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IRS Publication 946, How To Depreciate Property



Publication 946 How To Depreciate Property
Depreciation: What’s New For 2020

Section 179 deduction dollar limits. For tax years beginning in 2020, the maximum section 179 expense deduction is $1,040,000 ($1,075,000 for qualified enterprise zone property). This limit is reduced by the amount by which the cost of section 179 property placed in service during the tax year exceeds $2,590,000.Also, the maximum section 179 expense deduction for sport utility vehicles placed in service in tax years beginning in 2020 is $25,900.

The increased section 179 deduction will not apply to qualified empowerment zone property placed in service after December 31, 2020.

Expiration of the special depreciation allowance for qualified second generation biofuel plant property. The special depreciation allowance will not apply to qualified second generation biofuel plant property placed in service after December 31, 2020.
Expiration of the treatment for certain race horses. The 3-year recovery period for race horses 2 years old or younger will not apply to horses placed in service after December 31, 2020.

Expiration of the treatment for qualified motorsports entertainment complexes. Qualified motorsports entertainment complexes placed in service after December 31, 2020, will not be treated as 7-year property under MACRS.

Expiration of the accelerated depreciation for qualified Indian reservation property. The accelerated recovery period for qualified Indian reservation property will not apply to property placed in service after December 31, 2020.

Depreciation: What’s New For 2019

Increased section 179 deduction dollar limits. The maximum you can elect to deduct for most section 179 property you placed in service in tax years beginning in 2019 is $1,020,000 ($1,055,000 for qualified enterprise zone property). This limit is reduced by the amount by which the cost of section 179 property placed in service during the tax year exceeds $2,550,000. See Dollar Limits in chapter 2.Also, the maximum section 179 expense deduction for sport utility vehicles placed in service in tax years beginning in 2019 is $25,500.

Second generation biofuel plant property. The special depreciation allowance has been extended to include qualified second generation biofuel plant property placed in service before January 1, 2021. See Qualified Second Generation Biofuel Plant Property in chapter 3.

Certain race horses. The 3-year recovery period has been extended for race horses 2 years old or younger placed in service before January 1, 2021. See Which Property Class Applies in chapter 4.

Qualified motorsports entertainment complexes. The 7-year recovery period has been extended for qualified motorsports entertainment complexes placed in service before January 1, 2021. See Which Property Class Applies in chapter 4.

Qualified Indian reservation property. The accelerated recovery period for qualified Indian reservation property has been extended for property placed in service before January 1, 2021. See Indian Reservation Property in chapter 4.

Depreciation limits on business vehicles. The total section 179 deduction and depreciation you can deduct for a passenger automobile, including a truck or van, you use in your business and first placed in service in 2019 is $10,100, if the special depreciation allowance does not apply. See Maximum Depreciation Deduction in chapter 5.

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.

1. Overview of Depreciation
Introduction

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 and answers the following questions.

  • What property can be depreciated?
  • What property cannot be depreciated?
  • When does depreciation begin and end?
  • What method can you use to depreciate your property?
  • What is the basis of your depreciable property?
  • How do you treat repairs and improvements?
  • Do you have to file Form 4562?
  • How do you correct depreciation deductions?
Useful Items – You May Want To See:

Publication

  • 534 Depreciating Property Placed in Service Before 1987
  • 535 Business Expenses
  • 538 Accounting Periods and Methods 
  • 551 Basis of Assets

Form (And Instructions)

  • Sch C (Form 1040 or 1040-SR) Profit or Loss From Business
  • 2106 Employee Business Expenses
  • 3115 Application for Change in Accounting Method
  • 4562 Depreciation and Amortization

See chapter 6 for information about getting publications and forms.

What Property Can Be Depreciated?

You can depreciate most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. You can also 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 1 year.

The following discussions provide information about these requirements.

Property You Own

To claim depreciation, you must usually 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

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, generally you 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 Repairs and Improvements later in this chapter, and Additions and Improvements under Which Recovery Period Applies in chapter 4.If you lease property to someone, you can generally depreciate its cost even if the lessee (the person leasing from you) has agreed to preserve, replace, renew, and maintain the property. However, if the lease provides that the lessee is to maintain the property and return to you the same property or its equivalent in value at the expiration of the lease in as good condition and value as when leased, you cannot depreciate the cost of the property.

Incidents Of Ownership

Incidents of ownership in property include the following:

  • The legal title to the property.
  • The legal obligation to pay for the property.
  • The responsibility to pay maintenance and operating expenses.
  • The duty to pay any taxes on the property.
  • The risk of loss if the property is destroyed, condemned, or diminished in value through obsolescence or exhaustion.

Life Tenant

Generally, if you hold business or investment property as a life tenant, you can depreciate it as if you were the absolute owner of the property. However, see Certain term interests in propertyunder Excepted Propertylater.

Cooperative Apartments

If you are a tenant–stockholder in a cooperative housing corporation and use your cooperative apartment in your business or for the production of income, you can depreciate your stock in the corporation, even though the corporation owns the apartment.

Figure your depreciation deduction as follows.

Figure the depreciation for all the depreciable real property owned by the corporation 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.

  1. Multiply your cost per share by the total number of outstanding shares, including any shares held by the corporation.
  2. Add to the amount figured in (a) any mortgage debt on the property on the date you bought the stock.
  3. 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.
  1. 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.
  2. Divide the number of your shares of stock by the total number of outstanding shares, including any shares held by the corporation.
  3. 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 (½ of $50,000).

