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Depreciation
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534
15064O
Depreciating Property Placed in Service Before 1987
Introduction2
1. Accelerated Cost Recovery System (ACRS)2
ACRS Defined2
What Can and Cannot Be Depreciated Under ACRS2
How To Figure the Deduction3
Dispositions6
2. Other Methods of Depreciation7
How To Figure the Deduction7
Methods To Use8
How To Change Methods8
Dispositions9
3. Listed Property10
Listed Property Defined10
Predominant Use Test10
Deductions After Recovery Period12
Leased Property12
What Records Must Be Kept12
Appendix14
Index21
Important Change for 1995
- Major changes to Publications 534 and 946.
This publication, as well as Publication 946,How To Depreciate Property, has been changed. Publication 534 has been shortened. It no
longer contains general information on MACRS and the section 179 deduction. It contains a discussion of the accelerated cost recovery system (ACRS),
the ACRS Percentage Tables, a discussion of other methods of depreciation, and a limited discussion of listed property.
We expanded Publication 946 by adding material taken from Publication 534. We added more detail to the discussions of the section 179 deduction,
the modified accelerated cost recovery system (MACRS), and listed property. We replaced the partialMACRS Percentage Tables with the
complete ones from Publication 534. We also added the Table of Class Lives and Recovery Periods from Publication 534.
We made these changes to eliminate most of the duplication that existed in the two publications. This will save money and make it easier for you to
decide which publication you need. Use this publication to figure depreciation on property you placed in service before 1987; use Publication 946 to
figure depreciation on property you placed in service after 1986.
The law allows you to recover your cost in business or income-producing property through yearly tax deductions. You do this by depreciating your
property, that is, by deducting some of your cost on your tax return each year. You can depreciate both tangible property, such as a car, building, or
machinery, and certain intangible property, such as a copyright or a patent.
The amount you can deduct depends on:
How much the property cost,
When you began using it,
How long it will take to recover your cost, and
Which of several depreciation methods you use.
Depreciation defined.
Depreciation is a loss in the value of property over the time the property is being used. Events that can cause property to depreciate include wear
and tear, age, deterioration, and obsolescence. You can get back your cost of certain property, such as equipment you use in your business or property
used for the production of income by taking deductions for depreciation. Black's Law Dictionary
Amortization.
Amortization is similar to depreciation. Using amortization, you can recover your cost or basis in certain property proportionately over a specific
number of years or months. Examples of costs you can amortize are the costs of starting a business, reforestation, and pollution control facilities.
You can find information on amortization inchapter 12 of Publication 535, Business Expenses.
Alternative minimum tax.
If you use accelerated depreciation for real property, or personal property that is leased to others, you may be liable for the alternative minimum
tax. Accelerated depreciation is any method, that allows recovery at a faster rate in the earlier years than the straight line method. For more
information, you may wish to see the following:
Form 6251, Alternative Minimum Tax-Individuals, and
Publication 542, Tax Information on
Corporations.
Ordering publications and forms.
To order free publications and forms, 1-800-TAX-FORM (1-800-829-3676). You can also write to the IRS Forms Distribution Center nearest you. Check
your income tax package for the address.
If you have access to a personal computer and a modem, you can also get many forms and publications electronically. See How To Get Forms and
Publications in your income tax package for details.
Telephone help.
You can call the IRS with your tax question Monday through Friday during regular business hours. Check your telephone book for the local number or
you can call1-800-829-1040.
Telephone help for hearing-impaired persons.
If you have access to TDD equipment, you can call 1-800-829-4059 with your tax question or to order forms and publications. See your tax
package for the hours of operation.
How To Use This Publication
This publication describes the kinds of property that can be depreciated and the methods used to figure depreciation on property placed in service
before 1987. It is divided into three chapters and contains an appendix.
Chapter 1 explains the rules for depreciating property under the Accelerated Cost Recovery System (ACRS).
Chapter 2 explains the rules for depreciating property first used before 1981.
Chapter 3 explains the rules for listed property. Also this chapter defines listed property.
The appendix contains the ACRS Percentage Tables.
Accelerated Cost Recovery System (ACRS)
The definition of ACRS
What can and cannot be depreciated under ACRS
How to figure the deduction
Dispositions
Publication
544
Sales and Other Dispositions of Assets
551
Basis of Assets
583
Starting a Business and Keeping Records
Form (and Instructions)
Application for Change in Accounting Method
Depreciation and Amortization
The Accelerated Cost Recovery System (ACRS) applies to property first used before 1987. It is the name given to tax rules for getting back
(recovering) through depreciation deductions the cost of property used in a trade or business or to produce income. These rules are mandatory and
generally apply to tangible property placed in service after 1980 and before 1987. If you placed property in service during this period, you must
continue to figure your depreciation under ACRS.
If you used listed property placed in service after June 18, 1984, less than 50% for business in 1995, see Predominant Use Test in
chapter 3. Listed property includes cars, other means of transportation, and certain computers.
Any additions or improvements placed in service after 1986, including any components of a building (such as plumbing, wiring, storm windows, etc.),
are depreciated using MACRS, discussed in chapter 3 of Publication 946. It does not matter that the underlying property is depreciated under ACRS or
one of the other methods.
ACRS Defined
Accelerated cost recovery system (ACRS):
Accelerated cost recovery system (ACRS):
Defined
ACRS consists of accelerated depreciation methods and an alternate ACRS method that could have been elected. The alternate ACRS method used a
recovery percentage based on a modified straight line method. The law prescribes fixed percentages to be uses for each class of property.
Property depreciable under ACRS is called recovery property. The recovery class of property determines the recovery period. Generally,
the class life of property places it in a 3-year, 5-year, 10-year, 15-year, 18-year, or 19-year recovery class.
Under ACRS, the prescribed percentages are used to recover the unadjusted basis of recovery property. To figure a depreciation deduction, you
multiply the prescribed percentage for the recovery class by the unadjusted basis of the recovery property.
You must continue to figure your depreciation under ACRS for property placed in service after 1980 and before 1987. For property you placed in
service after 1986, you must use MACRS, discussed in chapter 3 of Publication 946.
What Can and Cannot Be Depreciated Under ACRS
Property:
ACRS
ACRS applies to most depreciable tangible property placed in service after 1980 and before 1987. It includes new or used and real or personal
property. The property must be for use in a trade or business or for the production of income. Property you acquired before 1981 or after 1986 is not
ACRS recovery property. For information on depreciating property acquired before 1981, see chapter 2. For information on depreciating property
acquired after 1986, see chapter 3 of Publication 946.
Recovery Property
Recovery property under ACRS is tangible depreciable property placed in service after 1980 and before 1987. It generally includes new or used
property that you acquired after 1980 and before 1987 for use in your trade or business or for the production of income.
Nonrecovery Property
You cannot use ACRS for property you placed in service before 1981 or after 1986. Nonrecovery property also includes:
Intangible property,
Property you elected to exclude from ACRS that is properly depreciated under a method of depreciation that is not based on a term of
years,
Certain public utility property, and
Certain property acquired and excluded from ACRS because of the antichurning rules.
Intangible property.
Intangible property is not depreciated under ACRS.
Property depreciated under methods not expressed in a term of years.
Certain property depreciated under a method not expressed in a term of years is not depreciated under ACRS. This included any property:
If you made an irrevocable election to exclude such property, and
In the first year that you could have claimed depreciation, you properly used the unit-of-production method or any method of depreciation
not expressed in a term of years (not including the retirement-replacement-betterment method).
Public utility property.
Public utility property for which the taxpayer does not use a normalization method of accounting is excluded from ACRS and is subject to
depreciation under a special rule.
Additions or improvements to ACRS property after 1986.
Any additions or improvements placed in service after 1986, including any components of a building (plumbing, wiring, storm windows, etc.) are
depreciated using MACRS, discussed in chapter 3 of Publication 946. It does not matter that the underlying property is depreciated under ACRS or one
of the other methods.
How To Figure the Deduction
Deduction:
ACRS
Methods of figuring depreciation:
ACRS
After you determine that your property can be depreciated under ACRS, you are ready to figure your deduction. Because the conventions are built
into the percentage table rates, you only need to know the following:
The unadjusted basis of your recovery property,
The classes of recovery property,
The recovery periods, and
Whether to use the prescribed percentages based on accelerated methods or percentages based on using the alternate ACRS method.
