service is
explained later.)
Equipment used
to build capital
improvements. You
must add otherwise
allowable
depreciation on the
equipment during the
period of
construction to the
basis of your
improvements. (See
Uniform
Capitalization Rules
in
Publication 551.)
Section 197
intangibles.
Certain term
interests.
Section
197 intangibles.
You cannot depreciate
section 197 intangibles.
Instead, you must
amortize their cost. For
information, see chapter
9 in Publication 535.
Section 197
intangibles include the
following types of
property.
Franchises.
Certain
agreements not
to compete.
Goodwill.
Trademarks
or trade names.
The
following
property, unless
you created it
other than in
connection with
acquiring assets
constituting a
business or a
substantial part
of a business.
Patents
and
copyrights.
Customer
or
subscription
lists,
location
contracts,
and
insurance
expirations.
Designs,
patterns,
and
formats,
including
certain
computer
software.
Computer software.
Computer software
includes all programs
designed to cause a
computer to perform a
desired function. It
also includes any data
base or similar item in
the public domain and
incidental to the
operation of qualifying
software. Computer
software is a section
197 intangible only if
you acquired it in
connection with the
acquisition of assets
constituting a business
or a substantial part of
a business.
However, computer
software is not a
section 197 intangible
and can be depreciated,
even if acquired in
connection with the
acquisition of a
business, if it meets
all of the following
tests.
It is
readily
available for
purchase by the
general public.
It is
subject to a
nonexclusive
license.
It has not
been
substantially
modified.
Note.
If the software meets
the tests above, it may
also qualify for the
section 179 deduction
and the special
depreciation allowance,
discussed later.
Certain
term interests in
property.
You cannot depreciate
a term interest in
property created or
acquired after July 27,
1989, for any period
during which the
remainder interest is
held, directly or
indirectly, by a person
related to you.
Related persons.
For a description of
related persons, see
Related persons
in the discussion on
property owned or used
in 1986 under
Can You Use MACRS To
Depreciate Your Property
later in this chapter.
For this purpose,
however, treat as
related persons only the
relationships listed in
items (1) through (10)
of that discussion and
substitute “50%”
for “10%”
each place it appears.
Basis adjustments.
If you would be
allowed a depreciation
deduction for a term
interest in property
except that the holder
of the remainder
interest is related to
you, you generally must
reduce your basis in the
term interest by any
depreciation or
amortization not
allowed.
If you hold the
remainder interest, you
generally must increase
your basis in that
interest by the
depreciation not allowed
to the term interest
holder. However, do not
increase your basis for
depreciation not allowed
for periods during which
either of the following
situations applies.
The term
interest is held
by an
organization
exempt from tax.
The term
interest is held
by a nonresident
alien individual
or foreign
corporation, and
the income from
the term
interest is not
effectively
connected with
the conduct of a
trade or
business in the
United States.
Exceptions.
The above rules do not
apply to the holder of a
term interest in
property acquired by
gift, bequest, or
inheritance. They also
do not apply to the
holder of dividend
rights that were
separated from any
stripped preferred stock
if the rights were
purchased after April
30, 1993, or to a person
whose basis in the stock
is determined by
reference to the basis
in the hands of the
purchaser.
When Does
Depreciation Begin
and End?
Terms you may
need to know
(see Glossary):
Basis
Exchange
Placed in
service
You begin to depreciate your
property when you place it in
service for use in your trade or
business or for the production
of income. You stop depreciating
property either when you have
fully recovered your cost or
other basis or when you retire
it from service, whichever
happens first.
Placed in
Service
You place property in
service when it is ready and
available for a specific
use, whether in a business
activity, an
income-producing activity, a
tax-exempt activity, or a
personal activity. Even if
you are not using the
property, it is in service
when it is ready and
available for its specific
use.
Example 1.
Donald Steep bought a
machine for his
business. The machine
was delivered last year.
However, it was not
installed and
operational until this
year. It is considered
placed in service this
year. If the machine had
been ready and available
for use when it was
delivered, it would be
considered placed in
service last year even
if it was not actually
used until this year.
Example 2.
