7.   Depreciation, Depletion, and Amortization

What's New for 2014

Decreased section 179 expense deduction dollar limits. The maximum amount you can elect to deduct for most section 179 property you placed in service in 2014 is $25,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $200,000. See Dollar Limits under Section 179 Expense Deduction , later.

Introduction

If you buy or make improvements to farm property such as machinery, equipment, livestock, or a structure with a useful life of more than a year, you generally cannot deduct its entire cost in one year. Instead, you must spread the cost over the time you use the property and deduct part of it each year. For most types of property, this is called depreciation.

This chapter gives information on depreciation methods that generally apply to property placed in service after 1986. For information on depreciating pre-1987 property, see Publication 534, Depreciating Property Placed in Service Before 1987.

Topics - This chapter discusses:

  • Overview of depreciation

  • Section 179 expense deduction

  • Special depreciation allowance

  • Modified Accelerated Cost Recovery 
    System (MACRS)

  • Listed property

  • Basic information on cost depletion (including timber depletion) and percentage depletion

  • Amortization of the costs of going into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles

Useful Items - You may want to see:

Publication

  • 463 Travel, Entertainment, Gift, and Car Expenses

  • 534 Depreciating Property Placed in Service Before 1987

  • 535 Business Expenses

  • 544 Sales and Other Dispositions of Assets

  • 551 Basis of Assets

  • 946 How To Depreciate Property

Form (and Instructions)

  • T (Timber), Forest Activities Schedule

  • 3115 Application for Change in Accounting Method

  • 4562 Depreciation and Amortization

  • 4797 Sales of Business Property

See chapter 16 for information about getting publications and forms.

It is important to keep good records for property you depreciate. Do not file these records with your return. Instead, you should keep them as part of the permanent records of the depreciated property. They will help you verify the accuracy of the depreciation of assets placed in service in the current and previous tax years. For general information on recordkeeping, see Publication 583, Starting a Business and Keeping Records. For specific information on keeping records for section 179 property and listed property, see Publication 946, How To Depreciate Property.

Overview of Depreciation

This overview discusses basic information on 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 is the basis of your depreciable property.

  • How to treat repairs and improvements.

  • When you must file Form 4562.

  • How you can correct depreciation claimed incorrectly.

What Property Can Be Depreciated?

You can depreciate most types of tangible property (except land), such as buildings, machinery, equipment, vehicles, certain livestock, and furniture. You can also depreciate certain intangible property, such as copyrights, patents, 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 have a useful life that extends substantially beyond the year you place it in service.

Property You Own

To claim depreciation, you usually must be the owner of the property. You are considered as owning property even if it is subject to a debt.

Leased property.   You can depreciate leased property only if you retain the incidents of ownership in the property. This means you bear the burden of exhaustion of the capital investment in the property. Therefore, if you lease property from someone to use in your trade or business or for the production of income, you generally cannot depreciate its cost because you do not retain the incidents of ownership. You can, however, depreciate any capital improvements you make to the leased property. See Additions and Improvements under Which Recovery Period Applies in chapter 4 of Publication 946.

  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, you cannot depreciate the cost of the property 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.

Life tenant.   Generally, if you hold business or investment property as a life tenant, you can depreciate it as if you were the absolute owner of the property. See Certain term interests in property , later, for an exception.

Property Used in Your Business or Income-Producing Activity

To claim depreciation on property, you must use it in your business or income-producing activity. If you use property to produce income (investment use), the income must be taxable. You cannot depreciate property that you use solely for personal activities. However, if you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the percentage of business or investment use.

Example 1.   If you use your car for farm business, you can deduct depreciation based on its percentage of use in farming. If you also use it for investment purposes, you can depreciate it based on its percentage of investment use.

Example 2.   If you use part of your home for business, you may be able to deduct depreciation on that part based on its business use. For more information, see Business Use of Your Home in chapter 4.

You may be able to use the simplified method to determine your business use of the home deduction. If you chose to use the simplified method, you cannot also deduct depreciation on the the part of the home used for business. For more information about the simplified method, see Publication 587, Business Use of Your Home.

Inventory.   You can never 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.

Livestock.   Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account. Livestock you raise usually has no depreciable basis because the costs of raising them are deducted and not added to their basis. However, see Immature livestock under When Does Depreciation Begin and End , later, for a special rule.

Property Having a Determinable Useful Life

To be depreciable, your property must have a determinable useful life. This means it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes.

Irrigation systems and water wells.   Irrigation systems and wells used in a trade or business can be depreciated if their useful life can be determined. You can depreciate irrigation systems and wells composed of masonry, concrete, tile, metal, or wood. In addition, you can depreciate costs for moving dirt to construct irrigation systems and water wells composed of these materials. However, land preparation costs for center pivot irrigation systems are not depreciable.

Dams, ponds, and terraces.   In general, you cannot depreciate earthen dams, ponds, and terraces unless the structures have a determinable useful life.

What Property Cannot Be Depreciated?

Certain property cannot be depreciated, even if the requirements explained earlier are met. This includes the following.

  • Land. You can never 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. Although you cannot depreciate land, you can depreciate certain costs incurred in preparing land for business use. See chapter 1 of Publication 946.

  • 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.

  • Intangible property such as section 197 intangibles. This property does not have a determinable useful life and generally cannot be depreciated. However, see Amortization , later. Special rules apply to computer software (discussed below).

  • Certain term interests (discussed below).

Computer software.   Computer software is generally not a section 197 intangible 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 can be depreciated and may qualify for the section 179 expense deduction and the special depreciation allowance (if applicable), discussed later.

Certain term interests in property.   You cannot depreciate a term interest in property created or acquired after July 27, 1989, for any period during which the remainder interest is held, directly or indirectly, by a person related to you. This rule does not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. For more information, see chapter 1 of Publication 946.

When Does Depreciation Begin and End?

You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first.

Placed in Service

Property is placed 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.

You bought a planter for use in your farm business. The planter was delivered in December 2013 after harvest was over. You begin to depreciate the planter for 2013 because it was ready and available for its specific use in 2013, even though it will not be used until the spring of 2014.

If your planter comes unassembled in December 2013 and is put together in February 2014, it is not placed in service until 2014. You begin to depreciate it in 2014.

If your planter was delivered and assembled in February 2014 but not used until April 2014, it is placed in service in February 2014, because this is when the planter was ready for its specified use. You begin to depreciate it in 2014.

Fruit or nut trees and vines.   If you acquire an orchard, grove, or vineyard before the trees or vines have reached the income-producing stage, and they have a preproductive period of more than 2 years, you must capitalize the preproductive-period costs under the uniform capitalization rules (unless you elect not to use these rules). See chapter 6 for information about the uniform capitalization rules. Your depreciation begins when the trees and vines reach the income-producing stage (that is, when they bear fruit, nuts, or grapes in quantities sufficient to commercially warrant harvesting).

Immature livestock.   Depreciation for livestock begins when the livestock reaches the age of maturity. If you bought immature livestock for drafting purposes, depreciation begins when they can be worked. If you bought immature livestock for dairy purposes, depreciation begins when they can be milked. If you bought immature livestock for breeding purposes, depreciation begins when they can be bred. Your basis for depreciation is your initial cost for the immature livestock.