Unadjusted Basis
Accelerated cost recovery system (ACRS):
Unadjusted basis
Basis:
Unadjusted, ACRS
To figure your ACRS deduction, you multiply the unadjusted basis in your recovery property by its applicable percentage for the year. Unadjusted
basis is the same amount you would use to figure gain on a sale, but it is figured without taking into account any depreciation taken in earlier
years. However, reduce your original basis by the amount of amortization taken on the property and by any section 179 deduction claimed as discussed
in chapter 2 of Publication 946.
If you buy property, your unadjusted basis is usually its cost minus any amortized amount and minus any section 179 deduction elected. If you
acquire property in some other way, such as by inheriting it, getting it as a gift, or building it yourself, you figure your unadjusted basis under
other rules. See Publication 551.
Classes of Recovery Property
Accelerated cost recovery system (ACRS):
Classes of recovery property
All recovery property under ACRS is in one of the following classes. The class for your property was determined when you began to depreciate it.
3-Year Property
3-year property includes automobiles, light-duty trucks (actual unloaded weight less than 13,000 pounds), and tractor units for use over-the-road.
Race horses over 2 years old when placed in service are 3-year property. Any other horses over 12 years old when you placed them in service are also
included in the 3-year property class.
The ACRS percentages for 3-year recovery property are:
Recovery Period
Percentage
1st year
25%
2nd year
38%
3rd year
37%
If you used the percentages above to depreciate your 3-year recovery property, your property, except for certain passenger automobiles, is fully
depreciated. You cannot claim depreciation for this property after 1988.
5-Year Property
5-year property includes computers, copiers, and equipment, such as office furniture and fixtures. It also includes single purpose agricultural or
horticultural structures and petroleum storage facilities (other than buildings and their structural components).
The ACRS percentages for 5-year recovery property are:
Recovery period
Percentage
1st year
15%
2nd year
22%
3rd through 5th year
21%
If you used the percentages above to depreciate your 5-year recovery property, it is fully depreciated. You cannot claim depreciation for this
property after 1990.
10-Year Property
10-year property includes certain real property such as theme-park structures and certain public utility property. Manufactured homes (including
mobile homes) and railroad tank cars are also 10-year property.
You do not treat a building, and its structural components, as 10-year property by reason of a change in use after you placed the property in
service. For example, a building (15-year real property) that was placed in service in 1981 and was converted to a theme-park structure in 1986
remains 15-year real property.
The ACRS percentages for 10-year recovery property are:
Recovery Period
Percentage
1st year
8%
2nd year
14%
3rd year
12%
4th through 6th year
10%
7th through 10th year
9%
If you used the percentages above, you cannot claim depreciation for this property after 1995.
Example.
On April 21, 1986, you bought and placed in service a new mobile home for $26,000 to be used as rental property. You paid $10,000 cash and signed a
note for $16,000 giving you an unadjusted basis of $26,000. On June 8, 1986, you bought and placed in service a used mobile home for use as rental
property at a total cost of $11,500. The total unadjusted basis of your 10-year recovery property placed in service in 1986 was $37,500 ($26,000 +
$11,500). Your ACRS deduction was $3,000 (8% × $37,500). In 1987, your ACRS deduction was $5,250 (14% × $37,500). In 1988, your ACRS
deduction was $4,500 (12% × $37,500). In 1989, 1990, and 1991, your ACRS deduction was $3,750 (10% × $37,500). In 1992, 1993, 1994, and
1995 your deduction for each year is $3,375 (9% × $37,500).
15-Year Real Property
15-year real property is real property that is recovery property placed in service before March 16, 1984. It includes all real property, such as
buildings, other than that designated as 5-year or 10-year property.
Unlike the 3-, 5-, or 10-year classes of property, the percentages for 15-year real property depend on when you placed the property in service
during your tax year. You could group 15-year real property by month and year placed in service.
In Table 1, at the end of this publication in the Appendix, find the month in your tax year that you placed the property in service in your trade
or business or for the production of income. You use the percentages listed under that month for each year of the recovery period to determine your
depreciation deduction each year.
Example.
On March 5, 1984, you placed an apartment building in service in your business. It is 15-year real property. After subtracting the value of the
land, your unadjusted basis in the building is $250,000. You use the calendar year as your tax year. March is the third month of your tax year. Your
ACRS deduction for 1984 was $25,000 (10% × $250,000). For 1985, the percentage for the third month of the second year of the recovery period is
11%. Your deduction was $27,500 (11% × $250,000). For the third, fourth, and fifth years of the recovery period (1986, 1987, and 1988), the
percentages are 9%, 8%, and 7%. For 1989 through 1992, the percentage for the third month is 6%. Your deduction each year is $15,000 (6% ×
$250,000). For 1993, 1994, and 1995, the percentage for the third month is 5%. Your depreciation deduction is $12,500 (5% × $250,000) for 1993,
1994, and 1995.
Low-Income Housing
Low-income housing that was assigned a 15-year recovery period under ACRS includes the following types of property:
Federally assisted housing projects where the mortgage is insured under section 221(d)(3) or 236 of the National Housing Act, or housing
financed or assisted by direct loan or tax abatement under similar provisions of state or local laws.
Low-income rental housing for which a depreciation deduction for rehabilitation expenditures is allowed.
Low-income rental housing held for occupancy by families or individuals eligible to receive subsidies under section 8 of the United States
Housing Act of 1937, as amended, or under the provisions of state or local laws that authorize similar subsidies for low-income families.
Housing financed or assisted by direct loan or insured under Title V of the Housing Act of 1949.
The ACRS percentages for low-income housing real property, like the regular 15-year real property percentages, depend on when you placed the
property in service. Find the month in your tax year in Table 2 or 3 at the end of this publication in the Appendix that you first placed the property
in service as rental housing. Use the percentages listed under that month for each year of the recovery period. Table 2 shows percentages for
low-income housing placed in service before May 9, 1985. Table 3 shows percentages for low-income housing placed in service after May 8, 1985, and
before 1987.
Example.
In May 1986, you acquired and placed in service a house that qualified as low-income rental housing under item 3) of the above listing. You use the
calendar year as your tax year. You use Table C–3 because the property was placed in service after May 8, 1985. Your unadjusted basis for the
property, not including the land, was $59,000.
Your deduction for 1986 through 2001 is shown in the following table.
Year
Rate
Deduction
1986
8.9%
$5,251
1987
12.1%
7,139
1988
10.5%
6,195
1989
9.1%
5,369
1990
7.9%
4,661
1991
6.9%
4,071
1992
5.9%
3,481
1993
5.2%
3,068
1994
4.6%
2,714
1995
4.6%
2,714
1996
4.6%
2,714
1997
4.6%
2,714
1998
4.6%
2,714
1999
4.5%
2,655
2000
4.5%
2,655
2001
1.5%
885
18-Year Real Property
18-year real property is real property that is recovery property placed in service after March 15, 1984, and before May 9, 1985. It includes real
property, such as buildings, other than that designated as 5-year, 10-year, 15-year real property, or low-income housing.
The ACRS percentages for 18-year real property depend on when you placed the property in service in your trade or business or for the production of
income during your tax year. There are also tables for 18-year real property in the Appendix. Table 4 shows the percentages for 18-year real property
you placed in service after June 22, 1984, and before May 9, 1985. Table 5 is for 18-year real property placed in service after March 15, 1984, and
before June 23, 1984.
Find the month in your tax year that you placed the property in service in a trade or business or for the production of income. Use the percentages
listed under that month for each year of the recovery period.
Example.
On April 28, 1985, you bought and placed in service a rental house. The house, not including the land, cost $95,000. This is your unadjusted basis
for the house. You use the calendar year as your tax year. Because the house was placed in service after June 22, 1984, and before May 9, 1985, it is
18-year real property. You use Table 4 to figure your deduction for the house. April is the fourth month of your tax year. Your deduction for 1985
through 2003 is shown in the following table.
Year
Rate
Deduction
1985
7.0%
$6,650
1986
9.0%
8,550
1987
8.0%
7,600
1988
7.0%
6,650
1989
7.0%
6,650
1990
6.0%
5,700
1991
5.0%
4,750
1992
5.0%
4,750
1993
5.0%
4,750
1994
5.0%
4,750
1995
5.0%
4,750
1996
5.0%
4,750
1997
5.0%
4,750
1998
4.0%
3,800
1999
4.0%
3,800
2000
4.0%
3,800
2001
4.0%
3,800
2002
4.0%
3,800
2003
1.0%
950
19-Year Real Property
19-year real property is real property that is recovery property placed in service after May 8, 1985, and before 1987. It includes all real
property, other than that designated as 5-year, 10-year, 15-year, or 18-year real property, or low-income housing.
