94613081FHow To
Depreciate
Property• Section 179 Deduction
• Special Depreciation
Allowance
• MACRS
• Listed PropertyWhat's New2Important Reminders2Introduction21. Overview of Depreciation3What Property Can Be Depreciated?3What Property Cannot Be Depreciated?5When Does Depreciation Begin and End?7Can You Use MACRS To Depreciate Your Property?7What Is the Basis of Your Depreciable Property?11How Do You Treat Improvements?12Do You Have To File Form 4562?12How Do You Correct Depreciation Deductions?132. Electing the Section 179 Deduction15What Property Qualifies?15What Property Does Not Qualify?16How Much Can You Deduct?17How Do You Elect the Deduction?22When Must You Recapture the Deduction?223. Claiming the Special Depreciation Allowance23What Is Qualified Property?23How Much Can You Deduct?28How Can You Elect Not To Claim an Allowance?29When Must You Recapture an Allowance?294. Figuring Depreciation Under MACRS30Which Depreciation System (GDS or ADS) Applies?30Which Property Class Applies Under GDS?31What Is the Placed-in-Service Date?33What Is the Basis for Depreciation?34Which Recovery Period Applies?34Which Convention Applies?36Which Depreciation Method Applies?37How Is the Depreciation Deduction Figured?38How Do You Use General Asset Accounts?48When Do You Recapture MACRS Depreciation?525. Additional Rules for Listed Property53What Is Listed Property?53Can Employees Claim a Deduction?55What Is the Business-Use Requirement?56Do the Passenger Automobile Limits Apply?60What Records Must Be Kept?63How Is Listed Property Information Reported?656. How To Get Tax Help66Appendix A — MACRS Percentage Table Guide68Appendix B — Table of Class Lives and Recovery Periods94Glossary105Index107What's NewIncreased section 179 deduction dollar limit.
The maximum amount you can elect to deduct for most section 179 property you placed in service in 2005 is $105,000 ($140,000 for qualified
enterprise zone, renewal community, and New York Liberty Zone (Liberty Zone) property). This limit is reduced by the amount by which the cost of the
property placed in service during the tax year exceeds $420,000. See Dollar Limits under How Much Can You Deduct in chapter 2.
Increased section 179 limits for Gulf Opportunity Zone property.
If you placed in service section 179 property that is qualified Gulf Opportunity Zone (GO Zone) property acquired after August 27, 2005, the
$105,000 section 179 deduction dollar limit and the $420,000 threshold used to figure any reduction in the amount for which you can make the section
179 election are increased. See Increased dollar limits under Gulf Opportunity Zone (GO Zone) Property in chapter 2.
Limited applicability of special depreciation allowance.
The additional special depreciation allowance (including the increased limits for passenger automobiles) only applies to certain property placed in
service in 2005. You can claim a special allowance for certain aircraft, certain property with a long production period, and qualified Liberty Zone
property you placed in service in 2005. You can also claim a special allowance for qualified GO Zone property you acquired after August 27, 2005. See
chapter 3, Claiming the Special Depreciation Allowance, later.
Recovery periods for certain natural gas gathering and transmission lines and electric transmission property.
Certain natural gas gathering lines placed in service after April 11, 2005, are treated as 7-year property under MACRS. In addition, certain
electric transmission property and natural gas distribution lines placed in service after April 11, 2005, are treated as 15-year property under MACRS.
See Which Property Class Applies Under GDS and Which Recovery Period Applies in chapter 4.
Depreciation limits on business vehicles.
The total section 179 deduction and depreciation you can deduct for a passenger automobile (that is not an electric vehicle or a truck or van) you
use in your business and first placed in service in 2005 is $2,960. The maximum deduction for an electric vehicle is $8,880. The maximum deduction you
can take for a truck or van you use in your business and first placed in service in 2005 is $3,260. See Maximum Depreciation Deduction in
chapter 5.
Important RemindersPhotographs of missing children.
The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Photographs of missing children
selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the
photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.
Property classification for qualified leasehold improvement and restaurant property.
Qualified leasehold improvement property and qualified restaurant property placed in service after December 31, 2005, will not be treated as
15-year property under MACRS. See Which Property Class Applies Under GDS in chapter 4.
Recovery periods for Indian Reservation property.
The shorter recovery periods for qualified property placed in service on an Indian reservation will not apply to property placed in service after
December 31, 2005. See Indian Reservation Property under Which Recovery Period Applies in chapter 4.
This publication explains how you can recover the cost of business or income-producing property through deductions for depreciation (for example,
the special depreciation allowance and deductions under the Modified Accelerated Cost Recovery System (MACRS)). It also explains how you can elect to
take a section 179 deduction, instead of depreciation deductions, for certain property and the additional rules for listed property.
The depreciation methods discussed in this publication generally do not apply to property placed in service before 1987. If you want information
about depreciating such property, see Publication 534.
Definitions.
Many of the terms used in this publication are defined in the Glossary near the end of the publication. Glossary terms used in each
discussion under the major headings are listed before the beginning of each discussion throughout the publication.
Do you need a different publication?
The following table shows where you can get more detailed information when depreciating certain types of property.