Idle Property

Continue to claim a deduction for depreciation on property used in your business or for the production of income even if it is temporarily idle. For example, if you stop using a machine because there is a temporary lack of a market for a product made with that machine, continue to deduct depreciation on the machine.

Cost or Other Basis Fully Recovered

You stop depreciating property when you have fully recovered your cost or other basis. This happens when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property.

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.

For information on abandonment of property, see chapter 8. For information on destroyed property, see chapter 11 and Publication 547, Casualties, Disasters, and Thefts.

Can You Use MACRS To Depreciate Your Property?

You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most business and investment property placed in service after 1986. MACRS is explained later under Figuring Depreciation Under MACRS .

You cannot use MACRS to depreciate the following property.

  • Property you placed in service before 1987. Use the methods discussed in Publication 534.

  • Certain property owned or used in 1986. See chapter 1 of Publication 946.

  • Intangible property.

  • Films, video tapes, and recordings.

  • Certain corporate or partnership property acquired in a nontaxable transfer.

  • Property you elected to exclude from MACRS.

For more information, see chapter 1 of Publication 946.

What Is the Basis of Your Depreciable Property?

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 or other basis.   The basis of property you buy is usually its cost plus amounts you paid for items such as sales tax, freight charges, and installation and testing fees. The cost includes the amount you pay in cash, debt obligations, other property, or services.

  There are times when you cannot use cost as basis. In these situations, the fair market value (FMV) or the adjusted basis of the property may be used.

Adjusted basis.   To find your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service.

Basis adjustment for depreciation allowed or allowable.   After you place your property in service, you must reduce the basis of the 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).

  For more information, see chapter 6.

How Do You Treat Repairs and Improvements?

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. Treat improvements as separate depreciable property. See chapter 1 of Publication 946 for more information.

Example.

You repair a small section on a corner of the roof of a barn that you rent to others. You deduct the cost of the repair as a business expense. However, if you replace the entire roof, the new roof is considered to be an improvement because it increases the value and lengthens the life for the property. You depreciate the cost of the new roof.

Improvements to rented property.   You can depreciate permanent improvements you make to business property you rent from someone else.

Do You Have To File Form 4562?

Use Form 4562 to claim your deduction for depreciation and amortization. You must complete and attach Form 4562 to your tax return if you are claiming any of the following.

  • A section 179 expense deduction for the current year or a section 179 carryover from a prior year.

  • 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.

  • Amortization of costs that began in the current year.

For more information, see the Instructions for Form 4562.

How Do You Correct Depreciation Deductions?

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. 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, for example, omitting an asset from the depreciation schedule.

  • You have not adopted a method of accounting for the 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.

Note.

You have adopted a method of accounting if you used the same incorrect method of depreciation for two or more consecutively filed returns.

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 the Instructions for Form 3115.

Section 179 Expense 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 expense deduction. You can elect the section 179 expense deduction instead of recovering the cost by taking depreciation deductions.

This part of the chapter explains the rules for the section 179 expense deduction. It explains what property qualifies for the deduction, what property does not qualify for the deduction, the limits that may apply, how to elect the deduction, and when you may have to recapture the deduction.

For more information, see chapter 2 of Publication 946.

What Property Qualifies?

To qualify for the section 179 expense 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.

Eligible Property

To qualify for the section 179 expense deduction, your property must be one of the following types of depreciable property.

  1. Tangible personal property.

  2. Other tangible property (except buildings and their structural components) used as:

    1. An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services;

    2. A research facility used in connection with any of the activities in (a) above; or

    3. A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities.

  3. Single purpose agricultural (livestock) or horticultural structures.

  4. Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product of petroleum.

Tangible 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 milk tanks, automatic feeders, barn cleaners, and office equipment.

  • Gasoline storage tanks and pumps at retail service stations.

  • Livestock, including horses, cattle, hogs, sheep, goats, and mink and other fur-bearing animals.

Facility used for the bulk storage of fungible commodities.   A facility used for the bulk storage of fungible commodities is qualifying property for purposes of the section 179 expense deduction if it is used in connection with any of the activities listed earlier in item (3)(a). Bulk storage means the storage of a commodity in a large mass before it is used.

Grain bins.   A grain bin is an example of a storage facility that is qualifying section 179 property. It is a facility used in connection with the production of grain or livestock for the bulk storage of fungible commodities.

Single purpose agricultural or horticultural structures.   A single purpose agricultural (livestock) or horticultural structure is qualifying property for purposes of the section 179 expense deduction.

Agricultural structure.   A single purpose agricultural (livestock) structure is any building or enclosure specifically designed, constructed, and used for both the following reasons.
  • To house, raise, and feed a particular type of livestock and its produce.

  • To house the equipment, including any replacements, needed to house, raise, or feed the livestock.

For this purpose, livestock includes poultry.

  Single purpose structures are qualifying property if used, for example, to breed chickens or hogs, produce milk from dairy cattle, or produce feeder cattle or pigs, broiler chickens, or eggs. The facility must include, as an integral part of the structure or enclosure, equipment necessary to house, raise, and feed the livestock.

Horticultural structure.   A single purpose horticultural structure is either of the following.
  • A greenhouse specifically designed, constructed, and used for the commercial production of plants.

  • A structure specifically designed, constructed, and used for the commercial production of mushrooms.

Use of structure.   A structure must be used only for the purpose that qualified it. For example, a hog barn will not be qualifying property if you use it to house poultry. Similarly, using part of your greenhouse to sell plants will make the greenhouse nonqualifying property.

  If a structure includes work space, the work space can be used only for the following activities.
  • Stocking, caring for, or collecting livestock or plants or their produce.

  • Maintaining the enclosure or structure.

  • Maintaining or replacing the equipment or stock enclosed or housed in the structure.

Property Acquired by Purchase

To qualify for the section 179 expense deduction, your property must have been acquired by purchase. For example, property acquired by gift or inheritance does not qualify. Property acquired from a related person (that is, your spouse, ancestors, or lineal descendants) is not considered acquired by purchase. New or used equipment you acquired by purchase during the current tax year qualifies for the section 179 deduction.

Example.

Ken is a farmer. He purchased two tractors, one from his brother and one from his father. He placed both tractors in service in the same year he bought them. The tractor purchased from his father does not qualify for the section 179 expense deduction because he is a related person (as defined above). The tractor purchased from his brother does qualify for the deduction because Ken is not a related person (as defined above).

What Property Does Not Qualify?

Land and improvements.   Land and land improvements, do not qualify as section 179 property. Land improvements include nonagricultural fences, swimming pools, paved parking areas, wharves, docks, bridges, and fences. However, agricultural fences do qualify as section 179 property. Similarly, field drainage tile also qualifies as section 179 property.

Excepted property.   Even if the requirements explained in the preceding discussions are met, farmers cannot elect the section 179 expense 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.

  • Property used by a tax-exempt organization (other than a tax-exempt farmers' cooperative) unless the property is used mainly in a taxable unrelated trade or business.

  • Property used by governmental units or foreign persons or entities (except property used under a lease with a term of less than 6 months).

How Much Can You Deduct?

Your section 179 expense 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. See also the special rules for applying the limits for partnerships and S corporations under Partnerships and S Corporations , later.

If you deduct only part of the cost of qualifying property as a section 179 expense deduction, you can generally depreciate the cost you do not deduct.

Use Part I of Form 4562 to figure your section 179 expense deduction.