On April 6, Sue Thorn
bought a house to use as
residential rental
property. She made
several repairs and had
it ready for rent on
July 5. At that time,
she began to advertise
it for rent in the local
newspaper. The house is
considered placed in
service in July when it
was ready and available
for rent. She can begin
to depreciate it in
July.
Example 3.
James Elm is a
building contractor who
specializes in
constructing office
buildings. He bought a
truck last year that had
to be modified to lift
materials to
second-story levels. The
installation of the
lifting equipment was
completed and James
accepted delivery of the
modified truck on
January 10 of this year.
The truck was placed in
service on January 10,
the date it was ready
and available to perform
the function for which
it was bought.
Conversion to business
use. If you place
property in service in a
personal activity, you
cannot claim
depreciation. However,
if you change the
property's use to use in
a business or
income-producing
activity, then you can
begin to depreciate it
at the time of the
change. You place the
property in service on
the date of the change.
Example.
You bought a home
and used it as your
personal home
several years before
you converted it to
rental property.
Although its
specific use was
personal and no
depreciation was
allowable, you
placed the home in
service when you
began using it as
your home. You can
begin to claim
depreciation in the
year you converted
it to rental
property because its
use changed to an
income-producing use
at that time.
Idle
Property
Continue to claim a
deduction for depreciation
on property used in your
business or for the
production of income even if
it is temporarily idle. For
example, if you stop using a
machine because there is a
temporary lack of a market
for a product made with that
machine, continue to deduct
depreciation on the machine.
Cost or
Other Basis
Fully Recovered
You stop depreciating
property when you have fully
recovered your cost or other
basis. You recover your
basis when your section 179
and allowed or allowable
depreciation deductions
equal your cost or
investment in the property.
See What Is the Basis of
Your Depreciable Property,
later.
Retired From
Service
You stop depreciating
property when you retire it
from service, even if you
have not fully recovered its
cost or other basis. You
retire property from service
when you permanently
withdraw it from use in a
trade or business or from
use in the production of
income because of any of the
following events.
You sell or
exchange the
property.
You convert the
property to personal
use.
You abandon the
property.
You transfer the
property to a
supplies or scrap
account.
The property is
destroyed.
Can You Use MACRS To
Depreciate Your
Property?
Terms you may
need to know
(see Glossary):
Adjusted basis
Basis
Convention
Exchange
Fiduciary
Grantor
Intangible
property
Nonresidential
real property
Placed in
service
Related persons
Residential
rental property
Salvage value
Section 1245
property
Section 1250
property
Standard mileage
rate
Straight line
method
Unit-of-production
method
Useful life
You must use the Modified
Accelerated Cost Recovery System
(MACRS) to depreciate most
property. MACRS is discussed in
chapter 4.
You cannot use MACRS to
depreciate the following
property.
Property you placed
in service before 1987.
Certain property
owned or used in 1986.
Intangible property.
Films, video tapes,
and recordings.
Certain corporate or
partnership property
acquired in a nontaxable
transfer.
Property you elected
to exclude from MACRS.
The following discussions
describe the property listed
above and explain what
depreciation method should be
used.
Property You
Placed in
Service Before
1987
You cannot use MACRS for
property you placed in
service before 1987 (except
property you placed in
service after July 31, 1986,
if MACRS was elected).
Property placed in service
before 1987 must be
depreciated under the
methods discussed in
Publication 534.
For a discussion of when
property is placed in
service, see
When Does Depreciation Begin
and End,
earlier.
Use of
real property changed.
You generally must use
MACRS to depreciate real
property that you
acquired for personal
use before 1987 and
changed to business or
income-producing use
after 1986.
Improvements made after
1986. You must
treat an improvement
made after 1986 to
property you placed in
service before 1987 as
separate depreciable
property. Therefore, you
can depreciate that
improvement as separate
property under MACRS if
it is the type of
property that otherwise
qualifies for MACRS
depreciation. For more
information about
improvements, see
How Do You Treat
Improvements,
later in this chapter,
and
Additions and
Improvements
under
Which Recovery
Period Applies
in chapter 4.
Property
Owned or Used in
1986
You may not be able to
use MACRS for property you
acquired and placed in
service after 1986 if any of
the situations described
below apply. If you cannot
use MACRS, the property must
be depreciated under the
methods discussed in
Publication 534.