For information
on depreciating:See Publication:A car463, Travel, Entertainment, Gift, and Car ExpensesResidential rental property527, Residential Rental PropertyOffice space in your home587, Business Use of Your Home (Including Use by Daycare Providers)Farm property225, Farmer's Tax Guide
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address shown under How To Get Tax Help in chapter 6.
Overview of Depreciation
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.
Publication534 Depreciating Property Placed in Service Before 1987535 Business Expenses 538 Accounting Periods and Methods 551 Basis of Assets Form (and Instructions)Profit or Loss From BusinessNet Profit From BusinessEmployee Business Expenses Unreimbursed Employee Business Expenses Application for Change in Accounting MethodDepreciation and Amortization
See chapter 6 for information about getting publications and forms.
What Property Can Be Depreciated?Property:Depreciable
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 OwnDepreciation:Property owned
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 to purchase 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.Property:Leased
You can depreciate leased property only if you retain the incidents of ownership in the property (explained below). 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.Ownership, incidents of
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.Life tenantTerm interests
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.
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 in which you have a proprietary lease or right of
tenancy. 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, including any shares held by the corporation.
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 outstanding shares, 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. You must also reduce your depreciation deduction if only a portion of the property is used in a business
or for the production of income.
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 ( 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 ActivityDepreciation:Property used in business
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.Business use of property, partialInvestment use of property, partial
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.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.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 treat certain property held in your business as depreciable property rather than as inventory.
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.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 LifeDepreciation:Determinable useful lifeDeterminable useful lifeUseful 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 YearDepreciation: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?
Amortization
Basis
Goodwill
Intangible property
Remainder interest
Term interest
Certain property cannot be depreciated. This includes the following.
LandLand:Not depreciable
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.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 PropertyDepreciation: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.)
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.
FranchiseSection 197 intangibles
Certain agreements not to compete.Agreement not to competeSection 197 intangibles
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.
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.
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.Term interestProperty:Term interest
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. A term interest in property means a life interest in property, an interest in property for a
term of years, or an income interest in a trust.
Related persons.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.Basis:Term interest
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?
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 ServicePlaced in service:Rule
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 PropertyIdle propertyProperty:Idle
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
(not in use). 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 ServiceProperty: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?
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 1987Placed 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.Property:PersonalPersonal 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.Property:RealReal 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.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.
A tax-exempt educational or charitable organization 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.Stock, constructive ownership of
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 PropertyIntangible property:Depreciation methodStraight line methodStraight line method
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 that is not a section 197 intangible. 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 to get his deduction of $225 for the first year. Next year,
Frank can deduct $300 for the full year.
Patents and copyrights.PatentSection 197 intangiblesCopyrightSection 197 intangibles
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.
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.Straight line method:Created intangibles
You can amortize certain intangibles created after December 30, 2003, over a 15-year period using the straight line method and no salvage value,
even though they have a limited useful life that cannot be estimated with reasonable accuracy. 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 MethodIntangible property:Depreciation methodIncome forecast methodIncome 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.FilmsVideo tapeSound recording
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.
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 10th 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 currently 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 MACRSElection:Exclusion 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?
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 BasisCost basisBasis:Cost
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.
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.Settlement fees
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 BasisBasis:Other than cost
Other basis usually 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.Basis:Change in 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).
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 MACRS depreciation deduction and special depreciation allowance
for 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.
There are also special rules for determining the basis of MACRS property involved in a like-kind exchange or involuntary conversion when the
property is contained in a general asset account. See How Do You Use General Aset Accounts in chapter 4.
Adjusted BasisAdjusted 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.
Basis adjustment for depreciation allowed or allowable.Basis:AdjustmentsDepreciation allowedDepreciation 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?ImprovementsProperty:Improvements
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.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.Rented property, improvements
You can depreciate permanent improvements you make to business property you rent from someone else.
Do You Have To File
Form 4562?
Amortization
Listed property
Placed in service
Standard mileage rate
You must complete and attach Form 4562 to your tax return for the current tax year 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 in chapter
5.
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 if the current year is the first year of the amortization period.
Depreciation or amortization 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.Employee:How to claim depreciation
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.
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, next. If you are not allowed to make the correction on an amended return, you may be able to change your
accounting method to claim the correct amount of depreciation. See Changing Your Accounting Method, later.
Filing an Amended ReturnAmended 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.
Adoption of accounting method defined.
Generally, you adopt a method of accounting for depreciation by using a permissible method of determining depreciation when you file your first tax
return, or by using the same impermissible method of determining depreciation in two or more consecutively filed tax returns. For an exception to this
2-year rule, see Revenue Procedure 2002-9 on page 327 of Internal Revenue Bulletin 2002-3, available at
www.irs.gov/pub/irs-irbs/irb02-03.pdf,
as modified by Revenue Procedure 2004-11 on page 311 of Internal Revenue Bulletin 2004-3, available at
www.irs.gov/pub/irs-irbs/irb04-03.pdf.
When to file.
If an amended return is allowed, you must file it by the later of the following.
3 years from the date you filed your original return for the year in which you did not deduct the correct amount. A return filed before an
unextended due date is considered filed on that due date.
2 years from the time you paid your tax for that year.
Changing Your Accounting MethodChanging accounting method
Generally, you must get IRS approval to change your method of accounting. You generally must file Form 3115, Application for Change in Accounting
Method, to request a change in your method of accounting for depreciation.