Partial business use.   When you use property for business and nonbusiness purposes, you can elect the section 179 expense deduction only if you use it more than 50% for business in the year you place it in service. If you used 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 expense deduction.

Trade-in of other property.   If you buy qualifying property with cash and a trade-in, its cost for purposes of the section 179 expense deduction includes only the cash you paid. For example, if you buy (for cash and a trade-in) a new tractor for use in your business, your cost for the section 179 expense deduction is the cash you paid. It does not include the adjusted basis of the old tractor you trade for the new tractor.

Example.

J-Bar Farms traded two cultivators having a total adjusted basis of $6,800 for a new cultivator costing $13,200. They received an $8,000 trade-in allowance for the old cultivators and paid $5,200 cash for the new cultivator. J-Bar also traded a used pickup truck with an adjusted basis of $8,000 for a new pickup truck costing $35,000. They received a $5,000 trade-in allowance and paid $30,000 cash for the new pickup truck.

Only the cash paid by J-Bar qualifies for the section 179 expense deduction. J-Bar's business costs that qualify for a section 179 expense deduction are $35,200 ($5,200 + $30,000). For information on the maximum amount you can elect to deduct, see Dollar Limits, below.

Dollar Limits

The total amount you can elect to deduct under section 179 for most property placed in service in 2014 is $25,000. If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 expense deduction among the items in any way, as long as the total deduction is not more than $25,000.

Reduced dollar limit for cost exceeding $200,000.   If the cost of your qualifying section 179 property placed in service in 2014 is over $200,000, you must reduce the dollar limit (but not below zero) by the amount of cost over $200,000. If the cost of your section 179 property placed in service during 2014 is $225,000 or more, you cannot take a section 179 expense deduction and you cannot carry over the cost that is more than $225,000.

Example.

This year, James Smith placed in service machinery costing $215,000. Because this cost is $15,000 more than $200,000, he must reduce his dollar limit to $10,000 ($25,000 − $15,000).

Limits for sport utility vehicles.   The total amount you can elect to deduct for certain sport utility vehicles and certain other vehicles placed in service in 2014 is $25,000. This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, and highways that is rated at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight.

  For more information, see chapter 2 of Publication 946.

Limits for passenger automobiles.   For a passenger automobile that is placed in service in 2014, the total section 179 and depreciation deduction is limited. See Do the Passenger Automobile Limits Apply , later.

Married individuals.   If you are married, how you figure your section 179 expense 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 $200,000. You must allocate the dollar limit (after any reduction) equally between you, 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.

Joint return after 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 $200,000).

  • The total cost of section 179 property you and your spouse elected to expense on your separate returns.

Business Income Limit

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. In addition to net income or loss from a sole proprietorship, partnership, or S corporation, net income or loss derived from a trade or business also includes the following items.
  • Section 1231 gains (or losses) as discussed in chapter 9.

  • Interest from working capital of your trade or business.

  • Wages, salaries, tips, or other pay earned by you (or your spouse if you file a joint return) as an employee of any employer.

  In addition, figure taxable income without regard to any of the following.
  • The section 179 expense 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 expense deduction, you may have a taxable income limit for some other deduction (for example, charitable contributions). You may have to figure the limit for this other deduction taking into account the section 179 expense deduction. If so, complete the following steps.
Step Action
1 Figure taxable income without the section 179 expense deduction or the other deduction.
2 Figure a hypothetical section 179 expense deduction using the taxable income figured in Step 1.
3 Subtract the hypothetical section 179 expense deduction figured in Step 2 from the taxable income figured in Step 1.
4 Figure a hypothetical amount for the other deduction using the amount figured in Step 3 as taxable income.
5 Subtract the hypothetical other deduction figured in Step 4 from the taxable income figured in  
Step 1.
6 Figure your actual section 179 expense deduction using the taxable income figured in Step 5.
7 Subtract your actual section 179 expense deduction figured in Step 6 from the taxable income figured in Step 1.
8 Figure your actual other deduction using the taxable income figured in Step 7.

Example.

On February 1, 2014, the XYZ farm corporation purchased and placed in service qualifying section 179 property that cost $25,000. It elects to expense the entire $25,000 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 expense deduction. The business income limit for the section 179 expense deduction is figured after subtracting any allowable charitable contributions. XYZ's taxable income figured without the section 179 expense deduction or the deduction for charitable contributions is $45,000. XYZ figures its section 179 expense deduction and its deduction for charitable contributions as follows.

Step 1. Taxable income figured without either deduction is $45,000.

Step 2. Using $45,000 as taxable income, XYZ's hypothetical section 179 expense deduction is $25,000.

Step 3. $20,000 ($45,000 − $25,000).

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. $43,000 ($45,000 − $2,000).

Step 6. Using $43,000 (from Step 5) as taxable income, XYZ figures the actual section 179 expense deduction. Because the taxable income is at least $25,000, XYZ can take a $25,000 section 179 expense deduction.

Step 7. $20,000 ($45,000 − $25,000).

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.   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.

  The amount you carry over is used in determining your section 179 expense deduction in the next year. However, it is subject to the limits in that 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 cost will be carried forward. Your selections must be shown in your books and records.

Example.

Last year, Joyce Jones placed in service a machine that cost $8,000 and elected to deduct all $8,000 under section 179. The taxable income from her business (determined without regard to both a section 179 expense deduction for the cost of the machine and the self-employment tax deduction) was $6,000. Her section 179 expense deduction was limited to $6,000. The $2,000 cost that was not allowed as a section 179 expense deduction (because of the business income limit) is carried to this year.

This year, Joyce placed another machine in service that cost $9,000. Her taxable income from business (determined without regard to both a section 179 expense deduction for the cost of the machine and the self-employment tax deduction) is $10,000. Joyce can deduct the full cost of the machine ($9,000) but only $1,000 of the carryover from last year because of the business income limit. She can carry over the balance of $1,000 to next year.

Partnerships and S Corporations

The section 179 expense deduction limits apply both to the partnership or S corporation and to each partner or shareholder. The partnership or S corporation determines its section 179 expense deduction subject to the limits. It then allocates the deduction among its partners or shareholders.

If you are a partner in a partnership or shareholder of an S corporation, you add the amount allocated from the partnership or S corporation to any section 179 costs not related to the partnership or S corporation and then apply the dollar limit to this total. To determine any reduction in the dollar limit for costs over $200,000, you do not include any of the cost of section 179 property placed in service by the partnership or S corporation. After you apply the dollar limit, you apply the business income limit to any remaining section 179 costs. For more information, see chapter 2 of Publication 946.

Example.

In 2014, Partnership P placed in service section 179 property with a total cost of $210,000. P must reduce its dollar limit by $10,000 ($210,000 − $200,000). Its maximum section 179 expense deduction is $15,000 ($25,000 − $10,000), and it elects to expense that amount. Because P's taxable income from the active conduct of all its trades or businesses for the year was $100,000, it can deduct the full $15,000. P allocates $10,000 of its section 179 expense deduction and $10,000 of its taxable income to John, one of its partners.

John also conducts a business as a sole proprietor and in 2014, placed in service in that business, section 179 property costing $38,000. John's taxable income from that business was $10,000. In addition to the $10,000 allocated from P, he elects to expense the $15,000 of his sole proprietorship's section 179 costs. However, John's deduction is limited to his business taxable income of $20,000 ($10,000 from P plus $10,000 from his sole proprietorship). He carries over $5,000 ($25,000 − $20,000) of the elected section 179 costs to 2015.