The ACRS percentages for 19-year real property depend on when you placed the property in service in a trade or business or for the production of
income during your tax year. Table 6 shows the percentages for 19-year real property.
You find the month in your tax year that you placed the property in service. You use the percentages listed under that month for each year of the
recovery period.
Recovery Periods
Accelerated cost recovery system (ACRS):
Recovery periods
Each item of recovery property is assigned to a class of property. The classes of recovery property establish the recovery periods over which the
unadjusted basis of items in a class is recovered. The classes of property are:
3-Year property
5-Year property
10-Year property
15-Year real property
Low-income housing
18-Year real property
19-Year real property
Alternate ACRS Method (Modified Straight Line Method)
Accelerated cost recovery system (ACRS):
Alternate method
ACRS provides an alternate ACRS method that could be elected. This alternate ACRS method uses a recovery percentage based on a modified straight
line method.
This alternate ACRS method generally uses percentages other than those from the tables. If you elected the alternate ACRS method, you determine the
recovery period by using the following schedule. This schedule is for other than 18- and 19-year real property and low-income housing:
In the case of:
You could have elected
a recovery period of:
3-year property
3, 5, or 12 years
5-year property
5, 12, or 25 years
15-year real property
15, 35, or 45 years
Percentages.
The straight-line percentages for the alternate ACRS method are:
Recovery Period
Percentage
5 years
20.00%
10 years
10.00%
12 years
8.333%
15 years
6.667%
25 years
4.00%
35 years
2.857%
You apply the percentage to the unadjusted basis(defined earlier) of the property to figure your ACRS deduction. There are tables for 18- and
19-year real property later in this publication in the Appendix. For 15-year real property, see 15-year real property, later.
3-, 5-, and 10-year property.
If you elected to use an alternate recovery percentage, you have to use the same recovery percentage for all property in that class that you placed
in service in that tax year. This applies throughout the recovery period you selected.
Half-year convention.
If you elected the alternate method, only a half-year of depreciation was deducted for the year you placed the property in service. This applied
regardless of when in the tax year you placed the property in service. For each of the remaining years in the recovery period, you take a full year's
deduction. If you hold the property for the entire recovery period, a half-year of depreciation is allowable for the year following the end of the
recovery period.
Example.
You operate a small upholstery business. On March 19, 1986, you bought and placed in service a $13,000 light-duty panel truck to be used in your
business and a $500 electric saw. You elected to use the alternate ACRS method. You did not elect to take a section 179 deduction. You decided to
recover the cost of the truck, which is 3-year recovery property, over 5 years. The saw is 5-year property, but you decided to recover its cost over
12 years.
For 1986, your ACRS deduction reflected the half-year convention. In the first year, you deducted half of the amount determined for a full year.
Your ACRS deduction for 1986 is as follows:
Light-duty truck
5 years straight line = 20%
20% ÷ $13,000 = $2,600
Half-year convention - of $2,600=
$1,300.00
Electric saw
12 years straight line = 8.333%
8.333% ÷ $500 = $41.67
Half-year convention - of $41.67=
20.84
Total ACRS deduction for 1986
$1,320.84
You take a full year of depreciation for both the truck and the saw for the years 1987 through 1990. Your ACRS deduction for each of those years is
as follows:
Light-duty truck
5 years straight line = 20%
20% ÷ $13,000 =
$2,600
Electric saw
12 years straight line = 8.333%
8.333% ÷ $500 =
$41.67
Total annual ACRS deduction for 1987 through 1990
$2,641.67
In 1991, you take a half-year of depreciation for the truck and a full year of depreciation for the saw. Your ACRS deduction for 1991 is as
follows:
Light-duty truck
5 years straight line = 20%
20% ÷ $13,000 = $2,600
Half-year convention - of $2,600=
$1,300.00
Electric saw
12 years straight line = 8.333%
8.333% ÷ $500 =
$41.67
Total ACRS deduction for 1991
$1,341.67
The truck is fully depreciated after 1991. You take a full year of depreciation for the saw for the years 1992 through 1997. Your ACRS deduction
for each of those years is as follows:
Electric saw
12 years straight line = 8.333%
8.333% ÷ $500 =
$41.67
Total annual ACRS deduction for 1992 through 1997
$41.67
You take a half-year of depreciation for the saw for 1998. Your ACRS deduction for 1998 is as follows:
Electric saw
12 years straight line = 8.333%
8.333% ÷ $500 =
$41.67
Half-year convention - of $41.67=
20.84
Total ACRS deduction for 1998
$20.84
The saw is fully depreciated after 1998.
15-year real property.
Under ACRS, you could also elect to use the alternate ACRS method for 15-year real property. The alternate ACRS method allows you to depreciate
your 15-year real property using the straight line ACRS method over the alternate recovery periods of 15, 35, or 45 years. If you selected a 15-year
recovery period, you use the percentage (6.667%) from the schedule above. You prorate this percentage for the number of months the property was in
service in the first year. If you selected a 35- or 45-year recovery period, you use either Table 11 or 15.
Alternate periods for 18-year real property.
For 18-year real property, the alternate recovery periods are 18, 35, or 45 years. The percentages for 18-year real property under the alternate
method are in Tables 7, 8, 10, 11, 14, and 15 in the Appendix. There are two tables for each alternate recovery period. One table shows the percentage
for property placed in service after June 22, 1984. The other table has the percentages for property placed in service after March 15, 1984, and
before June 23, 1984.
Alternate periods for 19-year real property.
For 19-year real property, the alternate recovery periods are 19, 35, or 45 years. If you selected a 19-year recovery period, use Table 9 to
determine your deduction. If you select a 35- or 45-year recovery period, use either Table 13 or 14.
Example.
You placed in service an apartment building on August 3, 1986. The building is 19-year real property. The sales contract allocated $300,000 to the
building and $100,000 to the land. You use the calendar year as your tax year. You chose the alternate ACRS method over a recovery period of 35 years.
For 1986, you figure your ACRS deduction usingTable 13. August is the eighth month of your tax year. The percentage from Table 13 for the eighth month
is 1.1%. Your deduction was $3,300 ($300,000 ÷ 1.1%). The deduction rate from ACRS Table 13 for years 2 through 20 is 2.9% so that your
deduction in 1987 through 2005 is $8,700 ($300,000 ÷ 2.9%).
Alternate periods for low-income housing.
For low-income housing, the alternate recovery periods are 15, 35, or 45 years. If you selected a 15-year period for this property, use 6.667% as
the percentage. If you selected a 35- or 45-year period, use either Table 11, 12, or 15.
Election.
You had to make the election to use the alternate ACRS method by the return due date (including extensions) for the tax year you placed the
property in service.
Revocation of election.
Your election to use an alternate ACRS method, once made, can be changed only with the consent of the Commissioner. The Commissioner grants consent
only in extraordinary circumstances. Any request for a revocation will be considered a request for a ruling.
ACRS Deduction in Short Tax Year
Accelerated cost recovery system (ACRS):
Deduction, short tax year
For a tax year that is less than 12 months, the ACRS deduction is prorated on a 12-month basis. Figure the amount of the ACRS deduction for a short
tax year as follows:
First, you figure the ACRS deduction for a full year. You figure this by multiplying the unadjusted basis by the recovery
percentage.
You then multiply the ACRS deduction determined for a full tax year by a fraction.
The numerator (top number) of the fraction is the number of months in the short tax year and the denominator (bottom number) is 12. For
example, a corporation placed in service in June 1986 an item of 3-year property with an unadjusted basis of $10,000. The corporation files a tax
return, because of a change in its accounting period, for the 6-month short tax year ending June 30, 1986. The full year's ACRS deduction for this
item is $2,500 ($10,000 ÷ 25%), the first year percentage from the 3-year table. The ACRS deduction for the short tax year is $1,250 ($2,500
÷ 6/12).
You use the full ACRS percentages during the remaining years of the recovery period. For the first tax year after the recovery period, the
unrecovered basis will be deductible.
Exception.
For the tax year in which you placed 15-, 18-, or 19-year real property in service or in the tax year you dispose of it, you compute the ACRS
deduction for the number of months that the property is in service during that tax year. You compute the number of months using either a full month or
mid-month convention. This is true regardless of the number of months in the tax year and the recovery period and method used.
Dispositions
Dispositions
A disposition is the permanent withdrawal of property from use in your trade or business or in the production of income. You can make a withdrawal
by sale, exchange, retirement, abandonment, or destruction.