The following are examples of a change in method of accounting for depreciation.
A change in the treatment of an asset from nondepreciable to depreciable or vice versa.
A change in the depreciation method, period of recovery, or convention of a depreciable asset.
A change from not claiming to claiming the special depreciation allowance if you did not make the election to not claim any special
allowance.
A change from claiming a 50% special depreciation allowance to claiming a 30% special depreciation allowance for qualified property
(including property that is included in a class of property for which you elected a 30% special allowance instead of a 50% special
allowance).
Changes in depreciation that are not a change in method of accounting (and may only be made on an amended return) include the following.
An adjustment in the useful life of a depreciable asset for which depreciation is determined under section 167.
A change in use of an asset in the hands of the same taxpayer.
Making a late depreciation election or revoking a timely valid depreciation election (including the election not to deduct the special
depreciation allowance). If you elected not to claim any special allowance, a change from not claiming to claiming the special allowance is a
revocation of the election and is not an accounting method change. Also, if the property is qualified property, a change from not claiming to claiming
any special allowance is a late election and is not an accounting method change.
Any change in the placed-in-service date of a depreciable asset.
See section 1.446-1T(e)(2)(ii)(d) of the regulations for more information and examples.
IRS approval.
In some instances, you may be able to get approval from the IRS to change your method of accounting for depreciation under the automatic change
request procedures generally covered in Revenue Procedure 2002-9. If you do not qualify to use the automatic procedures to get approval, you must use
the advance consent request procedures generally covered in Revenue Procedure 97-27, 1997-1 C.B. 680. Also see the Instructions for Form 3115 for more
information on getting approval, including lists of scope limitations and automatic accounting method changes.
Additional guidance.
For additional guidance and special procedures for changing your accounting method, automatic change procedures, amending your return, and filing
Form 3115, see Revenue Procedure 2004-11, Revenue Procedure 2005-43 on page 107 of Internal Revenue Bulletin 2005-29, available at
www.irs.gov/pub/irs-irbs/irb05-29.pdf,
and Revenue Procedure 2006-12 on page 310 of Internal Revenue Bulletin 2006-3, available at
www.irs.gov/pub/irs-irbs/irb06-03.pdf.
<ROM>Table 1-1.</ROM>
<IMARK>Purpose of Form 4562This table describes the purpose of the various parts of Form 4562. For more information, see Form 4562 and its
instructions.PartPurposeI• Electing the section 179 deduction
• Figuring the maximum section 179 deduction for the current year
• Figuring any section 179 deduction carryover to the next yearII• Reporting the special depreciation allowance for property (other than listed property)
placed in service during the tax year
• Reporting depreciation deductions on property being depreciated under any method other than Modified Accelerated Cost Recovery System
(MACRS)III• Reporting MACRS depreciation deductions for property placed in service before this year
• Reporting MACRS depreciation deductions for property (other than listed property) placed in service during the current yearIV• Summarizing other partsV• Reporting the special depreciation allowance for automobiles and other listed property
• Reporting MACRS depreciation on automobiles and other listed property
• Reporting the section 179 cost elected for automobiles and other listed property
• Reporting information on the use of automobiles and other transportation vehiclesVI• Reporting amortization deductions
Section 481(a) adjustment.
If you file Form 3115 and change from an impermissible method to a permissible method of accounting for depreciation, you can make a section 481(a)
adjustment for any unclaimed or excess amount of allowable depreciation. The adjustment is the difference between the total depreciation actually
deducted for the property and the total amount allowable prior to the year of change. If no depreciation was deducted, the adjustment is the total
depreciation allowable prior to the year of change. A negative section 481(a) adjustment results in a decrease in taxable income. It is taken into
account in the year of change and is reported on your business tax returns as other expenses. A positive section 481(a) adjustment results in
an increase in taxable income. It is generally taken into account over 4 tax years and is reported on your business tax returns as other
income. However, you can elect to use a one-year adjustment period and report the adjustment in the year of change if the total adjustment is less
than $25,000. Make the election by completing the appropriate line on Form 3115.
If you file a Form 3115 and change from one permissible method to another permissible method, the section 481(a) adjustment is zero.
Electing the Section 179 Deduction
You can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property
in service. This is the section 179 deduction. You can elect the section 179 deduction instead of recovering the cost by taking depreciation
deductions.
Estates and trusts cannot elect the section 179 deduction.
This chapter explains what property does and does not qualify for the section 179 deduction, what limits apply to the deduction (including special
rules for partnerships and corporations), and how to elect it. It also explains when and how to recapture the deduction.
Publication537 Installment Sales 544 Sales and Other Dispositions of Assets 954Tax Incentives for Distressed CommunitiesForm (and Instructions)Depreciation and Amortization Sales of Business Property
See chapter 6 for information about getting publications and forms.
What Property Qualifies?
Adjusted basis
Basis
Class life
Structural components
Tangible property
To qualify for the section 179 deduction, your property must meet all the following requirements.
It must be eligible property.
It must be acquired for business use.
It must have been acquired by purchase.
It must not be property described later under What Property Does Not Qualify.
The following discussions provide information about these requirements and exceptions.
To qualify for the section 179 deduction, your property must be one of the following types of depreciable property.