How Do You Elect the Deduction?

You elect to take the section 179 expense deduction by completing Part I of Form 4562.

If you elect the deduction for listed property, complete Part V of  
Form 4562 before completing Part I. 

File Form 4562 with either of the following:

  • Your original tax return (whether or not you filed it timely), or

  • An amended return filed within the time prescribed by law. An election made on an amended return must specify the item of section 179 property to which the election applies and the part of the cost of each such item to be taken into account. The amended return must also include any resulting adjustments to taxable income.

Revoking an election.    The election made for tax years beginning in 2014 (or any specification made in the election) cannot be revoked without obtaining IRS approval.

  The IRS will grant approval only in extraordinary circumstances. A request to change or revoke the election is subject to a user fee. You should follow the procedures for requesting a letter ruling in Rev. Proc. 2014-1, 2014–1 I.R.B. 1, available at www.irs.gov/pub/irs-irbs/irb14-01.pdf (or its successor) to file a request to change or revoke the election. When you file your request you must include the following information:
  • Your name,

  • Your address,

  • Your taxpayer identification number (TIN), and

  • A statement showing the year and property involved and a detailed description of your reasons for the request.

  See section 1.179-5(b) of the Regulations.

  The election made for tax years beginning after 2002 and before 2014 (or any specification made in the election) can be revoked without obtaining IRS approval by filing an amended return. The amended return must be filed within the time prescribed by law for the applicable tax year. The amended return must include any resulting adjustments to taxable income or to the tax liability (for example, allowable depreciation in that tax year for the item of section 179 property which the revocation pertains). For more information and examples, see sections 1.179-5(c)(3) and (c)(4) of the Regulations.

  Once made, the revocation is irrevocable.

When Must You Recapture the Deduction?

You may have to recapture the section 179 expense deduction if, in any year during the property's recovery period, the percentage of business use drops to 50% or less. In the year the business use drops to 50% or less, you include the recapture amount as ordinary income. You also increase the basis of the property by the recapture amount. Recovery periods for property are discussed later.

If you sell, exchange, or otherwise dispose of the property, do not figure the recapture amount under the rules explained in this discussion. Instead, use the rules for recapturing depreciation explained in  
chapter 9 under Section 1245 Property

If the property is listed property, do not figure the recapture amount under the rules explained in this discussion when the percentage of business use drops to 50% or less. Instead, use the rules for recapturing depreciation explained in chapter 5 of Publication 946 under Recapture of Excess Depreciation.

Figuring the recapture amount.   To figure the amount to recapture, take the following steps.
  1. Figure the allowable depreciation for the section 179 expense deduction you claimed. Begin with the year you placed the property in service and include the year of recapture.

  2. Subtract the depreciation figured in (1) from the section 179 expense deduction you actually claimed. The result is the amount you must recapture.

Example.

In January 2012, Paul Lamb, a calendar year taxpayer, bought and placed in service section 179 property costing $10,000. The property is not listed property. He elected a $5,000 section 179 expense deduction for the property and also elected not to claim a special depreciation allowance. He used the property only for business in 2012 and 2013. During 2014, he used the property 40% for business and 60% for personal use. He figures his recapture amount as follows.

Section 179 expense deduction claimed (2012) $5,000
Minus: Allowable depreciation 
(instead of section 179 expense deduction):
 
2012 $1,250  
2013 1,875  
2014 ($1,250 × 40% (business)) 500 3,625
2014 — Recapture amount $1,375
   

Paul must include $1,375 in income for 2014.

Where to report recapture.   Report any recapture of the section 179 expense deduction as ordinary income in Part IV of Form 4797 and include it in income on Schedule F (Form 1040).

Recapture for qualified section 179 GO Zone property.   If any qualified section 179 GO Zone property ceases to be used in the GO Zone in a later year, you must recapture the benefit of the increased section 179 expense deduction as “other income.

Claiming the Special Depreciation Allowance

For qualified property (defined below) placed in service in 2014, you can take an additional 50% special depreciation allowance. The allowance is an additional deduction you can take before you figure regular depreciation under MACRS. Figure the special depreciation allowance by multiplying the depreciable basis of the qualified property by 50%.

What is Qualified Property?

For farmers, qualified property generally is certain qualified property acquired after December 31, 2007, and placed in service before January 1, 2015.

Certain qualified property acquired after December 31, 2007, and placed in service before January 1, 2015.   Certain qualified property (defined below) acquired after December 31, 2007, and before January 1, 2015, is eligible for a 50% special depreciation allowance.

  Qualified property includes the following:
  • Certain property with a long production period.

  • Certain aircraft.

  Qualified property must also meet all of the following tests:
  • You must have acquired qualified property by purchase after December 31, 2007. If a binding contract to acquire the property existed before January 1, 2008, the property does not qualify.

  • Qualified property must be placed in service after December 31, 2007, and placed in service before January 1, 2015.

  • The original use of the property must begin with you after December 31, 2007.

For more information, see chapter 3 of Publication 946.

How Can You Elect Not To Claim the Allowance?

You can elect, for any class of property, not to deduct the special depreciation allowance for all property in such class placed in service during the tax year. To make the election, attach a statement to your return indicating the class of property for which you are making the election.

Generally, you must make the election on a timely filed tax return (including extensions) for the year in which you place the property in service. However, if you timely filed your return for the year without making the election, you still can make the election by filing an amended return within 6 months of the due date of the original return (not including extensions). Attach the election statement to the amended return. On the amended return, write “Filed pursuant to section 301.9100-2.

Once made, the election may not be revoked without IRS consent.

If you elect not to have the special depreciation allowance apply, the property may be subject to an alternative minimum tax adjustment for depreciation.

When Must You Recapture an Allowance

When you dispose of property for which you claimed a special depreciation allowance, any gain on the disposition is generally recaptured (included in income) as ordinary income up to the amount of the special depreciation allowance previously allowed or allowable. For more information, see chapter 3 of Publication 946.

Figuring Depreciation Under MACRS

The Modified Accelerated Cost Recovery System (MACRS) is used to recover the basis of most business and investment property placed in service after 1986. MACRS consists of two depreciation systems, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Generally, these systems provide different methods and recovery periods to use in figuring depreciation deductions.

To be sure you can use MACRS to figure depreciation for your property, see Can You Use MACRS To Depreciate Your Property, earlier.

This part explains how to determine which MACRS depreciation system applies to your property. It also discusses the following information that you need to know before you can figure depreciation under MACRS.

  • Property's recovery class.

  • Placed-in-service date.

  • Basis for depreciation.

  • Recovery period.

  • Convention.

  • Depreciation method.

Finally, this part explains how to use this information to figure your depreciation deduction.

Which Depreciation System (GDS or ADS) Applies?

Your use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period you use. You generally must use GDS unless you are specifically required by law to use ADS or you elect to use ADS.

Required use of ADS.   You must use ADS for the following property.
  • All property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect.

  • Listed property used 50% or less in a qualified business use. See Additional Rules for Listed Property , later.

  • Any tax-exempt use property.

  • Any tax-exempt bond-financed property.