You generally recognize gain or loss on the disposition of an asset by sale. However, nonrecognition rules can allow you to postpone some gain. See
Publication 544.
If you physically abandon property, you can deduct as a loss the adjusted basis of the asset at the time of its abandonment. Your intent must be to
discard the asset so that you will not use it again or retrieve it for sale, exchange, or other disposition.
Early dispositions.
The disposal of an asset before the end of its specified recovery period, is referred to as an early disposition. When an early disposition occurs,
the depreciation deduction in the year of disposition depends on the class of property involved.
Early dispositions of ACRS property other than 15-, 18-, or 19-year real property.
Accelerated cost recovery system (ACRS):
Dispositions
Generally, you get no ACRS deduction for the tax year in which you dispose of or retire recovery property, except for 15-, 18-, and 19-year real
property. This means there is no depreciation deduction under ACRS in the year you dispose of or retire any of your 3-, 5-, or 10-year recovery
property.
Dispositions — mass asset accounts.
The law provides a special rule to avoid the calculation of gain on the disposition of assets from mass asset accounts. A mass asset account
includes items usually minor in value in relation to the group, numerous in quantity, impractical to separately identify, and not usually accounted
for on a separate basis, but on a total dollar value. Examples of mass assets include minor items of office, plant, and store furniture and fixtures.
Under the special rule, if you elected to use a mass asset account, you recognize gain to the extent of the proceeds from the disposition of the
asset. You leave the unadjusted basis of the property in the account until recovered in future years. If you did this, include the total proceeds
realized from the disposition in income on the tax return for the year of disposition.
Early dispositions — 15-year real property.
If you dispose of 15-year real property, you base your ACRS deduction for the year of disposition on the number of months in use. You use a
full-month convention. For a disposition at any time during a particular month before the end of the recovery period, no deduction is
allowed for the month of disposition. This applies whether you use the regular ACRS method or elected the alternate ACRS method.
Example.
You purchased and placed in service a rental house on March 2, 1984, for $98,000 (not including the cost of land). You file your return based on a
calendar year. Your rate from Table 1 for the third month is 10%. Your ACRS deduction for 1984 was $9,800 ($98.000 ÷ 10%). For 1985 through
1988, you figured your ACRS deductions using 11%, 9%, 8%, and 7% ÷ $98,000. For 1989 through 1992, you figured your ACRS deductions using 6%
for each year. The deduction each year was $98,000 ÷ 6%. For 1993 and 1994, the ACRS deduction is ($98,000 ÷ 5%) $4,900 for each year.
You sell the house on June 1, 1995.
You figure your ACRS deduction for 1995 for the full year and then prorate that amount for the months of use. The full ACRS deduction for 1995 is
$4,900 ($98,000 ÷ 5%). You then prorate this amount to the 5 months in 1995 during which it was rented. Your ACRS deduction for 1995 is $2,042
($4,900 ÷ 5/12).
Early dispositions — 18- and 19-year real property.
If you dispose of 18- or 19-year real property, you base your ACRS deduction for the year of disposition on the number of months in use. For
18-year property placed in service before June 23, 1984, use a full-month convention on a disposition. For 18-year property placed in service after
June 22, 1984, and for 19-year property, determine the number of months in use by using the mid-month convention. Under the mid-month
convention,treat real property disposed of any time during a month as disposed of in the middle of that month. Count the month of disposition as
half a month of use.
Example.
You purchased and placed in service a rental house on July 2, 1984, for $100,000 (not including the cost of land). You file your return based on a
calendar year. Your rate from Table 4 for the seventh month is 4%. You figured your ACRS deduction for 1984 was $4,000 ($100,000 ÷ 4%). In 1985
through 1994, your ACRS deductions were 9%, 8%, 8%, 7%, 6%, 6%, 5%, 5%, and 5% ÷ $100,000. You sell the house on September 24, 1995. Figure
your ACRS deduction for 1995 for the months of use. The full ACRS deduction for 1995 is $5,000 ($100,000 ÷ 5%). Prorate this amount for the 8.5
months in 1995 that you held the property. Under the mid-month convention, you count September as half a month. Your ACRS deduction for 1995 is $3,542
($5,000 ÷ 8.5/12).
Depreciation Recapture
Recapture:
Depreciation
If you dispose of property depreciated under ACRS that is section 1245 recovery property, you will generally recognize gain or loss. Gain
recognized on a disposition is ordinary income to the extent of prior depreciation deductions taken. This recapture rule applies to all personal
property in the 3-year, 5-year, and 10-year classes. You recapture gain on manufactured homes and theme park structures in the 10-year class as
section 1245 property. Section 1245 property generally includes all personal property. See Section 1245 property in chapter 4 of
Publication 544 for more information.
You treat dispositions of section 1250 real property on which you have a gain as section 1245 recovery property. You recognize gain on this
property as ordinary income to the extent of prior depreciation deductions taken. Section 1250 property includes most real property. See Section
1250 property in chapter 4 of Publication 544 for more information. This rule applies to all section 1250 real property except the following
property:
Any 15-, 18-, or 19-year real property that is residential rental property.
Any 15-, 18-, or 19-year real property that you elected to depreciate using the alternate ACRS method.
Any 15-, 18-, or 19-year real property that is subsidized low-income housing.
For these recapture rules, you treat the section 179 deduction and 50% of the investment credit that reduced your basis as depreciation.
See Publication 544 for further discussion of dispositions of section 1245 and 1250 property.
Other Methods of Depreciation
How to figure the deduction
Methods to use
How to change methods
Dispositions
Publication
544
Sales and Other Dispositions of Assets
551
Basis of Assets
583
Starting a Business and Keeping Records
946
How To Depreciate Property
Form (and Instructions)
Application for Change in Accounting Method
Depreciation and Amortization
Profit or Loss From Business
If your property is being depreciated under ACRS, you must continue to use rules for depreciation that applied when you placed the property in
service. If your property qualified for MACRS, you must depreciate it under MACRS. See Publication 946.
However, you cannot use MACRS for certain property because of special rules that exclude it from MACRS. Also, you can elect to exclude certain
property from being depreciated under MACRS. Property that you cannot depreciate using MACRS includes:
Intangible property,
Property you can elect to exclude from MACRS that you properly depreciate under a method that is not based on a term of years,
Certain public utility property,
Any motion picture film or video tape,
Any sound recording, and
Certain real and personal property placed in service before 1987.
Intangible property.
Property:
Intangible
You cannot depreciate intangible property under ACRS or MACRS. You depreciate intangible property using any other reasonable method, usually, the
straight line method.
Note.
The cost of certain intangible property that you acquire after August 10, 1993, must be amortized over a 15-year period. For more information, see
chapter 12 of Publication 535.
Public utility property.
The law excludes from MACRS any public utility property for which the taxpayer does not use a normalization method of accounting. This type of
property is subject to depreciation under a special rule.
Videocassettes.
Videocassettes
If you are in the videocassette rental business, you can depreciate those videocassettes purchased for rental. You can depreciate the cost less
salvage value of those videocassettes that have a useful life over one year using either:
The straight line method, or
The income forecast method.
The straight line method, salvage value, and useful life are discussed later under Methods To Use. You can deduct in the year of
purchase as a business expense the cost of any cassette that has a useful life of one year or less.
How To Figure the Deduction
Deduction:
How to figure
Two other reasonable methods can be used to figure your deduction for property not covered under ACRS or MACRS. These methods are straight line and
declining balance.
To figure depreciation using these methods, you must generally determine three things about the property you intend to depreciate. They are:
The basis,
The useful life, and
The estimated salvage value at the end of its useful life.
The amount of the deduction in any year also depends on which method of depreciation you choose.
Basis
To deduct the proper amount of depreciation each year, first determine your basis in the property you intend to depreciate. The basis used for
figuring depreciation is the same as the basis that would be used for figuring the gain on a sale. Your original basis is usually the purchase price.
However, if you acquire property in some other way, such as inheriting it, getting it as a gift, or building it yourself, you have to figure your
original basis in a different way.
Adjusted basis.
Basis:
Adjusted
Events will often change the basis of property. When this occurs, the changed basis is called the adjusted basis. Some events, such as improvements
you make, increase basis. Events such as deducting casualty losses and depreciation decrease basis. If basis is adjusted, the depreciation deduction
may also have to be changed, depending on the reason for the adjustment and the method of depreciation you are using.