Tangible personal property.
Other tangible property (except buildings and their structural components) used as:
An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or
sewage disposal services,
A research facility used in connection with any of the activities in (a) above, or
A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities.
Single purpose agricultural (livestock) or horticultural structures. (See chapter 7 of Publication 225 for definitions and information
regarding the use requirements that apply to these structures.)
Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product
of petroleum.
Off-the-shelf computer software.
Tangible personal property.Property:Tangible personalTangible personal property
Tangible personal property is any tangible property that is not real property. It includes the following property.
Machinery and equipment.
Property contained in or attached to a building (other than structural components), such as refrigerators, grocery store counters, office
equipment, printing presses, testing equipment, and signs.
Gasoline storage tanks and pumps at retail service stations.
Livestock, including horses, cattle, hogs, sheep, goats, and mink and other furbearing animals.
The treatment of property as tangible personal property for the section 179 deduction is not controlled by its treatment under local law. For
example, property may not be tangible personal property for the deduction even if treated so under local law, and some property (such as fixtures) may
be tangible personal property for the deduction even if treated as real property under local law.
Off-the-shelf computer software placed in service during the tax year is qualifying property for purposes of the section 179 deduction. This is
computer software that is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially
modified. It includes any program designed to cause a computer to perform a desired function. However, a database or similar item is not considered
computer software unless it is in the public domain and is incidental to the operation of otherwise qualifying software.
Property Acquired for Business Use
To qualify for the section 179 deduction, your property must have been acquired for use in your trade or business. Property you acquire only for
the production of income, such as investment property, rental property (if renting property is not your trade or business), and property that produces
royalties, does not qualify.
Partial business use.Section 179 deduction:Business use requiredPartial business useSection 179 deduction:Limits:Partial business use
When you use property for both business and nonbusiness purposes, you can elect the section 179 deduction only if you use the property more than
50% for business in the year you place it in service. If you use the property more than 50% for business, multiply the cost of the property by the
percentage of business use. Use the resulting business cost to figure your section 179 deduction.
Example.
May Oak bought and placed in service an item of section 179 property costing $11,000. She used the property 80% for her business and 20% for
personal purposes. The business part of the cost of the property is $8,800 (80% × $11,000).
Property Acquired by PurchaseSection 179 deduction:Purchase requiredInheritanceBasis, other than costGiftBasis, other than cost
To qualify for the section 179 deduction, your property must have been acquired by purchase. For example, property acquired by gift or inheritance
does not qualify.
Property is not considered acquired by purchase in the following situations.
It is acquired by one member of a controlled group from another member of the same group.
Its basis is determined either—
In whole or in part by its adjusted basis in the hands of the person from whom it was acquired, or
Under the stepped-up basis rules for property acquired from a decedent.
It is acquired from a related person.
Related persons.Related persons
Related persons are described under Related persons in chapter 1 in the discussion on property owned or used in 1986 under Can You
Use MACRS To Depreciate Your Property. However, to determine whether property qualifies for the section 179 deduction, treat as an individual's
family only his or her spouse, ancestors, and lineal descendants and substitute "50%" for "10%" each place it appears.
Example.
Ken Larch is a tailor. He bought two industrial sewing machines from his father. He placed both machines in service in the same year he bought
them. They do not qualify as section 179 property because Ken and his father are related persons. He cannot claim a section 179 deduction for the cost
of these machines.
What Property Does Not Qualify?
Basis
Class life
Certain property does not qualify for the section 179 deduction. This includes the following.
Land and Improvements
Land and land improvements, such as buildings and other permanent structures and their components, are real property, not personal property and do
not qualify as section 179 property. Land improvements include swimming pools, paved parking areas, wharves, docks, bridges, and fences.
Even if the requirements explained earlier under What Property Qualifies are met, you cannot elect the section 179 deduction for the
following property.
Certain property you lease to others (if you are a noncorporate lessor).
Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging.
Air conditioning or heating units.
Property used predominantly outside the United States (except property described in section 168(g)(4) of the Internal Revenue
Code).
Property used by certain tax-exempt organizations (except property used in connection with the production of income subject to the tax on
unrelated trade or business income).
Property used by governmental units or foreign persons or entities (except property used under a lease with a term of less than 6
months).
Leased property.Leased propertyProperty:Leased
Generally, you cannot claim a section 179 deduction based on the cost of property you lease to someone else. (This rule does not apply to
corporations.) However, you can claim a section 179 deduction for the cost of the following property.
Property you manufacture or produce and lease to others.
Property you purchase and lease to others if both the following tests are met.
The term of the lease (including options to renew) is less than 50% of the property's class life.
For the first 12 months after the property is transferred to the lessee, the total business deductions you are allowed on the property
(other than rents and reimbursed amounts) are more than 15% of the rental income from the property.
Property used for lodging.Lodging
Generally, you cannot claim a section 179 deduction for property used predominantly to furnish lodging or in connection with the furnishing of
lodging. However, this does not apply to the following types of property.
Nonlodging commercial facilities that are available to those not using the lodging facilities on the same basis as they are available to
those using the lodging facilities.
Property used by a hotel or motel in connection with the trade or business of furnishing lodging where the predominant portion of the
accommodations is used by transients.