For the following
discussions, do not treat
property as owned before you
placed it in service. If you
owned property in 1986 but
did not place it in service
until 1987, you do not treat
it as owned in 1986.
Personal property.
You cannot use MACRS
for personal property
(section 1245 property)
in any of the following
situations.
You or
someone related
to you owned or
used the
property in
1986.
You acquired
the property
from a person
who owned it in
1986 and as part
of the
transaction the
user of the
property did not
change.
You lease
the property to
a person (or
someone related
to this person)
who owned or
used the
property in
1986.
You acquired
the property in
a transaction in
which:
The
user of
the
property
did not
change,
and
The
property
was not
MACRS
property
in the
hands of
the
person
from
whom you
acquired
it
because
of (2)
or (3)
above.
Real
property.
You generally cannot
use MACRS for real
property (section 1250
property) in any of the
following situations.
You or
someone related
to you owned the
property in
1986.
You lease
the property to
a person who
owned the
property in 1986
(or someone
related to that
person).
You acquired
the property in
a like-kind
exchange,
involuntary
conversion, or
repossession of
property you or
someone related
to you owned in
1986. MACRS
applies only to
that part of
your basis in
the acquired
property that
represents cash
paid or unlike
property given
up. It does not
apply to the
carried-over
part of the
basis.
Exceptions. The
rules above do not apply
to the following.
Residential
rental property
or
nonresidential
real property.
Any property
if, in the first
tax year it is
placed in
service, the
deduction under
the Accelerated
Cost Recovery
System (ACRS) is
more than the
deduction under
MACRS using the
half-year
convention. (For
information on
how to figure
depreciation
under ACRS, see
Publication
534.)
Property
that was MACRS
property in the
hands of the
person from whom
you acquired it
because of (2)
above.
Related
persons.
For this purpose, the
following are related
persons.
An
individual and a
member of his or
her family,
including only a
spouse, child,
parent, brother,
sister,
half-brother,
half-sister,
ancestor, and
lineal
descendant.
A
corporation and
an individual
who directly or
indirectly owns
more than 10% of
the value of the
outstanding
stock of that
corporation.
Two
corporations
that are members
of the same
controlled
group.
A trust
fiduciary and a
corporation if
more than 10% of
the value of the
outstanding
stock is
directly or
indirectly owned
by or for the
trust or grantor
of the trust.
The grantor
and fiduciary,
and the
fiduciary and
beneficiary, of
any trust.
The
fiduciaries of
two different
trusts, and the
fiduciaries and
beneficiaries of
two different
trusts, if the
same person is
the grantor of
both trusts.
Certain
educational and
charitable
organizations
and any person
(or, if that
person is an
individual, a
member of that
person's family)
who directly or
indirectly
controls the
organization.
Two S
corporations,
and an S
corporation and
a regular
corporation, if
the same persons
own more than
10% of the value
of the
outstanding
stock of each
corporation.
A
corporation and
a partnership if
the same persons
own both of the
following.
More
than 10%
of the
value of
the
outstanding
stock of
the
corporation.
More
than 10%
of the
capital
or
profits
interest
in the
partnership.
The executor
and beneficiary
of any estate.
A
partnership and
a person who
directly or
indirectly owns
more than 10% of
the capital or
profits interest
in the
partnership.
Two
partnerships, if
the same persons
directly or
indirectly own
more than 10% of
the capital or
profits interest
in each.
The related
person and a
person who is
engaged in
trades or
businesses under
common control.
(See section
52(a) and 52(b)
of the Internal
Revenue Code.)
When to determine
relationship.
You must determine
whether you are related
to another person at the
time you acquire the
property.
A partnership
acquiring property from
a terminating
partnership must
determine whether it is
related to the
terminating partnership
immediately before the
event causing the
termination. For this
rule, a terminating
partnership is one that
sells or exchanges,
within 12 months, 50% or
more of its total
interest in partnership
capital or profits.
Constructive ownership
of stock or partnership
interest.
To determine whether a
person directly or
indirectly owns any of
the outstanding stock of
a corporation or an
interest in a
partnership, apply the
following rules.