Publication 551 explains how to figure basis for property acquired in different ways. It also discusses what items increase and decrease basis, how
to figure adjusted basis, and how to allocate cost if you buy several pieces of property at one time.
Useful Life
Useful life
The useful life of a piece of property is an estimate of how long you can expect to use it in your trade or business, or to produce income. It is
the length of time over which you will make yearly depreciation deductions of your basis in the property. It is how long it will continue to be useful
to you, not how long the property will last.
Many things affect the useful life of property, such as:
Frequency of use,
Age when acquired,
Your repair policy, and
Environmental conditions.
The useful life can also be affected by technological improvements, progress in the arts, reasonably foreseeable economic changes, shifting of
business centers, prohibitory laws, and other causes. Consider all these factors before you arrive at a useful life for your property.
The useful life of the same type of property varies from user to user. When you determine the useful life of your property, keep in mind your own
experience with similar property. You can use the general experience of the industry you are in until you are able to determine a useful life of your
property from your own experience.
Change in useful life.
You base your estimate of useful life on certain facts. If these facts change significantly, you can adjust your estimate of the remaining useful
life. However, you redetermine the estimated useful life only when the change is substantial and there is a clear reason for making the change.
Salvage Value
Salvage value
It is important for you to accurately determine the correct salvage value of the property you want to depreciate. You generally cannot depreciate
property below a reasonable salvage value.
Determining salvage value.
Salvage value is the estimated value of property at the end of its useful life. It is what you expect to get for the property if you sell it after
you can no longer use it productively. You must estimate the salvage value of a piece of property when you first acquire it.
Salvage value is affected both by how you use the property and how long you use it. If it is your policy to dispose of property that is still in
good operating condition, the salvage value can be relatively large. However, if your policy is to use property until it is no longer usable, its
salvage value can be its junk value.
Changing salvage value.
Once you determine the salvage value for property, you should not change it merely because prices have changed. However, if you redetermine the
useful life of property, as discussed earlier under Change in useful life, you can also redetermine the salvage value. When you redetermine
the salvage value, take into account the facts that exist at the time.
Net salvage.
Net salvage is the salvage value of property minus what it costs to remove it when you dispose of it. You can choose either salvage value or net
salvage when you figure depreciation. You must consistently use the one you choose and the treatment of the costs of removal must be consistent with
the practice adopted. However, if the cost to remove the property is more than the estimated salvage value, then net salvage is zero. Your salvage
value can never be less than zero.
Ten percent rule.
If you acquire personal property that has a useful life of 3 years or more, you can use an amount for salvage value that is less than your actual
estimate. You can subtract from your estimate of salvage value an amount equal to 10% of your basis in the property. If salvage value is less than 10%
of basis, you can ignore salvage value when you figure depreciation.
Methods To Use
Two methods of depreciation are the straight line and declining balance methods. If ACRS or MACRS does not apply, you can use one of these methods.
The straight line and declining balance methods discussed in this section are not figured in the same way as straight line or declining balance
methods under MACRS.
Straight Line Method
Straight line method
Methods of figuring depreciation:
Straight line
Before 1981, you could use any reasonable method for every kind of depreciable property. One of these methods was the straight line method. This
method was also used for intangible property. It lets you deduct the same amount of depreciation each year.
To figure your deduction, determine the adjusted basis of your property, its salvage value, and its estimated useful life. Subtract the salvage
value, if any, from the adjusted basis. The balance is the total amount of depreciation you can take over the useful life of the property.
Divide the balance by the number of years remaining in the useful life. This gives you the amount of 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 1994, Frank bought a franchise for $5,600. It expires in 10 years. This property is intangible property that cannot be depreciated under
MACRS. Frank depreciates the franchise under the straight line method, using a 10-year useful life and no salvage value. He takes the $5,600 basis and
divides that amount by 10 years ($5,600 ÷ 10 = $560, a full year's use). He must prorate the $560 for his 9 months of use in 1994. This gives
him a deduction of $420 ($560 ÷ 9/12). In 1995, Frank can deduct $560 for the full year.
Declining Balance Method
Declining balance method
Methods of figuring depreciation:
Declining Balance
The declining balance method allows you to recover a larger amount of the cost of the property in the early years of your use of the property. The
rate cannot be more than twice the straight line rate.
Rate of depreciation.
Under this method, you must determine your declining balance rate of depreciation. The initial step is to:
Divide the number 1 by the useful life of your property to get a straight line rate. (For example, if property has a useful life of 5 years,
its normal straight line rate of depreciation is , or 20%.)
Multiply this straight line rate by a number that is more than 1 but not more than 2 to determine the declining balance rate.
Unless there is a change in the useful life during the time you depreciate the property, the rate of depreciation generally will not change.
Depreciation deductions.
After you determine the rate of depreciation, multiply the adjusted basis of the property by it. This gives you the amount of your deduction. For
example, if your adjusted basis at the beginning of the first year is $10,000, and your declining balance rate is 20%, your depreciation deduction for
the first year is $2,000 ($10,000 ÷ 20%). To figure your depreciation deduction in the second year, you must first adjust the basis for the
amount of depreciation you deducted in the first year. Subtract the previous year's depreciation from your basis ($10,000 − $2,000 = $8,000).
Multiply this amount by the rate of depreciation ($8,000 ÷ 20% = $1,600). Your depreciation deduction for the second year is $1,600.
As you can see from this example, your adjusted basis in the property gets smaller each year. Also, under this method, deductions are larger in the
earlier years and smaller in the later years. You can make a change to the straight line method without consent.
Salvage value.
Do not subtract salvage value when you figure your yearly depreciation deductions under the declining balance method. However, you cannot
depreciate the property below its reasonable salvage value. Determine salvage value using the rules discussed earlier, including the special 10% rule.
Example.
If your adjusted basis has been decreased to $1,000 and the rate of depreciation is 20%, your depreciation deduction should be $200. But if your
estimate of salvage value was $900, you can only deduct $100. This is because $100 is the amount that would lower your adjusted basis to equal salvage
value.
Income Forecast Method
The
Income forecast method
Methods of figuring depreciation:
Methods of figuring depreciation:
Income forecast income forecast method requires income projections for each videocassette or group of videocassettes. You
can group the videocassettes by title for making this projection. You determine the depreciation by applying a fraction to the cost less salvage value
of the cassette. The numerator is the income from the videocassette for the tax year and the denominator is the total projected income for the
cassette. For more information on the income forecast method, see Revenue Ruling 60-358 in Cumulative Bulletin 1960, Volume 2, on page 68.
How To Change Methods
Changing methods
In some cases, you may change your method of depreciation for property depreciated under a reasonable method. If you change your method of
depreciation, it is generally a change in your method of accounting. You must get IRS consent before making the change. However, you do not need
permission for certain changes in your method of depreciation. The rules discussed in this section do not apply to property depreciated under ACRS or
MACRS.
For information on ACRS elections,see Revocation of election, in chapter 1 under Alternate ACRS Method.
Change to the straight line method.
You can change from the declining balance method to the straight line method at any time during the useful life of your property without IRS
consent. However, if you have a written agreement with the IRS that prohibits a change, you must first get IRS permission. When the change is made,
figure depreciation based on your adjusted basis in the property at that time. Your adjusted basis takes into account all previous depreciation
deductions. Use the estimated remaining useful life of your property at the time of change and its estimated salvage value.
You can change from the declining balance method to straight line only on the original tax return for the year you first use the straight line
method. You cannot make the change on an amended return filed after the due date of the original return (including extensions).
When you make the change, attach a statement to your tax return showing:
When you acquired the property,
Its original cost or other original basis,
The total amount claimed for depreciation and other allowances since you acquired it,
Its salvage value and remaining useful life, and
A description of the property and its use.
After you change to straight line, you cannot change back to the declining balance method or to any other method for a period of 10 years without
written permission from the IRS.
Changes that require permission.
For most other changes in method of depreciation, you must get permission from the IRS. To request a change in method of depreciation, file Form
3115. File the application within the first 180 days of the tax year the change is to become effective. In most cases, there is a user fee that must
accompany Form 3115. See the instructions for Form 3115 to determine if a fee is required.
Changes granted automatically.
The IRS automatically approves certain changes of a method of depreciation. But, you must file Form 3115 for these automatic changes.
However, IRS can deny permission if Form 3115 is not filed on time. For more information on automatic changes, see Revenue Procedure 74-11, 1974-1
C.B. 420.
Changes for which approval is not automatic.