Change To Business Use

Although you can combine business and investment use of property when figuring depreciation deductions, do not treat investment use as qualified business use when determining whether the business-use requirement for listed property is met. For information about qualified business use of listed property, see What Is the Business-Use Requirement in chapter 5.

Office In The Home

If you use part of your home as an office, you may be able to deduct depreciation on that part based on its business use. For information about depreciating your home office, see Pub. 587.

Inventory

You cannot depreciate inventory because it is not held for use in your business. Inventory is any property you hold primarily for sale to customers in the ordinary course of your business.

If you are a rent-to-own dealer, you may be able to 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

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 1 year and meet the following requirements.

  • They qualify as property used in your business.
    – Title to the containers does not pass to the buyer.

To determine if these requirements are met, consider the following questions.

  • Does your sales contract, sales invoice, or other type of order acknowledgment indicate whether you have retained title?
  • Does your invoice treat the containers as separate items?
  • Do any of your records state your basis in the containers?

Property Having a Determinable Useful Life

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

Property Lasting More Than One Year

To be depreciable, property must have a useful life that extends substantially beyond the year you place it in service.

Example

You maintain a library for use in your profession. You can depreciate it. However, if you buy technical books, journals, or information services for use in your business that have a useful life of 1 year or less, you cannot depreciate them. Instead, you deduct their cost as a business expense.

What Property Cannot Be Depreciated?

Certain property cannot be depreciated. This includes land and certain excepted property.

Land

You cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping.

Although you cannot depreciate land, you can depreciate certain land preparation costs, such as landscaping costs, incurred in preparing land for business use. These costs must be so closely associated with other depreciable property that you can determine a life for them along with the life of the associated property.

Example

You constructed a new building for use in your business and paid for grading, clearing, seeding, and planting bushes and trees. Some of the bushes and trees were planted right next to the building, while others were planted around the outer border of the lot. If you replace the building, you would have to destroy the bushes and trees right next to it. These bushes and trees are closely associated with the building, so they have a determinable useful life. Therefore, you can depreciate them. Add your other land preparation costs to the basis of your land because they have no determinable life and you cannot depreciate them.

Excepted Property

Even if the requirements explained in the preceding discussions are met, you cannot depreciate the following property:

– Property placed in service and disposed of in the same year. Determining when property is placed in service is explained later.
– Equipment used to build capital improvements. You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements. See Uniform Capitalization Rules in Pub. 551.Section 197 intangibles. You must amortize these costs.
– Section 197 intangibles are discussed in detail in chapter 8 of Pub. 535. Intangible property, such as certain computer software, that is not section 197 intangible property, can be depreciated if it meets certain requirements. See Intangible Property , later.
– Certain term interests.

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. 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.

For a description of related persons, see Related Persons , later. For this purpose, however, treat as related persons only the relationships listed in items (1) through (10) of that discussion and substitute “50%” for “10%” each place it appears.

Basis Adjustments.

If you would be allowed a depreciation deduction for a term interest in property except that the holder of the remainder interest is related to you, you must generally reduce your basis in the term interest by any depreciation or amortization not allowed.If you hold the remainder interest, you must generally 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?

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

Placed in Service

You place property in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.

Example 1.

Donald Steep bought a machine for his business. The machine was delivered last year. However, it was not installed and operational until this year. It is considered placed in service this year. If the machine had been ready and available for use when it was delivered, it would be considered placed in service last year even if it was not actually used until this year.

Example 2.

On April 6, Sue Thorn bought a house to use as residential rental property. She made several repairs and had it ready for rent on July 5. At that time, she began to advertise it for rent in the local newspaper. The house is considered placed in service in July when it was ready and available for rent. She can begin to depreciate it in July.

Example 3.

 James Elm is a building contractor who specializes in constructing office buildings. He bought a truck last year that had to be modified to lift materials to second-story levels. The installation of the lifting equipment was completed and James accepted delivery of the modified truck on January 10 of this year. The truck was placed in service on January 10, the date it was ready and available to perform the function for which it was bought.

Conversion To Business Use.

If you place property in service in a personal activity, you cannot claim depreciation. However, if you change the property’s use to use in a business or income-producing activity, then you can begin to depreciate it at the time of the change. You place the property in service in the business or income-producing activity on the date of the change.

Example.

You bought a home and used it as your personal home several years before you converted it to rental property. Although its specific use was personal and no depreciation was allowable, you placed the home in service when you began using it as your home. You can begin to claim depreciation in the year you converted it to rental property because its use changed to an income-producing use at that time.

Idle Property

Continue to claim a deduction for depreciation on property used in your business or for the production of income even if it is temporarily idle (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 fully recover your basis when your section 179 deduction, allowed or allowable depreciation deductions, and salvage value, if applicable, equal the cost or investment in the property. See What Is the Basis of Your Depreciable Property , later.

Retired From Service

You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events.

  • You sell or exchange the property.
  • You convert the property to personal use.
  • You abandon the property.
  • You transfer the property to a supplies or scrap account.
  • The property is destroyed.

If you included the property in a general asset account, see How Do You Use General Asset Accounts in chapter 4 for the rules that apply when you dispose of that property.

What Method Can You Use To Depreciate Your Property?

You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most property. MACRS is discussed in chapter 4.

  • You cannot use MACRS to depreciate the following property.
  • Property you placed in service before 1987.
  • Certain property owned or used in 1986.
  • Intangible property.
  • Films, video tapes, and recordings.
  • Certain corporate or partnership property acquired in a nontaxable transfer.
  • Property you elected to exclude from MACRS.

The following discussions describe the property listed above and explain what depreciation method should be used.

Property You Placed in Service Before 1987

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