Any certified historic structure to the extent its basis is due to qualified rehabilitation expenditures.
Any energy property.
Energy property.Energy property
Energy property is property that meets the following requirements.
It is one of the following types of property.
Equipment that uses solar energy to generate electricity, to heat or cool a structure, to provide hot water for use in a structure, or to
provide solar process heat.
Equipment acquired after December 31, 2005, that uses solar energy to illuminate the inside of a structure using fiberoptic distributed
sunlight.
Equipment used to produce, distribute, or use energy derived from a geothermal deposit. For electricity generated by geothermal power, this
includes equipment up to (but not including) the electrical transmission stage.
Qualified fuel cell property or qualified microturbine property acquired after December 31, 2005.
The construction, reconstruction, or erection of the property must be completed by you.
For property you acquire, the original use of the property must begin with you.
The property must meet the performance and quality standards, if any, prescribed by Income Tax Regulations in effect at the time you get the
property.
Energy property does not include any property that is public utility property as defined by section 46(f)(5) of the Internal Revenue Code (as in
effect on November 4, 1990).
How Much Can You Deduct?Deduction limit:Section 179Limit on deduction:Section 179
Adjusted basis
Basis
Placed in service
Your section 179 deduction is generally the cost of the qualifying property. However, the total amount you can elect to deduct under section 179 is
subject to a dollar limit and a business income limit. These limits apply to each taxpayer, not to each business. However, see Married
Individuals under Dollar Limits, later. Also, see the special rules for applying the limits for partnerships and S corporations later
under Partnerships and Partners and under S Corporations. For a passenger automobile placed in service in 2005, the total
section 179 and depreciation deduction is limited. See Do the Passenger Automobile Limits Apply in chapter 5.
If you deduct only part of the cost of qualifying property as a section 179 deduction, you can generally depreciate the cost you do not deduct. See
Claiming the Special Depreciation Allowance and Figuring Depreciation Under MACRS, later.
Trade-in of other property.Trade-in of property
If you buy qualifying property with cash and a trade-in, its cost for purposes of the section 179 deduction includes only the cash you paid.
Example.
Silver Leaf, a retail bakery, traded two ovens having a total adjusted basis of $680 for a new oven costing $1,320. They received an $800 trade-in
allowance for the old ovens and paid $520 in cash for the new oven. The bakery also traded a used van with an adjusted basis of $4,500 for a new van
costing $9,000. They received a $4,800 trade-in allowance on the used van and paid $4,200 in cash for the new van.
Only the portion of the new property's basis paid by cash qualifies for the section 179 deduction. Therefore, Silver Leaf's qualifying costs for
the section 179 deduction are $4,720 ($520 + $4,200).
Dollar LimitsSection 179 deduction:Limits:Dollar
The total amount you can elect to deduct under section 179 for most property placed in service in 2005 generally cannot be more than $105,000
($108,000 in 2006). If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179
deduction among the items in any way, as long as the total deduction is not more than $105,000. You do not have to claim the full $105,000.
The amount you can elect to deduct is not affected if you place qualifying property in service in a short tax year or if you place qualifying
property in service for only a part of a 12-month tax year.
After you apply the dollar limit to determine a tentative deduction, you must apply the business income limit (described later) to determine your
actual section 179 deduction.
Example.
In 2005, you bought and placed in service a $108,000 tractor and a $2,000 circular saw for your business. You elect to deduct $103,000 for the
tractor and the entire $2,000 for the saw, a total of $105,000. This is the maximum amount you can deduct. Your $2,000 deduction for the saw
completely recovered its cost. Your basis for depreciation is zero. The basis for depreciation of your tractor is $5,000. You figure this by
subtracting your $103,000 section 179 deduction for the tractor from the $108,000 cost of the tractor.
Reduced dollar limit for cost exceeding $420,000.
If the cost of your qualifying section 179 property placed in service in a year is more than $420,000 ($430,000 in 2006), you generally must reduce
the dollar limit (but not below zero) by the amount of cost over $420,000. If the cost of your section 179 property placed in service during 2005 is
$525,000 ($535,000 in 2006) or more, you cannot take a section 179 deduction.
Example.
In 2005, Jane Ash placed in service machinery costing $495,000. This cost is $75,000 more than $420,000, so she must reduce her dollar limit to
$30,000 ($105,000 − $75,000).
Situations affecting dollar limit.
Under certain circumstances, the general dollar limits on the section 179 deduction may be reduced or increased or there may be an additional
dollar limit. The general dollar limit is affected by any of the following situations.
You placed qualified property in service in the New York Liberty Zone.
Your business is an enterprise zone business or a renewal community business.
You placed qualified property in service in the Gulf Opportunity Zone.
You placed in service a sport utility vehicle.
Liberty Zone PropertySection 179 deduction:Limits:Liberty Zone property
An increased section 179 deduction is available for qualified Liberty Zone property (defined next) you place in service in the New York Liberty
Zone (Liberty Zone). The Liberty Zone is the area located on or south of Canal Street, East Broadway (east of its intersection with Canal Street), or
Grand Street (east of its intersection with East Broadway) in the Borough of Manhattan in the City of New York, New York.
Qualified Liberty Zone property.