The automatic change procedures do not apply to:
Property or an account where you made a change in depreciation within the last 10 tax years (unless the change was made under the Class Life
System),
Class Life Asset Depreciation Range System, and
Public utility property.
You must request and receive permission for these changes. To make the request, file Form 3115 during the first 180 days of the tax year for which
you want the change to be effective.
Change from an improper method.
If the IRS disallows the method you are using, you do not need permission to change to a proper method. You can adopt the straight line method, or
any other method that would have been permitted if you had used it from the beginning. If you file your tax return using an improper method, but later
file an amended return, you can use a proper method on the amended return without getting IRS permission. However, you must file the amended return
before the filing date for the next tax year.
Dispositions
Dispositions
Retirement is the permanent withdrawal of depreciable property from use in your trade or business or for the production of income. You can do this
by selling, exchanging, or abandoning the item of property. You can also withdraw it from use without disposing of it. For example, you could place it
in a supplies or scrap account. Retirements can be either normal or abnormal depending on all facts and circumstances. The rules discussed next do not
apply to MACRS and ACRS property.
Normal retirement.
A normal retirement is a permanent withdrawal of depreciable property from use if the following apply:
The retirement is made within the useful life you estimated originally, and
The property has reached a condition at which you customarily retire or would retire similar property from use.
A retirement is generally considered normal unless you can show that you retired the property because of a reason you did not consider when
you originally estimated the useful life of the property.
Abnormal retirement.
A retirement can be abnormal if you withdraw the property early or under other circumstances. For example, if the property is damaged by a fire or
suddenly becomes obsolete and is now useless.
Gain or loss on retirement.
There are special rules for figuring the gain or loss on retirement of property. The gain or loss will depend on several factors. These include the
type of withdrawal, if the withdrawal was from a single property or multiple property account, and if the retirement was normal or abnormal. A single
property account contains only one item of property. A multiple property account is one in which several items have been combined with a single rate
of depreciation assigned to the entire account.
Sale or exchange.
If property is retired by sale or exchange, you figure gain or loss by the usual rules that apply to sales or other dispositions of property. See
Publication 544.
Property not disposed of or abandoned.
If property is retired permanently, but not disposed of or physically abandoned, you do not recognize gain. You are allowed a loss in such a case,
but only if the retirement is:
An abnormal retirement,
A normal retirement from a single property account in which you determined the life of each item of property separately, or
A normal retirement from a multiple property account in which the depreciation rate is based on the maximum expected life of the longest
lived item of property and the loss occurs before the expiration of the full useful life. However, you are not allowed a loss if the depreciation rate
is based on the average useful life of the items of property in the account.
To figure your loss, subtract the estimated salvage or fair market value of the property at the date of retirement, whichever is more, from its
adjusted basis.
Special rule for normal retirements from item accounts.
You can generally deduct losses upon retirement of a few depreciable items of property with similar useful lives, if:
You account for each one in a separate account, and
You use the average useful life to figure depreciation.
However, you cannot deduct losses if you use the average useful life to figure depreciation and they have a wide range of useful lives.
If you have a large number of depreciable property items and use average useful lives to figure depreciation, you cannot deduct the losses upon
normal retirements from these accounts.
Abandoned property.
If you physically abandon property, you can deduct as a loss the adjusted basis of the property at the time of its abandonment. However, your
intent must be to discard the property so that you will not use it again or retrieve it for sale, exchange, or other disposition.
Basis of property retired.
The basis for figuring gain or loss on the retirement of property is its adjusted basis at the time of retirement, as determined in the following
discussions.
Single item accounts.
If an item of property is accounted for in a single item account, the adjusted basis is the basis you would use to figure gain or loss for a sale
or exchange of the property. This is generally the cost or other basis of the item of property less depreciation. See Publication 551.
Multiple property account.
For a normal retirement from a multiple property account, if you figured depreciation using the average expected useful life, the adjusted basis is
the salvage value estimated for the item of property when it was originally acquired. If you figured depreciation using the maximum expected useful
life of the longest lived item of property in the account, you must use the depreciation method used for the multiple property account and a rate
based on the maximum expected useful life of the item of property retired.
You make the adjustment for depreciation for an abnormal retirement from a multiple property account at the rate that would be proper if the item
of property was depreciated in a single property account. The method of depreciation used for the multiple property account is used. You base the rate
on either the average expected useful life or the maximum expected useful life of the retired item of property, depending on the method used to
determine the depreciation rate for the multiple property account.
Listed Property
Listed property defined
The predominant use test
What records must be kept
Publication
463
Travel, Entertainment, and Gift Expenses
587
Business Use of Your Home (Including Use by Day-Care Providers)
917
Business Use of a Car
946
How To Depreciate Property
Form (and Instructions)
Unreimbursed Employee Business Expenses
Employee Business Expenses
Recapture of Investment Credit
Depreciation and Amortization
This chapter discusses some special rules and recordkeeping requirements for listed property. For complete coverage of the rules, including the
rules concerning passenger automobiles, see Publication 946.
If listed property is not used predominantly (more than 50%) in a qualified business use as discussed inPredominant Use Test, later, the
section 179 deduction is not allowable and the property must be depreciated using the straight line method.
Listed Property Defined
Listed property:
Listed property:
Defined
Listed property is any of the following:
Any passenger automobile (defined later),
Any other property used for transportation,
Any property of a type generally used for entertainment, recreation, or amusement (including photographic, phonographic, communication, and
video recording equipment),
Any computer and related peripheral equipment, defined later, unless it is used only at a regular business establishment and
owned or leased by the person operating the establishment. A regular business establishment includes a portion of a dwelling unit (defined later), if,
and only if, that portion is used both regularly and exclusively for business as discussed in Publication 587.
Any cellular telephone (or similar telecommunication equipment) placed in service or leased in a tax year beginning after 1989.
Passenger Automobile Defined
Passenger automobile:
Defined
A passenger automobile is any four-wheeled vehicle made primarily for use on public streets, roads, and highways and rated at 6,000 pounds or less
of unloaded gross vehicle weight (at 6,000 pounds or less of gross vehicle weight for trucks and vans). It includes any part, component, or other item
physically attached to the automobile or usually included in the purchase price of an automobile.
A passenger automobile does not include:
An ambulance, hearse, or combination ambulance-hearse used directly in a trade or business, and
A vehicle used directly in the trade or business of transporting persons or property for compensation or hire.
Dwelling Unit
A dwelling unit is a house or apartment used to provide living accommodations in a building or structure. It does not include a unit in a hotel,
motel, inn, or other establishment where more than half the units are used on a transient basis.
Other Property Used for Transportation
Listed property:
Other transportation property
Other property used for transportation includes trucks, buses, boats, airplanes, motorcycles, and any other vehicles for transporting persons or
goods.
Listed property does not include:
Any vehicle which, by reason of its design, is not likely to be used more than a minimal amount for personal purposes, such as clearly
marked police and fire vehicles, ambulances, or hearses used for those purposes,
Any vehicle that is designed to carry cargo and that has a loaded gross vehicle weight over 14,000 pounds, bucket trucks (cherry pickers),
cement mixers, combines, cranes and derricks, delivery trucks with seating only for the driver (or only for the driver plus a folding jump seat), dump
trucks (including garbage trucks), flatbed trucks, forklifts, qualified moving vans, qualified specialized utility repair trucks, and refrigerated
trucks,
Any passenger bus used for that purpose with a capacity of at least 20 passengers and school buses,
Any tractor or other special purpose farm vehicle, and unmarked vehicles used by law enforcement officers if the use is officially
authorized, and
Any vehicle, such as a taxicab, if substantially all its use is in the trade or business of providing services to transport persons or
property for compensation or hire by unrelated persons.
Computers and Related Peripheral Equipment
Listed property:
Computers, related equipment
A computer is a programmable electronically activated device that:
Is capable of accepting information, applying prescribed processes to the information, and supplying the results of those processes with or
without human intervention, and
Consists of a central processing unit with extensive storage, logic, arithmetic, and control capabilities.
Related peripheral equipment is any auxiliary machine which is designed to be controlled by the central processing unit of a computer.
Computer or peripheral equipment does not include:
Any equipment which is an integral part of property which is not a computer,
Typewriters, calculators, adding and accounting machines, copiers, duplicating equipment, and similar equipment, and
Equipment of a kind, used primarily for the user's amusement or entertainment, such as video games.
Predominant Use Test
Listed property:
Predominant use test
If listed property, defined earlier, placed in service after June 18, 1984, is not used predominantly (more than 50%) in a qualified
business use during any tax year:
The section 179 deduction on the property is not allowable, and
You must depreciate the property using the straight line method.