Stock or a
partnership
interest
directly or
indirectly owned
by or for a
corporation,
partnership,
estate, or trust
is considered
owned
proportionately
by or for its
shareholders,
partners, or
beneficiaries.
However, for a
partnership
interest owned
by or for a C
corporation,
this applies
only to
shareholders who
directly or
indirectly own
5% or more of
the value of the
stock of the
corporation.
An
individual is
considered to
own the stock or
partnership
interest
directly or
indirectly owned
by or for the
individual's
family.
An
individual who
owns, except by
applying rule
(2), any stock
in a corporation
is considered to
own the stock
directly or
indirectly owned
by or for the
individual's
partner.
For purposes
of rules (1),
(2), or (3),
stock or a
partnership
interest
considered to be
owned by a
person under
rule (1) is
treated as
actually owned
by that person.
However, stock
or a partnership
interest
considered to be
owned by an
individual under
rule (2) or (3)
is not treated
as owned by that
individual for
reapplying
either rule (2)
or (3) to make
another person
considered to be
the owner of the
same stock or
partnership
interest.
Intangible
Property
Generally, if you can
depreciate intangible
property, you usually use
the straight line method of
depreciation. However, you
can choose to depreciate
certain intangible property
under the income forecast
method (discussed later).
You cannot depreciate
intangible property that is
a section 197 intangible or
that otherwise does not meet
all the requirements
discussed earlier under What
Property Can Be Depreciated.
Straight
Line Method
This method lets you
deduct the same amount
of depreciation each
year over the useful
life of the property. To
figure your deduction,
first determine the
adjusted basis, salvage
value, and estimated
useful life of your
property. Subtract the
salvage value, if any,
from the adjusted basis.
The balance is the total
depreciation you can
take over the useful
life of the property.
Divide the balance by
the number of years in
the useful life. This
gives you your yearly
depreciation deduction.
Unless there is a big
change in adjusted basis
or useful life, this
amount will stay the
same throughout the time
you depreciate the
property. If, in the
first year, you use the
property for less than a
full year, you must
prorate your
depreciation deduction
for the number of months
in use.
Example.
In April, Frank
bought a patent for
$5,100. It was not
acquired in
connection with the
acquisition of any
part of a trade or
business. He
depreciates the
patent under the
straight line
method, using a
17-year useful life
and no salvage
value. He divides
the $5,100 basis by
17 years to get his
$300 yearly
depreciation
deduction. He only
used the patent for
9 months during the
first year, so he
multiplies $300 by
9/12 to get his
deduction of $225
for the first year.
Next year, Frank can
deduct $300 for the
full year.
Patents and
copyrights.
If you can
depreciate the cost
of a patent or
copyright, use the
straight line method
over the useful
life. The useful
life of a patent or
copyright is the
lesser of the life
granted to it by the
government or the
remaining life when
you acquire it.
However, if the
patent or copyright
becomes valueless
before the end of
its useful life, you
can deduct in that
year any of its
remaining cost or
other basis.
Computer software.
If you can
depreciate the cost
of computer
software, use the
straight line method
over a useful life
of 36 months.
Tax-exempt use
property subject to
a lease.
The useful life of
computer software
leased under a lease
agreement entered
into after March 12,
2004, to a
tax-exempt
organization,
governmental unit,
or foreign person or
entity (other than a
partnership), cannot
be less than 125
percent of the lease
term.
Certain created
intangibles.
You can amortize
certain intangibles
created after
December 30, 2003,
with a limited
useful life that
cannot be estimated
with reasonable
accuracy, over a
15-year period using
the straight line
method and no
salvage value. For
example, amounts
paid to acquire
memberships or
privileges of
indefinite duration,
such as a trade
association
membership are
eligible costs.
The following are
not eligible.
Any
intangible
asset
acquired
from another
person.
Created
financial
interests.
Any
intangible
asset that
has a useful
life that
can be
estimated
with
reasonable
accuracy.
Any
intangible
asset that
has an
amortization
period or
useful life
that is
specifically
prescribed
or
prohibited
by the Code,
regulations,
or other
published
IRS
guidance.
Any
amount paid
to
facilitate
an
acquisition
of a trade
or business,
a change in
the capital
structure of
a business
entity, and
certain
other
transactions.