To qualify for this increased section 179 deduction, you must acquire section 179 property that is either:
Qualified Liberty Zone property, or
Property that would be qualified Liberty Zone property except for the fact that it is eligible for the special depreciation
allowance.
See Qualified Liberty Zone Property in chapter 3 for an explanation of qualified Liberty Zone property. See What Is Qualified
Property in chapter 3 for an explanation of property eligible for the special depreciation allowance.
You take into account only 50% (instead of 100%) of the cost of qualified Liberty Zone property placed in service in a year when figuring the
reduced dollar limit for costs exceeding $420,000 (explained earlier).
Increased dollar limit.
The dollar limit on the section 179 deduction is increased by the smaller of:
$35,000, or
The cost of section 179 property that is qualified Liberty Zone property placed in service during the year (including such property placed
in service by your spouse, even if you are filing a separate return).
Enterprise Zone and Renewal Community BusinessesSection 179 deduction:Limits:Enterprise zone business
An increased section 179 deduction is available to enterprise zone businesses and renewal community businesses for qualified zone property or
qualified renewal property placed in service in an empowerment zone or renewal community. For definitions of enterprise zone business,renewal community business,qualified zone property, and qualified renewal property, see Publication 954, Tax Incentives for
Distressed Communities.
Increased dollar limit.
The dollar limit on the section 179 deduction is increased if your business qualifies as an enterprise zone business or a renewal community
business. The increase is the smaller of:
$35,000, or
The cost of section 179 property that is also qualified zone property or qualified renewal property (including such property placed in
service by your spouse, even if you are filing a separate return).
Reduced dollar limit.
You take into account only 50% (instead of 100%) of the cost of qualified zone property placed in service in a year when figuring the reduced
dollar limit for costs exceeding $420,000 (explained earlier).
For purposes of this increased section 179 deduction, do not treat qualified section 179 Gulf Opportunity Zone property (defined next under
Gulf Opportunity (GO) Zone Property) as qualified zone property (or qualified renewal property) unless you elect not to treat the property
as section 179 GO Zone property.
Gulf Opportunity Zone (GO Zone) PropertySection 179 deduction:Limits:Gulf Opportunity Zone property
An increased section 179 deduction is available for qualified section 179 GO Zone property (defined next) you place in service in the GO Zone. The
GO Zone is that portion of the Hurricane Katrina disaster area that is determined by the Federal Emergency Management Agency (FEMA) to warrant
individual only or both individual and public assistance from the federal government. See Publication 4492, Information for Taxpayers Affected by
Hurricanes Katrina, Rita, and Wilma, for a list of the areas affected.
Qualified section 179 GO Zone property.
Qualified section 179 GO Zone property is section 179 property (described earlier) acquired after August 27, 2005, that is also qualified GO Zone
property. See Qualified Gulf Opportunity Zone Property in chapter 3 for a description of qualified GO Zone property.
Increased dollar limits.
The limit on the section 179 deduction is increased by the smaller of:
$100,000, or
The cost of qualified section 179 GO Zone property placed in service during the year (including such property placed in service by your
spouse, even if you are filing a separate return).
The amount for which you can make the election is reduced if the cost of all section 179 property placed in service during the year exceeds
$420,000 increased by the smaller of:
$600,000, or
The cost of qualified section 179 GO Zone property placed in service during the year.
.
Sport Utility and Certain Other Vehicles
You cannot elect to expense more than $25,000 of the cost of any heavy sport utility vehicle (SUV) and certain other vehicles placed in service in
2005. This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, or highways, that is rated
at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight. However, the $25,000 limit does not apply to any
vehicle:
Designed to seat more than nine passengers behind the driver's seat,
Equipped with a cargo area (either open or enclosed by a cap) of at least six feet in interior length that is not readily accessible from
the passenger compartment, or
That has an integral enclosure fully enclosing the driver compartment and load carrying device, does not have seating rearward of the
driver's seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield.
Married IndividualsSection 179 deduction:Married filing separate returns
If you are married, how you figure your section 179 deduction depends on whether you file jointly or separately. If you file a joint return, you
and your spouse are treated as one taxpayer in determining any reduction to the dollar limit, regardless of which of you purchased the property or
placed it in service. If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit, including the reduction for
costs over $420,000. You must allocate the dollar limit (after any reduction) between you equally, unless you both elect a different allocation. If
the percentages elected by each of you do not total 100%, 50% will be allocated to each of you.
Example.
Jack Elm is married. He and his wife file separate returns. Jack bought and placed in service $420,000 of qualified farm machinery in 2005. His
wife has her own business, and she bought and placed in service $10,000 of qualified business equipment. Their combined dollar limit is $95,000. This
is because they must figure the limit as if they were one taxpayer. They reduce the $105,000 dollar limit by the $10,000 excess of their costs over
$420,000.
They elect to allocate the $95,000 dollar limit as follows.
$90,250 ($95,000 x 95%) to Mr. Elm's machinery.
$4,750 ($95,000 x 5%) to Mrs. Elm's equipment.
If they did not make an election to allocate their costs in this way, they would have to allocate $47,500 ($95,000 × 50%) to each of
them.
Joint return after filing separate returns.
If you and your spouse elect to amend your separate returns by filing a joint return after the due date for filing your return, the dollar limit on
the joint return is the lesser of the following amounts.
