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Taxmap/pub17/p17-050.htm#TXMP47fb5c3f Depreciation

Depreciation

You recover your cost in income producing property through yearly tax deductions. You do this by depreciating the property; that is, by deducting some of your cost on your tax return each year.

Three basic factors determine how much depreciation you can deduct. They are: (1) your basis in the property, (2) the recovery period for the property, and (3) the depreciation method used. You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures and equipment, as an expense.

You can deduct depreciation only on the part of your property used for rental purposes. Depreciation reduces your basis for figuring gain or loss on a later sale or exchange.

You may have to use Form 4562 to figure and report your depreciation. See How To Report Rental Income and Expenses, later.

Taxmap/pub17/p17-050.htm#TXMP06700ebd Claiming the correct amount of depreciation.

Claiming the correct amount of depreciation.

You should claim the correct amount of depreciation each tax year. Even if you did not claim depreciation that you were entitled to deduct, you must still reduce your basis in the property by the full amount of depreciation that you could have deducted. If you did not deduct the correct amount of depreciation for property in any year, you may be able to make a correction for that year by filing Form 1040X, Amended U.S Individual Income Tax Return. If you are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of depreciation. See Claiming the correct amount of depreciation in Publication 527 for more information.

Taxmap/pub17/p17-050.htm#TXMP704a9359 Changing your accounting method to deduct unclaimed depreciation.

To change your accounting method, you must file Form 3115, Application for Change in Accounting Method, to get the consent of the IRS. In some instances, you can receive automatic consent. For more information, see chapter 1 of Publication 946.

Taxmap/pub17/p17-050.htm#TXMP71173c6e Land.

Land.

You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The costs of clearing, grading, planting, and landscaping are usually all part of the cost of land and cannot be depreciated.

Taxmap/pub17/p17-050.htm#TXMP4a86fcdb Depreciation Methods

Depreciation, Method

There are three ways to figure depreciation. The depreciation method you use depends on the type of property and when it was placed in service. For property used in rental activities you use one of the following.

• MACRS (Modified Accelerated Cost Recovery System) for property placed in service after 1986.
• ACRS (Accelerated Cost Recovery System) for property placed in service after 1980 but before 1987.
• Useful lives and either straight line or an accelerated method of depreciation, such as the declining balance method, for property placed in service before 1981.

This chapter discusses MACRS only. If you need more information about depreciating property placed in service before 1987, see Publication 534.

If you placed property in service before 2004, continue to use the same method of figuring depreciation that you used in the past.

Taxmap/pub17/p17-050.htm#TXMP055b434f Section 179 election.

Section 179 election

You cannot claim the section 179 deduction for property held to produce rental income. See chapter 2 of Publication 946.

Taxmap/pub17/p17-050.htm#TXMP1d8b8f4f No deduction greater than basis.

No deduction greater than basis.

The total of all your yearly depreciation deductions cannot be more than the cost or other basis of the property. For this purpose, your yearly depreciation deductions include any depreciation that you were allowed to claim, even if you did not claim it.

Taxmap/pub17/p17-050.htm#TXMP28500490 Cooperative apartments.

Cooperative apartment.

If you are a tenant-stockholder in a cooperative housing corporation and rent your cooperative apartment to others, you can deduct depreciation for your stock in the corporation. Your depreciation deduction is your share of the corporation's depreciation. See Cooperative apartments in Publication 527 for information on how to figure your depreciation deduction.

Taxmap/pub17/p17-050.htm#TXMP5d73a69e Special Depreciation Allowance

Special Depreciation Allowance

You can claim a special depreciation allowance (in addition to your regular MACRS depreciation deduction) for qualified property you placed in service in 2004. The allowance is 50% of the property's depreciable basis. You figure the special depreciation allowance before you figure your regular MACRS deduction.

Taxmap/pub17/p17-050.htm#TXMP3f8ddfe9 Electing to claim a lower or no special depreciation allowance.

Electing to claim a lower or no special depreciation allowance.

You can elect, for any class of property, to deduct the 30% (instead of 50%) special allowance for all property in such class placed in service during the tax year. Or, you can elect not to deduct any special allowance for all property in such class placed in service during the tax year.

Taxmap/pub17/p17-050.htm#TXMP159aa0aa Qualified property.

Qualified Property

To qualify for the special depreciation allowance, your property must meet the following requirements.

1. It must be new property that is depreciated under MACRS with a recovery period of 20 years or less.
2. It must meet the following tests.
   1. Acquisition date test.
   2. Placed-in-service date test.
   3. Original use test.

Taxmap/pub17/p17-050.htm#TXMP16643f99 Acquisition date test.

Generally, you must have acquired the property after September 10, 2001 (after May 5, 2003, to be eligible for the 50% special depreciation allowance).

Taxmap/pub17/p17-050.htm#TXMP6e9957d2 Placed-in-service date test.

Placed-in-service date test.

Generally, the property must be placed in service for use in your trade or business or for the production of income after September 10, 2001 (after May 5, 2003, to be eligible for the 50% special depreciation allowance), and before January 1, 2005.

Taxmap/pub17/p17-050.htm#TXMP51804a8f Original use test.

The original use of the property must have begun with you after September 10, 2001 (after May 5, 2003, to be eligible for the 50% special depreciation allowance). "Original use" means the first use to which the property is put, whether or not by you.

Taxmap/pub17/p17-050.htm#TXMP62e94134
Example.

Dave bought and placed in service a new refrigerator ($700) for one of his residential rental properties in 2004. Dave notes that the refrigerator has a 5-year recovery period (see Table 10-1). Dave's refrigerator is qualifying property and he claims the 50% special depreciation allowance.