  • Any property imported from a foreign country for which an Executive Order is in effect because the country maintains trade restrictions or engages in other discriminatory acts.

  • Any tangible property used predominantly outside the United States during the year.

If you are required to use ADS to depreciate your property, you cannot claim the special depreciation allowance.

Electing ADS.   Although your property may qualify for GDS, you can elect to use ADS. The election generally must cover all property in the same property class you placed in service during the year. However, the election for residential rental property and nonresidential real property can be made on a property-by-property basis. Once you make this election, you can never revoke it.

  You make the election by completing line 20 in Part III of Form 4562.

Which Property Class Applies Under GDS?

The following is a list of the nine property classes under GDS.

  1. 3-year property.

  2. 5-year property.

  3. 7-year property.

  4. 10-year property.

  5. 15-year property.

  6. 20-year property.

  7. 25-year property.

  8. Residential rental property.

  9. Nonresidential real property.

See Which Property Class Applies Under GDS in chapter 4 of Publication 946 for examples of the types of property included in each class.

What Is the Placed-in-Service Date?

You begin to claim depreciation when your property is placed in service for use either in a trade or business or for the production of income. The placed-in-service date for your property is the date the property is ready and available for a specific use. It is therefore not necessarily the date it is first used. If you converted property held for personal use to use in a trade or business or for the production of income, treat the property as being placed in service on the conversion date. See Placed in Service under When Does Depreciation Begin and End , earlier, for examples illustrating when property is placed in service.

What Is the Basis for Depreciation?

The basis for depreciation of MACRS property is the property's cost or other basis multiplied by the percentage of business/investment use. Reduce that amount by any credits and deductions allocable to the property. The following are examples of some of the credits and deductions that reduce basis.

  • Any deduction for section 179 property.

  • Any deduction for removal of barriers to the disabled and the elderly.

  • Any disabled access credit, enhanced oil recovery credit, and credit for employer-provided childcare facilities and services.

  • Any special depreciation allowance.

  • Basis adjustment for investment credit property under section 50(c) of the Internal Revenue Code.

For information about how to determine the cost or other basis of property, see What Is the Basis of Your Depreciable Property , earlier. Also, see chapter 6.

For additional credits and deductions that affect basis, see section 1016 of the Internal Revenue Code.

Which Recovery Period Applies?

The recovery period of property is the number of years over which you recover its cost or other basis. It is determined based on the depreciation system (GDS or ADS) used. See Table 7-1 for recovery periods under both GDS and ADS for some commonly used assets. For a complete list of recovery periods, see the Table of Class Lives and Recovery Periods in Appendix B of Publication 946.

House trailers for farm laborers.   To depreciate a house trailer you supply as housing for those who work on your farm, use one of the following recovery periods if the house trailer is mobile (it has wheels and a history of movement).
  • A 7-year recovery period under GDS.

  • A 10-year recovery period under ADS.

  However, if the house trailer is not mobile (its wheels have been removed and permanent utilities and pipes attached to it), use one of the following recovery periods.
  • A 20-year recovery period under GDS.

  • A 25-year recovery period under ADS.

Water wells.   Water wells used to provide water for raising poultry and livestock are land improvements. If they are depreciable, use one of the following recovery periods.
  • A 15-year recovery period under GDS.

  • A 20-year recovery period under ADS.

  The types of water wells that can be depreciated were discussed earlier in Irrigation systems and water wells under Property Having a Determinable Useful Life .

Table 7-1. Farm Property Recovery Periods

  Recovery Period in Years
Assets GDS ADS
Agricultural structures (single purpose) 10 15
Automobiles 5 5
Calculators and copiers 5 6
Cattle (dairy or breeding) 5 7
Communication equipment1 7 10
Computer and peripheral equipment 5 5
Drainage facilities 15 20
Farm buildings2 20 25
Farm machinery and equipment 7 10
Fences (agricultural) 7 10
Goats and sheep (breeding) 5 5
Grain bin 7 10
Hogs (breeding) 3 3
Horses (age when placed in service)    
Breeding and working (12 years or less) 7 10
Breeding and working (more than 12 years) 3 10
Racing horses (more than 2 years) 3 12
Horticultural structures (single purpose) 10 15
Logging machinery and equipment3 5 6
Nonresidential real property 394 40
Office furniture, fixtures, and equipment (not calculators, copiers, or typewriters) 7 10
Paved lots 15 20
Residential rental property 27.5 40
Tractor units (over-the-road) 3 4
Trees or vines bearing fruit or nuts 10 20
Truck (heavy duty, unloaded weight 13,000 lbs. or more) 5 6
Truck (actual weight less than 13,000 lbs) 5 5
Water wells 15 20
1 Not including communication equipment listed in other classes.
2 Not including single purpose agricultural or horticultural structures.
3 Used by logging and sawmill operators for cutting of timber.
4 For property placed in service after May 12, 1993; for property placed in service before May 13, 1993,  
the recovery period is 31.5 years.

Which Convention Applies?

Under MACRS, averaging conventions establish when the recovery period begins and ends. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property. Use one of the following conventions.

  • The half-year convention.

  • The mid-month convention.

  • The mid-quarter convention.

For a detailed explanation of each convention, see Which Convention Applies in chapter 4 of Publication 946. Also, see the Instructions for Form 4562.

Which Depreciation Method Applies?

MACRS provides three depreciation methods under GDS and one depreciation method under ADS.

  • The 200% declining balance method over a GDS recovery period.

  • The 150% declining balance method over a GDS recovery period.

  • The straight line method over a GDS recovery period.

  • The straight line method over an ADS recovery period.

Depreciation Table.   The following table lists the types of property you can depreciate under each method. The declining balance method is abbreviated as DB and the straight line method is abbreviated as SL.

Depreciation Table

System/Method   Type of Property
GDS using  
150% DB
All property used in a farming business (except real property)
  All 15- and 20-year property
  Nonfarm 3-, 5-, 7-, and 10-year property1
GDS using SL Nonresidential real property
  Residential rental property
  Trees or vines bearing fruit or nuts
  All 3-, 5-, 7-, 10-, 15-, and 20-year property1
ADS using SL Property used predomi- 
nantly outside the United States
  Farm property used when an election not to apply the uniform capitalization rules is in effect
  Tax-exempt property
  Tax-exempt bond-financed property
  Imported property2
  Any property for which you elect to use this method1
GDS using  
200% DB
Nonfarm 3-, 5-, 7-, and 
10-year property
1Elective method
2See section 168(g)(6) of the Internal Revenue  
Code

Property used in farming business.   For personal property placed in service after 1988 in a farming business, you must use the 150% declining balance method over a GDS recovery period or you can elect one of the following methods.
  • The straight line method over a GDS recovery period.

  • The straight line method over an ADS recovery period.

For property placed in service before 1999, you could have elected to use the 150% declining balance method using the ADS recovery periods for certain property classes. If you made this election, continue to use the same method and recovery period for that property.

Real property.   You can depreciate real property using the straight line method under either GDS or ADS.

Switching to straight line.   If you use a declining balance method, you switch to the straight line method in the year it provides an equal or greater deduction. If you use the MACRS percentage tables, discussed later under How Is the Depreciation Deduction Figured , you do not need to determine in which year your deduction is greater using the straight line method. The tables have the switch to the straight line method built into their rates.