You must also
increase the 15-year
safe harbor
amortization period
to a 25-year period
for certain
intangibles related
to benefits arising
from the provision,
production, or
improvement of real
property. For this
purpose, real
property includes
property that will
remain attached to
the real property
for an indefinite
period of time (such
as roads, bridges,
tunnels, pavements,
pollution control
facilities, etc.).
Income
Forecast
Method
You can choose to use
the income forecast
method instead of the
straight line method to
depreciate the following
depreciable intangibles.
Motion
picture films or
video tapes.
Sound
recordings.
Copyrights.
Books.
Patents.
Under the income
forecast method, each
year's depreciation
deduction is equal to
the cost, less salvage
value, of the property,
multiplied by a
fraction. The numerator
of the fraction is the
current year's net
income from the
property, and the
denominator is the total
income anticipated from
the property through the
end of the 10th taxable
year following the
taxable year the
property is placed in
service. For more
information, see section
167(g) of the Internal
Revenue Code.
Films, video tapes,
and recordings.
You cannot use
MACRS for motion
picture films, video
tapes, and sound
recordings. For this
purpose, sound
recordings are
discs, tapes, or
other
phonorecordings
resulting from the
fixation of a series
of sounds. You can
depreciate this
property using
either the straight
line method or the
income forecast
method.
Participations
and residuals.
For property
placed in service
after October 22,
2004, you can
include
participations and
residuals in the
adjusted basis of
the property for
purposes of
computing your
depreciation
deduction under the
income forecast
method. The
participations and
residuals must
relate to income to
be derived from the
property before the
end of the tenth
taxable year after
the property is
placed in service.
For this purpose,
participations and
residuals are
defined as costs
which by contract
vary with the amount
of income earned in
connection with the
property.
Instead of
including these
amounts in the
adjusted basis of
the property, you
can deduct the costs
in the taxable year
that they are paid.
Videocassettes.
If you are in the
business of renting
videocassettes, you
can depreciate only
those videocassettes
bought for rental.
If the videocassette
has a useful life of
one year or less,
you can deduct the
cost as a business
expense.
Corporate or
Partnership
Property
Acquired in a
Nontaxable
Transfer
MACRS does not apply to
property used before 1987
and transferred after 1986
to a corporation or
partnership (except property
the transferor placed in
service after July 31, 1986,
if MACRS was elected) to the
extent its basis is carried
over from the property's
adjusted basis in the
transferor's hands. You must
continue to use the same
depreciation method as the
transferor and figure
depreciation as if the
transfer had not occurred.
However, if MACRS would
otherwise apply, you can use
it to depreciate the part of
the property's basis that
exceeds the carried-over
basis.
The nontaxable transfers
covered by this rule include
the following.
A distribution
in complete
liquidation of a
subsidiary.
A transfer to a
corporation
controlled by the
transferor.
An exchange of
property solely for
corporate stock or
securities in a
reorganization.
A contribution
of property to a
partnership in
exchange for a
partnership
interest.
A partnership
distribution of
property to a
partner.
Election To
Exclude Property
From MACRS
If you can properly
depreciate any property
under a method not based on
a term of years, such as the
unit-of-production method,
you can elect to exclude
that property from MACRS.
You make the election by
reporting your depreciation
for the property on line 15
in Part II of Form 4562 and
attaching a statement as
described in the
instructions for Form 4562.
You must make this election
by the return due date
(including extensions) for
the tax year you place your
property in service.
However, if you timely filed
your return for the year
without making the election,
you can still make the
election by filing an
amended return within six
months of the due date of
the return (excluding
extensions). Attach the
election to the amended
return and write “Filed
pursuant to section
301.9100-2” on the
election statement. File the
amended return at the same
address you filed the
original return.
Use of
standard mileage rate.
If you use the
standard mileage rate to
figure your tax
deduction for your
business automobile, you
are treated as having
made an election to
exclude the automobile
from MACRS. See
Publication 463 for a
discussion of the
standard mileage rate.
What Is the Basis of
Your Depreciable
Property?
Terms you may
need to know
(see Glossary):
Abstract fees
Adjusted basis
Basis
Exchange
Fair market
value
To figure your depreciation
deduction, you must determine
the basis of your property. To
determine basis, you need to
know the cost or other basis of
your property.