Listed property placed in service before 1987.
For listed property placed in service before 1987, depreciate the property over the following period:
Class of Property
Listed Property
Recovery Period
3-year property
5 years
5-year property
12 years
10-year property
25 years
18-year real property
40 years
19-year real property
40 years
If you must use the above recovery periods for listed property not used predominantly in a trade or business, use the percentages from Table
16 titled Listed Property Not Used Predominantly (Other Than 18- or 19-year Real Property), and Table 17 for 18- or 19-year real property,
near the end of this publication in the Appendix.
Listed property placed in service after 1986.
For information on listed property placed in service after 1986, see Publication 946.
Meeting the Predominant Use Test
Listed property meets the predominant use test for any tax year if its business use is more than 50% of its total use. You must allocate the use of
any item of listed property used for more than one purpose during the tax year among its various uses. The percentage of investment use of listed
property cannot be used as part of the percentage of qualified business use to meet the predominant use test. However, the combined total of business
and investment use is taken into account to figure your depreciation deduction for the property.
Note:
Property does not stop being predominantly used in a qualified business use because of a transfer at death.
Example.
Sarah Bradley uses a home computer 50% of the time to manage her investments. She also uses the computer 40% of the time in her part-time consumer
research business. Sarah's home computer is listed property because it is not used at a regular business establishment. Because her business use of
the computer does not exceed 50%, the computer is not predominantly used in a qualified business use for the tax year. Because she does not meet the
predominant use test, she cannot elect a section 179 deduction for this property. Her combined rate of business/investment use for determining her
depreciation deduction is 90%.
Qualified Business Use
Listed property:
Qualified business use
A qualified business use is any use in your trade or business. However, it does not include:
The use of property held merely to produce income (investment use),
The leasing of property to any 5% owner or related person (to the point that the property is used by a 5% owner or person related
to the owner or lessee of the property),
The use of property as compensation for the performance of services by a 5% owner or related person, or
The use of property as compensation for the performance of services by any person (other than a5% owner or related person) unless
the value of the use is included in that person's gross income for the use of the property and income tax is withheld on that amount where required.
See Employees, later.
5% owner.
Listed property:
5% owner
A 5% owner of a business, other than a corporation, is any person who owns more than 5% of the capital or profits interest in the business.
A 5% owner of a corporation is any person who owns, or is considered to own:
More than 5% of the outstanding stock of the corporation, or
Stock possessing more than 5% of the total combined voting power of all stock in the corporation.
Related person.
Listed property:
Related person
A related person is anyone related to a taxpayer as discussed under Related persons, in chapter 2 under Nonqualifying Property
in Publication 946.
Entertainment Use
Listed property:
Entertainment use
The use of listed property for entertainment, recreation, or amusement purposes is treated as a qualified business use only to the extent that
expenses (other than interest and property tax expenses) for its use are deductible as ordinary and necessary business expenses. See Publication 463.
Leasing or Compensatory Use of Aircraft
If at least 25% of the total use of any aircraft during the tax year is for a qualified business use, the leasing or compensatory use of the
aircraft by a 5% owner or related person is treated as a qualified business use.
Commuting
The use of a vehicle for commuting is not business use, regardless of whether work is performed during the trip.
Use of Your Passenger Automobile by Another Person
If someone else uses your automobile, that use is not business use unless:
That use is directly connected with your business,
The value of the use is property reported by you as income to the other person and tax is withheld on the income where required,
or
The value of the use results in a payment of fair market rent.
Any payment to you for the use of the automobile is treated as a rent payment for 3).
Employees
Listed property:
Use by employee
Any use by an employee of his or her own listed property (or listed property rented by an employee) in performing services as an employee is not
business use unless:
The use is for the employer's convenience, and
The use is required as a condition of employment.
Use for the employer's convenience.
Whether the use of listed property is for the employer's convenience must be determined from all the facts. The use is for the employer's
convenience if it is for a substantial business reason of the employer. The use of listed property during the employee's regular working hours to
carry on the employer's business is generally for the employer's convenience.
Use required as a condition of employment.
Whether the use of listed property is a condition of employment depends on all the facts and circumstances. The use of property must be required
for the employee to perform duties properly. The employer need not explicitly require the employee to use the property. A mere statement by the
employer that the use of the property is a condition of employment is not sufficient.
Example 1.
Virginia Sycamore is employed as a courier with We Deliver which provides local courier services. She owns and uses a motorcycle to deliver
packages to downtown offices. We Deliver explicitly requires all delivery persons to own a small car or motorcycle for use in their employment. The
company reimburses delivery persons for their costs. Virginia's use of the motorcycle is for the convenience of We Deliver and is required as a
condition of employment.
Example 2.
Bill Nelson is an inspector for Uplift, a construction company with many sites in the local area. He must travel to these sites on a regular basis.
Uplift does not furnish an automobile or explicitly require him to use his own automobile. However, it reimburses him for any costs he incurs in
traveling to the various sites. The use of his own automobile or a rental automobile is for the convenience of Uplift and is required as a condition
of employment.
Method of Allocating Use
For passenger automobiles and other means of transportation, allocate the property's use on the basis of mileage. You determine the percentage of
qualified business use by dividing the number of miles the vehicle is driven for business purposes during the year by the total number of miles the
vehicle is driven for all purposes (including business miles) during the year.
For other items of listed property, allocate the property's use on the basis of the most appropriate unit of time. For example, you can determine
the percentage of business use of a computer by dividing the number of hours the computer is used for business purposes during the year by the total
number of hours the computer is used for all purposes (including business hours) during the year.
Applying the Predominant Use Test
Predominant use test, applying
You must apply the predominant use test for an item of listed property each year of the recovery period.
First Recovery Year
If any item of listed property is not used predominantly in a qualified business use in the year it is placed in service:
The property is not eligible for a section 179 deduction, and
The depreciation deduction must be figured using the straight line method.
Note:
The required use of the straight line method for an item of listed property that does not meet the predominant use test is not the same as electing
the straight line method. It does not mean that you have to use the straight line method for other property in the same class as the item of listed
property.
Years After the First Recovery Year
If you use listed property predominantly (more than 50%) in a qualified business use in the tax year you place it in service, but not in a
subsequent tax year during the recovery period, the following rules apply:
Figure depreciation using the straight line method. Do this for each year, beginning with the year you no longer use the property
predominantly in a qualified business use, and
Figure any excess depreciation on the property and add it to:
Your gross income, and
The adjusted basis of your property.
See Recapture of excess depreciation, next.
Recapture of excess depreciation.
Recapture:
Excess depreciation, listed property
You must include any excess depreciation in your gross income for the first tax year the property is not predominantly used in a qualified business
use. Any excess depreciation must also be added to the adjusted basis of your property. Excess depreciation is the excess (if any) of:
The amount of depreciation allowable for the property (including any section 179 deduction claimed) for tax years before the first tax year
the property was not predominantly used in a qualified business use, over
The amount of depreciation that would have been allowable for those years if the property were not used predominantly in a qualified
business use for the year it was placed in service. This means you figure your depreciation using the percentages fromTable 16 or 17.
For information on investment credit recapture, see the instructions for Form 4255.
Deductions After Recovery Period
When listed property (other than passenger automobiles) is used for business, investment, and personal purposes, no deduction is ever allowable for
the personal use. In tax years after the recovery period, you must determine if there is any unrecovered basis remaining before you compute the
depreciation deduction for that tax year. To make this determination, figure the depreciation for earlier tax years as if your property were used 100%
for business or investment purposes, beginning with the first tax year in which some or all use is for business or investment. See Car Used 50%
or Less for Business in Publication 917.
Leased Property
Listed property:
Leased
The limitations on cost recovery deductions apply to the rental of listed property. The following discussion covers the rules that apply to the
lessor (the owner of the property) and the lessee (the person who rents the property from the owner). SeeLeasing a Car in Publication 917
for a discussion of leased passenger automobiles.
Lessor
The limitations on cost recovery generally do not apply to any listed property leased or held for leasing by anyone regularly engaged in the
business of leasing listed property.
A person is considered regularly engaged in the business of leasing listed property only if contracts for leasing of listed property are
entered into with some frequency over a continuous period of time. This determination is made on the basis of the facts and circumstances in each case
and takes into account the nature of the person's business in its entirety. Occasional or incidental leasing activity is insufficient. For example, a
person leasing only one passenger automobile during a tax year is not regularly engaged in the business of leasing automobiles. An employer who allows
an employee to use the employer's property for personal purposes and charges the employee for the use is not regularly engaged in the business of
leasing the property used by the employee.