Fruit or nut trees and vines.   Depreciate trees and vines bearing fruit or nuts under GDS using the straight line method over a 10-year recovery period.

ADS required for some farmers.   If you elect not to apply the uniform capitalization rules to any plant shown in Table 6-1 of chapter 6 and produced in your farming business, you must use ADS for all property you place in service in any year the election is in effect. See chapter 6 for a discussion of the application of the uniform capitalization rules to farm property.

Electing a different method.   As shown in the Depreciation Table , you can elect a different method for depreciation for certain types of property. You must make the election by the due date of the return (including extensions) for the year you placed the 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 6 months of the due date of your 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. Once you make the election, you cannot change it.

  
If you elect to use a different method for one item in a property class, you must apply the same method to all property in that class placed in service during the year of the election. However, you can make the election on a property-by-property basis for residential rental and nonresidential real property.

Straight line election.   Instead of using the declining balance method, you can elect to use the straight line method over the GDS recovery period. Make the election by entering “S/L” under column (f) in Part III of Form 4562.

ADS election.   As explained earlier under Which Depreciation System (GDS or ADS) Applies , you can elect to use ADS even though your property may come under GDS. ADS uses the straight line method of depreciation over the ADS recovery periods, which are generally longer than the GDS recovery periods. The ADS recovery periods for many assets used in the business of farming are listed in Table 7–1. Additional ADS recovery periods for other classes of property may be found in the Table of Class Lives and Recovery Periods in Appendix B of Publication 946.

How Is the Depreciation Deduction Figured?

To figure your depreciation deduction under MACRS, you first determine the depreciation system, property class, placed-in-service date, basis amount, recovery period, convention, and depreciation method that applies to your property. Then you are ready to figure your depreciation deduction. You can figure it in one of two ways.

  • You can use the percentage tables provided by the IRS.

  • You can figure your own deduction without using the tables.

Figuring your own MACRS deduction will generally result in a slightly different amount than using the tables.

Using the MACRS Percentage Tables

To help you figure your deduction under MACRS, the IRS has established percentage tables that incorporate the applicable convention and depreciation method. These percentage tables are in Appendix A of Publication 946.

Rules for using the tables.   The following rules cover the use of the percentage tables.
  1. You must apply the rates in the percentage tables to your property's unadjusted basis. Unadjusted basis is the same basis amount you would use to figure gain on a sale but figured without reducing your original basis by any MACRS depreciation taken in earlier years.

  2. You cannot use the percentage tables for a short tax year. See chapter 4 of Publication 946 for information on how to figure the deduction for a short tax year.

  3. You generally must continue to use them for the entire recovery period of the property.

  4. You must stop using the tables if you adjust the basis of the property for any reason other than—

    1. Depreciation allowed or allowable, or

    2. An addition or improvement to the property, which is depreciated as a separate property.

Basis adjustment due to casualty loss.   If you reduce the basis of your property because of a casualty, you cannot continue to use the percentage tables. For the year of the adjustment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year. See Figuring the Deduction Without Using the Tables in chapter 4 of Publication 946.

Figuring depreciation using the 150% DB method and half-year convention.    Table 7-2 has the percentages for 3-, 5-, 7-, and 20-year property. The percentages are based on the 150% declining balance method with a change to the straight line method. This table covers only the half-year convention and the first 8 years for 20-year property. See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention.

  The following examples show how to figure depreciation under MACRS using the percentages in Table 7-2 .

Example 1.

During the year, you bought an item of 7-year property for $10,000 and placed it in service. You do not elect a section 179 expense deduction for this property. In addition, the property is not qualified property for purposes of the special depreciation allowance. The unadjusted basis of the property is $10,000. You use the percentages in Table 7-2 to figure your deduction.

Since this is 7-year property, you multiply $10,000 by 10.71% to get this year's depreciation of $1,071. For next year, your depreciation will be $1,913 ($10,000 × 19.13%).

Example 2.

You had a barn constructed on your farm at a cost of $20,000. You placed the barn in service this year. You elect not to claim the special depreciation allowance. The barn is 20-year property and you use the table percentages to figure your deduction. You figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 3.75% to get $750. For next year, your depreciation will be $1,443.80 ($20,000 × 7.219%).

Table 7-2. 150% Declining Balance Method (Half-Year Convention)

Year 3-Year 5-Year 7-Year 20-Year
1 25.0 % 15.00 % 10.71 % 3.750 %
2 37.5   25.50   19.13   7.219  
3 25.0   17.85   15.03   6.677  
4 12.5   16.66   12.25   6.177  
5     16.66   12.25   5.713  
6     8.33   12.25   5.285  
7         12.25   4.888  
8         6.13   4.522  
Figuring depreciation using the straight line method and half-year convention.   The following table has the straight line percentages for 3-, 5-, 7-, and 20-year property using the half-year convention. The table covers only the first 8 years for 20-year property. See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention.

Table 7-3. Straight Line Method (Half-Year Convention)

Year 3-Year 5-Year 7-Year 20-Year
1 16.67 % 10 % 7.14 % 2.5 %
2 33.33   20   14.29   5.0  
3 33.33   20   14.29   5.0  
4 16.67   20   14.28   5.0  
5     20   14.29   5.0  
6     10   14.28   5.0  
7         14.29   5.0  
8         7.14   5.0  

  The following example shows how to figure depreciation under MACRS using the straight line percentages in Table 7-3 .

Example.

If in Example 2, earlier, you had elected the straight line method, you figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 2.5% to get $500. For next year, your depreciation will be $1,000  
($20,000 × 5%).

Figuring Depreciation Without the Tables

If you are required to or would prefer to figure your own depreciation without using the tables, see Figuring the Deduction Without Using the Tables in chapter 4 of Publication 946.

Figuring the Deduction for Property Acquired in a Nontaxable Exchange

If your property has a carryover basis because you acquired it in an exchange or involuntary conversion of other property or in a nontaxable transfer, you generally figure depreciation for the property as if the exchange, conversion, or transfer had not occurred.

Property acquired in a like-kind exchange or involuntary conversion.   You generally must depreciate the carryover basis of MACRS property acquired in a like-kind exchange or involuntary conversion over the remaining recovery period of the property exchanged or involuntarily converted. You also generally continue to use the same depreciation method and convention used for the exchanged or involuntarily converted property. This applies only to acquired property with the same or a shorter recovery period and the same or more accelerated depreciation method than the property exchanged or involuntarily converted. The excess basis, if any, of the acquired MACRS property is treated as newly placed in service MACRS property.

Election out.   You can elect not to use the above rules. The election, if made, applies to both the acquired property and the exchanged or involuntarily converted property. If you make the election, figure depreciation by treating the carryover basis and excess basis, if any, for the acquired property as if placed in service the later of on the date you acquired it, or the time of the disposition of the exchanged or involuntarily converted property. For depreciation purposes, the adjusted basis of the exchanged or involuntarily converted property is treated as if it was disposed of at the time of the exchange or conversion.

When to make the election.   You must make the election on a timely filed return (including extensions) for the year of replacement. Once made, the election may not be revoked without IRS consent.

  For more information and special rules, see chapter 4 of Publication 946.