Cost as
Basis
The basis of property you
buy is its cost plus amounts
you paid for items such as
sales tax (see
Exception,
below), freight charges, and
installation and testing
fees. The cost includes the
amount you pay in cash, debt
obligations, other property,
or services.
Exception.
For tax years
beginning after 2003,
you can elect to deduct
state and local general
sales taxes instead of
state and local income
taxes as an itemized
deduction on Schedule A
(Form 1040). If you make
that choice, you cannot
include those sales
taxes as part of your
cost basis.
Assumed
debt. If you buy
property and assume (or
buy subject to) an
existing mortgage or
other debt on the
property, your basis
includes the amount you
pay for the property
plus the amount of the
assumed debt.
Example.
You make a
$20,000 down payment
on property and
assume the seller's
mortgage of
$120,000. Your total
cost is $140,000,
the cash you paid
plus the mortgage
you assumed.
Settlement costs.
The basis of real
property also includes
certain fees and charges
you pay in addition to
the purchase price.
These generally are
shown on your settlement
statement and include
the following.
Legal and
recording fees.
Abstract
fees.
Survey
charges.
Owner's
title insurance.
Amounts the
seller owes that
you agree to
pay, such as
back taxes or
interest,
recording or
mortgage fees,
charges for
improvements or
repairs, and
sales
commissions.
For fees and charges
you cannot include in
the basis of property,
see
Real Property
in Publication 551.
Property you construct
or build. If you
construct, build, or
otherwise produce
property for use in your
business, you may have
to use the uniform
capitalization rules to
determine the basis of
your property. For
information about the
uniform capitalization
rules, see Publication
551 and the regulations
under section 263A of
the Internal Revenue
Code.
Other Basis
Other basis refers to
basis that is determined by
the way you received the
property. For example, your
basis is other than cost if
you acquired the property in
exchange for other property,
as payment for services you
performed, as a gift, or as
an inheritance. If you
acquired property in this or
some other way, see
Publication 551 to determine
your basis.
Property
Changed From
Personal Use
If you held property for
personal use and later use
it in your business or
income-producing activity,
your depreciable basis is
the lesser of the following.
The fair market
value (FMV) of the
property on the date
of the change in
use.
Your original
cost or other basis
adjusted as follows.
Increased by
the cost of
any
permanent
improvements
or additions
and other
costs that
must be
added to
basis.
Decreased by
any
deductions
you claimed
for casualty
and theft
losses and
other items
that reduced
your basis.
Example.
Several years ago,
Nia paid $160,000 to
have her home built on a
lot that cost her
$25,000. Before changing
the property to rental
use last year, she paid
$20,000 for permanent
improvements to the
house and claimed a
$2,000 casualty loss
deduction for damage to
the house. Land is not
depreciable, so she
includes only the cost
of the house when
figuring the basis for
depreciation.
Nia's adjusted basis
in the house when she
changed its use was
$178,000 ($160,000 +
$20,000 - $2,000). On
the same date, her
property had an FMV of
$180,000, of which
$15,000 was for the land
and $165,000 was for the
house. The basis for
depreciation on the
house is the FMV on the
date of change
($165,000), because it
is less than her
adjusted basis
($178,000).
Adjusted
Basis
To find your property's
basis for depreciation, you
may have to make certain
adjustments (increases and
decreases) to the basis of
the property for events
occurring between the time
you acquired the property
and the time you placed it
in service. These events
could include the following.
Installing
utility lines.
Paying legal
fees for perfecting
the title.
Settling zoning
issues.
Receiving
rebates.
Incurring a
casualty or theft
loss.
For a discussion of
adjustments to the basis of
your property, see
Adjusted Basis
in Publication 551.
If you depreciate your
property under MACRS, you
also may have to reduce your
basis by certain deductions
and credits with respect to
the property. For more
information, see
What Is the Basis For
Depreciation in
chapter 4.
Property acquired in a
nontaxable transaction.