The dollar limit (after reduction for any cost of section 179 property over $420,000).
The total cost of section 179 property you and your spouse elected to expense on your separate returns.
Example.
The facts are the same as in the previous example except that Jack elected to deduct $30,000 of the cost of section 179 property on his separate
return and his wife elected to deduct $2,000. After the due date of their returns, they file a joint return. Their dollar limit for the section 179
deduction is $32,000. This is the lesser of the following amounts.
$95,000—The dollar limit less the cost of section 179 property over $420,000.
$32,000—The total they elected to expense on their separate returns.
Business Income LimitSection 179 deduction:Limits:Business (taxable) income
The total cost you can deduct each year after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or
business during the year. Generally, you are considered to actively conduct a trade or business if you meaningfully participate in the management or
operations of the trade or business.
Any cost not deductible in one year under section 179 because of this limit can be carried to the next year. See Carryover of disallowed
deduction, later.
Taxable income.
In general, figure taxable income for this purpose by totaling the net income and losses from all trades and businesses you actively conducted
during the year. Net income or loss from a trade or business includes the following items.
Section 1231 gains (or losses).
Interest from working capital of your trade or business.
Wages, salaries, tips, or other pay earned as an employee.
For information about section 1231 gains and losses, see chapter 3 in Publication 544.
In addition, figure taxable income without regard to any of the following.
The section 179 deduction.
The self-employment tax deduction.
Any net operating loss carryback or carryforward.
Any unreimbursed employee business expenses.
Two different taxable income limits.
In addition to the business income limit for your section 179 deduction, you may have a taxable income limit for some other deduction. You may have
to figure the limit for this other deduction taking into account the section 179 deduction. If so, complete the following steps.
StepAction1Figure taxable income without the section 179 deduction or the other deduction.2Figure a hypothetical section 179 deduction using the taxable income figured in Step 1.3Subtract the hypothetical section 179 deduction figured in Step 2 from the taxable income figured in Step 1.4Figure a hypothetical amount for the other deduction using the amount figured in Step 3 as taxable income.5Subtract the hypothetical other deduction figured in Step 4 from the taxable income figured in Step 1.6Figure your actual section 179 deduction using the taxable income figured in Step 5.7Subtract your actual section 179 deduction figured in Step 6 from the taxable income figured in Step 1.8Figure your actual other deduction using the taxable income figured in Step 7.
Example.
On February 1, 2005, the XYZ corporation purchased and placed in service qualifying section 179 property that cost $105,000. It elects to expense
the entire $105,000 cost under section 179. In June, the corporation gave a charitable contribution of $10,000. A corporation's limit on charitable
contributions is figured after subtracting any section 179 deduction. The business income limit for the section 179 deduction is figured after
subtracting any allowable charitable contributions. XYZ's taxable income figured without the section 179 deduction or the deduction for charitable
contributions is $125,000. XYZ figures its section 179 deduction and its deduction for charitable contributions as follows.
Step 1– Taxable income figured without either deduction is $125,000.
Step 2– Using $125,000 as taxable income, XYZ's hypothetical section 179 deduction is $105,000.
Step 3– $20,000 ($125,000 − $105,000).
Step 4– Using $20,000 (from Step 3) as taxable income, XYZ's hypothetical charitable contribution (limited to 10% of
taxable income) is $2,000.
Step 5– $123,000 ($125,000 − $2,000).
Step 6– Using $123,000 (from Step 5) as taxable income, XYZ figures the actual section 179 deduction. Because the taxable
income is at least $105,000, XYZ can take a $105,000 section 179 deduction.
Step 7– $20,000 ($125,000 − $105,000).
Step 8– Using $20,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable
income) is $2,000.
Carryover of disallowed deduction.Section 179 deduction:CarryoverCarryover of section 179 deduction
You can carry over for an unlimited number of years the cost of any section 179 property you elected to expense but were unable to because of the
business income limit. This disallowed deduction amount is shown on line 13 of Form 4562. You use the amount you carry over to determine your section
179 deduction in the next year. Enter that amount on line 10 of your Form 4562 for the next year.
If you place more than one property in service in a year, you can select the properties for which all or a part of the costs will be carried
forward. Your selections must be shown in your books and records. For this purpose, treat section 179 costs allocated from a partnership or an S
corporation as one item of section 179 property. If you do not make a selection, the total carryover will be allocated equally among the properties
you elected to expense for the year.
If costs from more than one year are carried forward to a subsequent year in which only part of the total carryover can be deducted, you must
deduct the costs being carried forward from the earliest year first.
If there is a sale or other disposition of your property (including a transfer at death) before you can use the full amount of any outstanding
carryover of your disallowed section 179 deduction, neither you nor the new owner can deduct any of the unused amount. Instead, you must add it back
to the property's basis.
Partnerships and PartnersSection 179 deduction:Partnership rules
The section 179 deduction limits apply both to the partnership and to each partner. The partnership determines its section 179 deduction subject to
the limits. It then allocates the deduction among its partners.