Property acquired in a nontaxable transfer.   You must depreciate MACRS property acquired by a corporation or partnership in certain nontaxable transfers over the property's remaining recovery period in the transferor's hands, as if the transfer had not occurred. You must continue to use the same depreciation method and convention as the transferor. You can depreciate the part of the property's basis in excess of its carried-over basis (the transferor's adjusted basis in the property) as newly purchased MACRS property. For information on the kinds of nontaxable transfers covered by this rule, see chapter 4 of Publication 946.

How Do You Use General Asset Accounts?

To make it easier to figure MACRS depreciation, you can group separate assets into one or more general asset accounts (GAAs). You can then depreciate all the assets in each account as a single asset. Each account must include only assets, recovery period, depreciation method, and convention. You cannot include an asset if you use it in both a personal activity and a trade or business (or for the production of income) in the year in which you first placed it in service.

After you have set up a GAA, you generally figure the depreciation for it by using the applicable depreciation method, recovery period, and convention for the assets in the GAA. For each GAA, record the depreciation allowance in a separate depreciation reserve account.

There are additional rules for grouping assets in a GAA, figuring depreciation for a GAA, disposing of GAA assets, and terminating GAA treatment. Special rules apply in determining the basis and figuring the depreciation deduction for MACRS property in a GAA acquired in a like-kind exchange or involuntary conversion. For more details, see section 1.168(i)-1 (as in effect for tax years beginning after December 31, 2013). Also, seechapter 4 in Publication 946.

When Do You Recapture MACRS Depreciation?

When you dispose of property you depreciated using MACRS, any gain on the disposition is generally recaptured (included in income) as ordinary income up to the amount of the depreciation previously allowed or allowable for the property. For more information on depreciation recapture, see chapter 9. Also, see chapter 4 of Publication 946.

Additional Rules for Listed Property

Listed property includes cars and other property used for transportation, property used for entertainment, and certain computers.

Deductions for listed property (other than certain leased property) are subject to the following special rules and limits.

  • Deduction for employees.

  • Business-use requirement.

  • Passenger automobile limits and rules.

What Is Listed Property?

Listed property is any of the following.

  • Passenger automobiles weighing 6,000 pounds or less.

  • Any other property used for transportation, unless it is an excepted vehicle.

  • Property generally used for entertainment, recreation, or amusement.

  • Computers and related peripheral equipment unless used only at a regular business establishment and owned or leased by the person operating the establishment.

  • Certain aircraft.

Passenger automobiles.   A passenger automobile is any 4-wheeled vehicle made primarily for use on public streets, roads, and highways and rated at 6,000 pounds or less of unloaded gross vehicle weight (6,000 pounds or less of gross vehicle weight for trucks and vans). It includes any part, component, or other item physically attached to the automobile or usually included in the purchase price of an automobile. Electric passenger automobiles are vehicles produced by an original equipment manufacturer and designed to run primarily on electricity.

A truck or van that is a qualified nonpersonal use vehicle is not considered a passenger automobile. See Qualified nonpersonal use vehicles under Passenger Automobiles in chapter 5 of Publication 946 for the definition of qualified nonpersonal use vehicles.

Other property used for transportation.   This includes trucks, buses, boats, airplanes, motorcycles, and other vehicles used for transporting persons or goods.

Excepted vehicles.   Other property used for transportation does not include the following vehicles.
  • Tractors and other special purpose farm vehicles.

  • Bucket trucks (cherry pickers), dump trucks, flatbed trucks, and refrigerated trucks.

  • Combines, cranes and derricks, and forklifts.

  • Any vehicle designed to carry cargo with a loaded gross vehicle weight of over 14,000 pounds.

For more information, see chapter 5 of Publication 946.

What Is the Business-Use Requirement?

You can claim the section 179 expense deduction for listed property and depreciate listed property using GDS and a declining balance method, if the property meets the business-use requirement. To meet this requirement, listed property must be used predominantly (more than 50% of its total use) for qualified business use. To determine whether the business-use requirement is met, you must allocate the use of any item of listed property used for more than one purpose during the year among its various uses.

Do the Passenger Automobile Limits Apply?

The depreciation deduction (including the section 179 expense deduction) you can claim for a passenger automobile each year is limited. The passenger automobile limits are the maximum depreciation amounts you can deduct for a passenger automobile. They are based on the date you placed the vehicle in service. See chapter 5 of Publication 946 for tables that show the maximum depreciation deduction for passenger automobiles. Also, see the Instructions for Form 4562.

For information about deducting expenses for the business use of your passenger automobile, see chapter 4 in Publication 463.

Deductions for passenger automobiles acquired in a trade-in.   Special rules apply in figuring the depreciation for a passenger automobile received in a like-kind exchange or involuntary conversion. See chapter 5 of Publication 946 and Regulations section 1.168(i)-6(d)(3).

Depletion

Depletion is the using up of natural resources by mining, quarrying, drilling, or felling. The depletion deduction allows an owner or operator to account for the reduction of a product's reserves.

Who Can Claim Depletion?

If you have an economic interest in mineral property or standing timber (defined below), you can take a deduction for depletion. More than one person can have an economic interest in the same mineral deposit or timber.

You have an economic interest if both the following apply.

  • You have acquired by investment any interest in mineral deposits or standing timber.

  • You have a legal right to income from the extraction of the mineral or the cutting of the timber, to which you must look for a return of your capital investment.

A contractual relationship that allows you an economic or monetary advantage from products of the mineral deposit or standing timber is not, in itself, an economic interest. A production payment carved out of, or retained on the sale of, mineral property is not an economic interest.

Mineral property is each separate interest you own in each mineral deposit in each separate tract or parcel of land. You can treat two or more separate interests as one property or as separate properties. See section 614 of the Internal Revenue Code and the related regulations for rules on how to treat separate mineral interests.

Timber property is your economic interest in standing timber in each tract or block representing a separate timber account.

Figuring Depletion

There are two ways of figuring depletion.

  • Cost depletion.

  • Percentage depletion.

For mineral property, you generally must use the method that gives you the larger deduction. For standing timber, you must use cost depletion.

Cost Depletion

To figure cost depletion you must first determine the following.

  • The property's basis for depletion.

  • The total recoverable units of mineral in the property's natural deposit.

  • The number of units of mineral sold during the tax year.

You must estimate or determine recoverable units (tons, barrels, board feet, thousands of cubic feet, or other measure) using the current industry method and the most accurate and reliable information you can obtain.

Basis for depletion and total recoverable units are explained in chapter 9 of Publication 535.

Number of units sold.   You determine the number of units sold during the tax year based on your method of accounting. Use the following table to make this determination.

  
IF you use... THEN the units sold during the year are...
The cash method of accounting The units sold for which you receive payment during the tax year (regardless of the year of sale).
An accrual method of accounting The units sold based on your inventories.

  The number of units sold during the tax year does not include any units for which depletion deductions were allowed or allowable in earlier years.

Figuring the cost depletion deduction.   Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you can figure your cost depletion deduction by taking the following steps.
Step Action Result
1 Divide your property's basis for depletion by total recoverable units. Rate per unit.
2 Multiply the rate per unit by units sold during the tax year. Cost depletion deduction.

Cost depletion for ground water in Ogallala Formation.   Farmers who extract ground water from the Ogallala Formation for irrigation are allowed cost depletion. Cost depletion is allowed when it can be demonstrated the ground water is being depleted and the rate of recharge is so low that, once extracted, the water would be lost to the taxpayer and immediately succeeding generations. To figure your cost depletion deduction, use the guidance provided in Revenue Procedure 66-11 in Cumulative Bulletin 1966-1.