Generally, if you
receive property in a
nontaxable exchange, the
basis of the property
you receive is the same
as the adjusted basis of
the property you gave
up. Special rules apply
in determining the basis
and figuring the
depreciation deduction
for MACRS property
acquired in a like-kind
exchange or involuntary
conversion. See
Like-kind exchanges
and involuntary
conversions
under
How Much Can You
Deduct in
chapter 3 and
Figuring the
Deduction for Property
Acquired in a Nontaxable
Exchange
under
Figuring
Depreciation Under MACRS
in chapter 4.
Basis
adjustment for
depreciation allowed or
allowable.
You must reduce the
basis of property by the
depreciation allowed or
allowable, whichever is
greater. Depreciation
allowed is depreciation
you actually deducted
(from which you received
a tax benefit).
Depreciation allowable
is depreciation you are
entitled to deduct.
If you do not claim
depreciation you are
entitled to deduct, you
must still reduce the
basis of the property by
the full amount of
depreciation allowable.
If you deduct more
depreciation than you
should, you must reduce
your basis by any amount
deducted from which you
received a tax benefit
(the depreciation
allowed).
How Do You Treat
Improvements?
Terms you may
need to know
(see Glossary):
Improvement
If you improve depreciable
property, you must treat the
improvement as separate
depreciable property. For more
information, see
Additions and Improvements under
Which
Recovery Period Applies
in chapter 4.
Repairs.
You generally deduct the
cost of repairing business
property in the same way as
any other business expense.
However, if a repair or
replacement increases the
value of your property,
makes it more useful, or
lengthens its life, you must
treat it as an improvement
and depreciate it.
Example.
You repair a small
section on one corner of
the roof of a rental
house. You deduct the
cost of the repair as a
rental expense. However,
if you completely
replace the roof, the
new roof is an
improvement because it
increases the value and
lengthens the life of
the property. You
depreciate the cost of
the new roof.
Improvements to rented
property.
You can depreciate
permanent improvements you
make to business property
you rent from someone else.
Do
You Have To File
Form 4562?
Terms you may
need to know
(see Glossary):
Amortization
Listed property
Placed in
service
Standard mileage
rate
You must complete and attach
Form 4562 to your tax return if
you are claiming any of the
following items.
A section 179
deduction for the
current year or a
section 179 carryover
from a prior year. See
chapter 2 for
information on the
section 179 deduction.
Depreciation for
property placed in
service during the
current year.
Depreciation on any
vehicle or other listed
property, regardless of
when it was placed in
service. Listed property
is discussed later.
A deduction for any
vehicle if the deduction
is reported on a form
other than Schedule C
(Form 1040) or Schedule
C-EZ (Form 1040).
Amortization of
costs that began in the
current year.
Depreciation on any
asset on a corporate
income tax return (other
than Form 1120S, U.S.
Income Tax Return for an
S Corporation)
regardless of when it
was placed in service.
You must submit a
separate Form 4562 for each
business or activity on your
return for which a Form 4562 is
required.
Table 1-1 presents an
overview of the purpose of the
various parts of Form 4562.
Employee.
Do not use Form 4562 if
you are an employee and you
deduct job-related vehicle
expenses using either actual
expenses (including
depreciation) or the
standard mileage rate.
Instead, use either Form
2106 or Form 2106-EZ. Use
Form 2106-EZ if you are
claiming the standard
mileage rate and you are not
reimbursed by your employer
for any expenses.
How Do You Correct
Depreciation
Deductions?
Terms you may
need to know
(see Glossary):
Basis
If you deducted an incorrect
amount of depreciation in any
year, you may be able to make a
correction by filing an amended
return for that year. See
Filing an Amended Return, below. If you are not
allowed to make the correction
on an amended return, you can
change your accounting method to
claim the correct amount of
depreciation. See
Changing Your Accounting Method,
later.
Filing an
Amended Return
You can file an amended
return to correct the amount
of depreciation claimed for
any property in any of the
following situations.
You claimed the
incorrect amount
because of a
mathematical error
made in any year.
You claimed the
incorrect amount
because of a posting
error made in any
year.
You have not
adopted a method of
accounting for
property placed in
service by you in
tax years ending
after December 29,
2003.
You claimed the
incorrect amount on
property placed in
service by you in
tax years ending
before December 30,
2003.
When to
file. If an
amended return is
allowed, you must file
it by the later of the
following.