Each partner adds the amount allocated from partnerships (shown on Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc.)
to his or her nonpartnership section 179 costs and then applies the dollar limit to this total. To determine any reduction in the dollar limit for
costs over $420,000, the partner does not include any of the cost of section 179 property placed in service by the partnership. After the dollar limit
(reduced for any nonpartnership section 179 costs over $420,000) is applied, any remaining cost of the partnership and nonpartnership section 179
property is subject to the business income limit.
Partnership's taxable income.
For purposes of the business income limit, figure the partnership's taxable income by adding together the net income and losses from all trades or
businesses actively conducted by the partnership during the year. See Publication 541, Partnerships, for information on how to figure partnership net
income (or loss). However, figure taxable income without regard to credits, tax-exempt income, the section 179 deduction, and guaranteed payments
under section 707(c) of the Internal Revenue Code.
Partner's share of partnership's taxable income.
For purposes of the business income limit, the taxable income of a partner engaged in the active conduct of one or more of a partnership's trades
or businesses includes his or her allocable share of taxable income derived from the partnership's active conduct of any trade or business.
Example.
In 2005, Beech Partnership placed in service section 179 property with a total cost of $445,000. The partnership must reduce its dollar limit by
$25,000 ($445,000 − $420,000). Its maximum section 179 deduction is $80,000 ($105,000 − $25,000), and it elects to expense that amount.
The partnership's taxable income from the active conduct of all its trades or businesses for the year was $100,000, so it can deduct the full $80,000.
It allocates $40,000 of its section 179 deduction and $50,000 of its taxable income to Dean, one of its partners.
In addition to being a partner in Beech Partnership, Dean is also a partner in the Cedar Partnership, which allocated to him a $30,000 section 179
deduction and $35,000 of its taxable income from the active conduct of its business. He also conducts a business as a sole proprietor and, in 2005,
placed in service in that business qualifying section 179 property costing $55,000. He had a net loss of $5,000 from that business for the year.
Dean does not have to include section 179 partnership costs to figure any reduction in his dollar limit, so his total section 179 costs for the
year are not more than $420,000 and his dollar limit is not reduced. His maximum section 179 deduction is $105,000. He elects to expense all of the
$70,000 in section 179 deductions allocated from the partnerships ($40,000 from Beech Partnership plus $30,000 from Cedar Partnership), plus $35,000
of his sole proprietorship's section 179 costs, and notes that information in his books and records. However, his deduction is limited to his business
taxable income of $80,000 ($50,000 from Beech Partnership, plus $35,000 from Cedar Partnership minus $5,000 loss from his sole proprietorship). He
carries over $25,000 ($105,000 − $80,000) of the elected section 179 costs to 2006. He allocates the carryover amount to the cost of section 179
property placed in service in his sole proprietorship, and notes that allocation in his books and records.
Different tax years.
For purposes of the business income limit, if the partner's tax year and that of the partnership differ, the partner's share of the partnership's
taxable income for a tax year is generally the partner's distributive share for the partnership tax year that ends with or within the partner's tax
year.
Example.
John and James Oak are equal partners in Oak Company. Oak Company uses a tax year ending January 31. John and James both use a tax year ending
December 31. For its tax year ending January 31, 2005, Oak Company's taxable income from the active conduct of its business is $80,000, of which
$70,000 was earned during 2004. John and James each include $40,000 (each partner's entire share) of partnership taxable income in computing their
business income limit for the 2005 tax year.
Adjustment of partner's basis in partnership.Basis:Adjustments
A partner must reduce the basis of his or her partnership interest by the total amount of section 179 expenses allocated from the partnership even
if the partner cannot currently deduct the total amount. If the partner disposes of his or her partnership interest, the partner's basis for
determining gain or loss is increased by any outstanding carryover of disallowed section 179 expenses allocated from the partnership.
Adjustment of partnership's basis in section 179 property.
The basis of a partnership's section 179 property must be reduced by the section 179 deduction elected by the partnership. This reduction of basis
must be made even if a partner cannot deduct all or part of the section 179 deduction allocated to that partner by the partnership because of the
limits.
S CorporationsSection 179 deduction:S corporation rules
Generally, the rules that apply to a partnership and its partners also apply to an S corporation and its shareholders. The deduction limits apply
to an S corporation and to each shareholder. The S corporation allocates its deduction to the shareholders who then take their section 179 deduction
subject to the limits.
Figuring taxable income for an S corporation.
To figure taxable income (or loss) from the active conduct by an S corporation of any trade or business, you total the net income and losses from
all trades or businesses actively conducted by the S corporation during the year.
To figure the net income (or loss) from a trade or business actively conducted by an S corporation, you take into account the items from that trade
or business that are passed through to the shareholders and used in determining each shareholder's tax liability. However, you do not take into
account any credits, tax-exempt income, the section 179 deduction, and deductions for compensation paid to shareholder-employees. For purposes of
determining the total amount of S corporation items, treat deductions and losses as negative income. In figuring the taxable income of an S
corporation, disregard any limits on the amount of an S corporation item that must be taken into account when figuring a shareholder's taxable income.
Other Corporations
A corporation's taxable income from its active conduct of any trade or business is its taxable income figured with the following changes.
It is figured before deducting the section 179 deduction, any net operating loss deduction, and special deductions (as reported on the
corporation's income tax return).
It is adjusted for items of income or deduction included in the amount figured in 1, above, not derived from a trade or business actively
conducted by the corporation during the tax year.