Timber Depletion

Depletion takes place when you cut standing timber (including Christmas trees). You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation.

Figuring the timber depletion deduction.   To figure your cost depletion allowance, multiply the number of units of standing timber cut by your depletion unit.

Timber units.   When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. You measure the timber using board feet, log scale, cords, or other units. If you later determine that you have more or less units of timber, you must adjust the original estimate.

Depletion units.   You figure your depletion unit each year by taking the following steps.
  1. Determine your cost or the adjusted basis of the timber on hand at the beginning of the year.

  2. Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital.

  3. Figure the number of timber units to take into account by adding the number of timber units acquired during the year to the number of timber units on hand in the account at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account.

  4. Divide the result of (2) by the result of (3). This is your depletion unit.

When to claim timber depletion.   Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you elect to treat the cutting of timber as a sale or exchange as explained in chapter 8. Include allowable depletion for timber products not sold during the tax year the timber is cut, as a cost item in the closing inventory of timber products for the year. The inventory is your basis for determining gain or loss in the tax year you sell the timber products.

Form T (Timber).   Complete and attach Form T (Timber) to your income tax return if you are claiming a deduction for timber depletion, electing to treat the cutting of timber as a sale or exchange, or making an outright sale of timber. See the Instructions for Form T (Timber).

Example.

Sam Brown bought a farm that included standing timber. This year Sam determined that the standing timber could produce 300,000 units when cut. At that time, the adjusted basis of the standing timber was $24,000. Sam then cut and sold 27,000 units. (Sam did not elect to treat the cutting of the timber as a sale or exchange.) Sam's depletion for each unit for the year is $.08 ($24,000 ÷ 300,000). His deduction for depletion is $2,160 (27,000 × $.08). If Sam had cut 27,000 units but sold only 20,000 units during the year, his depletion for each unit would have remained at $.08. However, his depletion deduction would have been $1,600 (20,000 × $.08) for this year and he would have included the balance of $560 (7,000 × $.08) in the closing inventory for the year.

Percentage Depletion

You can use percentage depletion on certain mines, wells, and other natural deposits. You cannot use the percentage method to figure depletion for standing timber, soil, sod, dirt, or turf.

To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the year. See Mines and other natural deposits in chapter 9 of Publication 535 for a list of the percentages. You can find a complete list in section 613(b) of the Internal Revenue Code.

Taxable income limit.   The percentage depletion deduction cannot be more than 50% (100% for oil and gas property) of your taxable income from the property figured without the depletion deduction and the domestic production activities deduction.

  The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit.
  • Do not deduct any net operating loss deduction from the gross income from the property.

  • Corporations do not deduct charitable contributions from the gross income from the property.

  • If, during the year, you disposed of an item of section 1245 property used in connection with the mineral property, reduce any allowable deduction for mining expenses by the part of any gain you must report as ordinary income that is allocable to the mineral property. See Regulations section 1.613-5(b)(1) for information on how to figure the ordinary gain allocable to the property.

For more information on depletion, see chapter 9 in Publication 535.

Amortization

Amortization is a method of recovering (deducting) certain capital costs over a fixed period of time. It is similar to the straight line method of depreciation. The amortizable costs discussed in this section include the start-up costs of going into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles. See chapter 8 in Publication 535 for more information on these topics.

Business Start-Up Costs

When you go into business, treat all costs you incur to get your business started as capital expenses. Capital expenses are a part of your basis in the business. Generally, you recover costs for particular assets through depreciation deductions. However, you generally cannot recover other costs until you sell the business or otherwise go out of business.

Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Start-up costs include any amounts paid or incurred in connection with any activity engaged in for profit and for the production of income before the trade or business begins, in anticipation of the activity becoming an active trade or business.

You can elect to currently deduct a limited amount of business start-up costs paid or incurred after October 22, 2004. See Capital Expenses in chapter 4. If this election is made, any costs that are not currently deducted can be amortized.

Amortization period.   The amortization period for business start-up costs paid or incurred before October 23, 2004, is 60 months or more. For start-up costs paid or incurred after October 22, 2004, the amortization period is 180 months. The period starts with the month your active trade or business begins.

Reporting requirements.   To amortize your start-up costs that are not currently deductible under the election to deduct, complete Part VI of Form 4562 and attach a statement containing any required information. See the Instructions for Form 4562.

For more information, see Starting a Business in chapter 8 of Publication 535.

Reforestation Costs

You can elect to currently deduct a limited amount of qualifying reforestation costs for each qualified timber property. See Capital Expenses in chapter 4. You can elect to amortize over 84 months any amount not deducted. There is no annual limit on the amount you can elect to amortize. Reforestation costs are the direct costs of planting or seeding for forestation or reforestation.

Qualifying costs.   Qualifying costs include only those costs you must otherwise capitalize and include in the adjusted basis of the property. They include costs for the following items.
  • Site preparation.

  • Seeds or seedlings.

  • Labor.

  • Tools.

  • Depreciation on equipment used in planting and seeding.

  If the government reimburses you for reforestation costs under a cost-sharing program, you can amortize these costs only if you include the reimbursement in your income.

Qualified timber property.   Qualified timber property is property that contains trees in significant commercial quantities. It can be a woodlot or other site that you own or lease. The property qualifies only if it meets all the following requirements.
  • It is located in the United States.

  • It is held for the growing and cutting of timber you will either use in, or sell for use in, the commercial production of timber products.

  • It consists of at least one acre planted with tree seedlings in the manner normally used in forestation or reforestation.

  Qualified timber property does not include property on which you have planted shelter belts or ornamental trees, such as Christmas trees.

Amortization period.   The 84-month amortization period starts on the first day of the first month of the second half of the tax year you incur the costs (July 1 for a calendar year taxpayer), regardless of the month you actually incur the costs. You can claim amortization deductions for no more than 6 months of the first and last (eighth) tax years of the period.

How to make the election.   To elect to amortize qualifying reforestation costs, enter your deduction in Part VI of Form 4562. Attach a statement containing any required information. See the Instructions for Form 4562.

  Generally, you must make the election on a timely filed return (including extensions) for the year in which you incurred the costs. 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 6 months of the due date of your return (excluding extensions). Attach Form 4562 and the statement to the amended return and write “Filed pursuant to section 301.9100-2” on Form 4562. File the amended return at the same address you filed the original return.

  For additional information on reforestation costs, see chapter 8 of Publication 535.

Section 197 Intangibles

You must generally amortize over 15 years the capitalized costs of section 197 intangibles you acquired after August 10, 1993. You must amortize these costs if you hold the section 197 intangible in connection with your farming business or in an activity engaged in for the production of income. Your amortization deduction each year is the applicable part of the intangible's adjusted basis (for purposes of determining gain), figured by amortizing it ratably over 15 years (180 months). You are not allowed any other depreciation or amortization deduction for an amortizable section 197 intangible.

Section 197 intangibles include the following assets.

  • Goodwill.

  • Patents.

  • Copyrights.

  • Designs.

  • Formulas.

  • Licenses.

  • Permits.

  • Covenants not to compete.

  • Franchises.

  • Trademarks.

See chapter 8 in Publication 535 for more information, including a complete list of assets that are section 197 intangibles and special rules.


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