Lessee
A lessee of listed property (other than passenger automobiles), must include an amount in gross income called the inclusion amount for the first
tax year the property is not used predominantly in a qualified business use.
Inclusion amount for property leased before 1987.
You determine the inclusion amount for property leased after June 18, 1984 and before 1987 by multiplying the fair market value of the property by
both the average business/investment use percentage and the applicable percentage. You can find the applicable percentages for listed property that is
5- or 10-year recovery property in Tables 19 or 20 in Appendix A of Publication 946.
The lease term for listed property other than 18- or 19-year real property, and residential rental or nonresidential real property,
includes options to renew. For 18- or 19-year real property and residential rental or nonresidential real property that is listed property, the period
of the lease does not include any option to renew at fair market value, determined at the time of renewal. You treat two or more successive leases
that are part of the same transaction (or a series of related transactions) for the same or substantially similar property as one lease.
Special rules.
The lessee adds the inclusion amount to gross income in the next tax year if:
The lease term begins within 9 months before the close of the lessee's tax year,
The lessee does not use the property predominantly in a qualified business use during that portion of the tax year, and
The lease term continues into the lessee's next tax year.
The lessee determines the inclusion amount by taking into account the average of the business/investment use for both tax years and the
applicable percentage for the tax year the lease term begins.
If the lease term is less than one year, the amount included in gross income is the amount that bears the same ratio to the additional inclusion
amount as the number of days in the lease term bears to 365.
Maximum inclusion amount.
The inclusion amount cannot be more than the sum of the deductible amounts of rent allocable to the lessee's tax year in which the amount must be
included in gross income.
What Records Must Be Kept
Listed property:
Recordkeeping
Recordkeeping:
For listed property
You cannot take any depreciation or section 179 deduction for the use of listed property (including passenger automobiles) unless you can prove
business/investment use with adequate records or sufficient evidence to support your own statements.
How long to keep records.
For listed property, records must be kept for as long as any excess depreciation can be recaptured (included in income).
Adequate Records
Listed property:
Recordkeeping
To meet the adequate records requirement, you must maintain an account book, diary, log, statement of expense, trip sheet, or similar record or
other documentary evidence that, together with the receipt, is sufficient to establish each element of an expenditure or use. It is not necessary to
record information in an account book, diary, or similar record if the information is already shown on the receipt. However, your records should back
up your receipts in an orderly manner.
Elements of Expenditure or Use
The records or other documentary evidence must support:
The amount of each separate expenditure, such as the cost of acquiring the item, maintenance and repair costs, capital improvement costs,
lease payments, and any other expenses,
The amount of each business and investment use (based on an appropriate measure, such as mileage for vehicles and time for other listed
property), and the total use of the property for the tax year,
The date of the expenditure or use, and
The business or investment purpose for the expenditure or use.
Written documents of your expenditure or use are generally better evidence than oral statements alone. A written record prepared at or near the
time of the expenditure or use has greater value as proof of the expenditure or use. A daily log is not required. However, some type of record
containing the elements of an expenditure or the business or investment use of listed property made at or near the time and backed up by other
documents is preferable to a statement prepared later.
Timeliness
The elements of an expenditure or use must be recorded at the time you have full knowledge of the elements. An expense account statement made from
an account book, diary, or similar record prepared or maintained at or near the time of the expenditure or use is generally considered a timely record
if in the regular course of business:
The statement is submitted by an employee to the employer, or
The statement is submitted by an independent contractor to the client or customer.
For example, a log maintained on a weekly basis, which accounts for use during the week, will be considered a record made at or near the time of
use.
Business Purpose Supported
An adequate record of business purpose must generally be in the form of a written statement. However, the amount of backup necessary to establish a
business purpose depends on the facts and circumstances of each case. A written explanation of the business purpose will not be required if the
purpose can be determined from the surrounding facts and circumstances. For example, a salesperson visiting customers on an established sales route
will not normally need a written explanation of the business purpose of his or her travel.
Business Use Supported
An adequate record contains enough information on each element of every business or investment use. The amount of detail required to support the
use depends on the facts and circumstances. For example, a taxpayer whose only business use of a truck is to make customer deliveries on an
established route can satisfy the requirement by recording the length of the route, including the total number of miles driven during the tax year and
the date of each trip at or near the time of the trips.
Although an adequate record generally must be written, a record of the business use of listed property, such as a computer or automobile, can be
prepared in a computer memory device using a logging program.
Separate or Combined
Expenditures or Uses
Each use by you is normally considered a separate use. However, repeated uses can be combined as a single item.
Each expenditure is recorded as a separate item and not combined with other expenditures. If you choose, however, amounts spent for the use of
listed property during a tax year, such as for gasoline or automobile repairs, can be combined. If these expenses are combined, you do not need to
support the business purpose of each expense. Instead, you can divide the expenses based on the total business use of the listed property.
Uses which can be considered part of a single use, such as a round trip or uninterrupted business use, can be accounted for by a single record. For
example, use of a truck to make deliveries at several locations which begin and end at the business premises and can include a stop at the business in
between deliveries can be accounted for by a single record of miles driven. Use of a passenger automobile by a salesperson for a business trip away
from home over a period of time can be accounted for by a single record of miles traveled. Minimal personal use (such as a stop for lunch between two
business stops) is not an interruption of business use.
Confidential Information
If any of the information on the elements of an expenditure or use is confidential, it does not need to be in the account book or similar record if
it is recorded at or near the time of the expenditure or use. It must be kept elsewhere and made available as support to the district director on
request.
Substantial Compliance
If you have not fully supported a particular element of an expenditure or use, but have complied with the adequate records requirement for the
expenditure or use to the district director's satisfaction, you can establish this element by any evidence the district director deems adequate.
If you fail to establish that you have substantially complied with the adequate records requirement for an element of an expenditure or use to the
district director's satisfaction, you must establish the element:
By your own oral or written statement containing detailed information as to the element, and
By other evidence sufficient to establish the element.
If the element is the cost or amount, time, place, or date of an expenditure or use, its supporting evidence must be direct, such as oral testimony
by witnesses or a written statement setting forth detailed information about the element or the documentary evidence. If the element is the business
purpose of an expenditure, its supporting evidence can be circumstantial evidence.
Sampling
You can maintain an adequate record for portions of a tax year and use that record to support your business and investment use for the entire tax
year if it can be shown by other evidence that the periods for which an adequate record is maintained are representative of use throughout the year.
Loss of Records
When you establish that failure to produce adequate records is due to loss of the records through circumstances beyond your control, such as
through fire, flood, earthquake, or other casualty, you have the right to support a deduction by reasonable reconstruction of your expenditures and
use.
Reporting Information
on Form 4562
Listed property:
Reporting on Form 4562
If you claim a deduction for any listed property, you must provide the requested information on page 2, Section B of Form 4562. If you claim a
deduction for any vehicle, you must answer certain questions onpage 2 of Form 4562 to provide information about the vehicle use.
Employees.
Employees claiming the standard mileage rate or actual expenses (including depreciation) must use Form 2106 instead of Part V of Form 4562.
Employees claiming the standard mileage rate may be able to use Form 2106–EZ.
Employer who provides vehicles to employees.
An employer who provides vehicles to employees must obtain enough information from those employees to provide the requested information onForm
4562.
An employer who provides more than five vehicles to employees need not include any information on his or her tax return. Instead, the employer must
obtain the information from his or her employees and indicate on his or her return that the information was obtained and is being retained.
You do not need to provide the information requested on page 2 of Form 4562 if, as an employer:
You can satisfy the requirements of a written policy statement for vehicles either not used for personal purposes, or not used for personal
purposes other than commuting, or
You treat all vehicle use by employees as personal use.
See the instructions for Form 4562.
Deductions in Later Years
When listed property is used for business, investment, and personal purposes, no deduction is allowable for its personal use either in the current
year or any later tax year. In later years, you must determine if there is any remaining unadjusted or unrecovered basis before you compute the
depreciation deduction for that tax year. In making this determination, figure the depreciation deductions for earlier tax years as if the listed
property were used 100% for business or investment purposes in those years, beginning with the first tax year in which some or all of the property use
is for business or investment.
For more information about deductions after the recovery period for automobiles, see Publication 917.
Appendix
The following tables are for use in figuring depreciation deductions under the ACRS system.
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