Dave determines the total depreciable basis of the property to be $700. Next, he multiplies this amount by 50% to figure his special depreciation allowance deduction of $350 ($700 × 50%). This leaves an adjusted basis of $350 ($700 − $350), which he will use to figure his MACRS deduction.

For more information, see Special Depreciation Allowance in Publication 946.

Taxmap/pub17/p17-050.htm#TXMP24323620 MACRS

MACRS

Most business and investment property placed in service after 1986 is depreciated using MACRS.

MACRS consists of two systems that determine how you depreciate your property—the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). GDS is used to figure your depreciation deduction for property used in most rental activities, unless you elect ADS.

To figure your MACRS deduction, you need to know the following information about your property:

• Its recovery period,
• Its placed-in-service date, and
• Its depreciable basis.

Taxmap/pub17/p17-050.htm#TXMP26a7a128 Personal home changed to rental use.

Rental of Home

You must use MACRS to figure the depreciation on property you used as your home and changed to rental property in 2004.

Taxmap/pub17/p17-050.htm#TXMP6520099c Excluded property.

Excluded property.

You cannot use MACRS for certain personal property placed in service in your rental property in 2004 if it had been previously placed in service before MACRS became effective.

In addition, you may elect to exclude certain property from the application of MACRS. See Publication 946 for more information.

Taxmap/pub17/p17-050.htm#TXMP239c615d Recovery Periods Under GDS

Recovery Periods Under GDS

Each item of property that can be depreciated is assigned to a property class. The recovery period of the property depends on the class the property is in. Under GDS, the recovery period of an asset is generally the same as its property class. The property classes under GDS are:

• 3-year property,
• 5-year property,
• 7-year property,
• 10-year property,
• 15-year property,
• 20-year property,
• Nonresidential real property, and
• Residential rental property.

Recovery periods for property used in rental activities are shown in Table 10-1.

The class to which property is assigned is determined by its class life. Class lives and recovery periods for most assets are listed in Appendix B in Publication 946.

Taxmap/pub17/p17-050.htm#TXMP58360387 Additions or improvements to property.

Additions or improvements to property.

Treat depreciable additions or improvements you make to any property as separate property items for depreciation purposes. The recovery period for an addition or improvement to property begins on the later of:

• The date the addition or improvement is placed in service, or
• The date the property to which the addition or improvement was made is placed in service.

The property class and recovery period of the addition or improvement is the one that would apply to the original property if it were placed in service at the same time as the addition or improvement.

Taxmap/pub17/p17-050.htm#TXMP6f723584
Example.

You own a residential rental house that you have been renting since 1986 and that you are depreciating under ACRS. You put an addition onto the house and you placed it in service in 2004. You must use MACRS for the addition. Under GDS, the addition is depreciated as residential rental property over 27.5 years.

Taxmap/pub17/p17-050.htm#TXMP6431d831 Placed-in-Service Date

Placed-in-Service Date

You can begin to depreciate property when you place it in service in your trade or business or for the production of income. Property is considered placed in service in a rental activity when it is ready and available for a specific use in that activity.

Taxmap/pub17/p17-050.htm#TXMP11eb6ec0 Depreciable Basis

Depreciable Basis

To deduct the proper amount of depreciation each year, you must first determine your basis in the property you intend to depreciate. The basis used for figuring depreciation is your original basis in the property increased by any additions or improvements made to the property. Your original basis is usually your cost. However, if you acquire the property in some other way, such as by inheriting it, getting it as a gift, or building it yourself, you may have to figure your original basis in another way. Other adjustments could also affect your basis. See chapter 14.

Taxmap/pub17/p17-050.htm#TXMP4dd1e7a7 Conventions

Conventions

Under MACRS, 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.

Taxmap/pub17/p17-050.htm#TXMP0a8a0318 Mid-month convention.

A mid-month convention is used for all residential rental property and nonresidential real property. Under this convention, you treat all property placed in service, or disposed of, during any month as placed in service, or disposed of, at the midpoint of that month.

Taxmap/pub17/p17-050.htm#TXMP1440091c Mid-quarter convention.

A mid-quarter convention must be used if the mid-month convention does not apply and the total depreciable basis of MACRS property you placed in service in the last 3 months of a tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) is more than 40% of the total basis of all such property you place in service during the tax year.

Taxmap/pub17/p17-050.htm#TXMP0ec44a87 Half-year convention.

The half-year convention is used if neither the mid-quarter convention nor the mid-month convention applies. Under this convention, you treat all property placed in service, or disposed of, during a tax year as placed in service, or disposed of, at the midpoint of that tax year.

If this convention applies, you deduct a half-year of depreciation for the first year and the last year that you depreciate the property. You deduct a full year of depreciation for any other year during the recovery period.

Taxmap/pub17/p17-050.htm#TXMP3c91f25f

Under this convention, you treat all property placed in service, or disposed of, during any quarter of a tax year as placed in service, or disposed of, at the midpoint of the quarter.

Taxmap/pub17/p17-050.htm#TXMP7daf5158
Example.

During the tax year, Jordan Gregory purchased the following items to use in his rental property. He elects not to claim the special depreciation allowance, discussed earlier.

• A dishwasher for $400, that he placed in service in January.
• Used furniture for $100, that he placed in service in September.
• A refrigerator for $500, that he placed in service in October.

Jordan uses the calendar year as his tax year. The total basis of all property placed in service in that year is $1,000. The $500 basis of the refrigerator placed in service during the last 3 months of his tax year exceeds $400 (40% × $1,000). Jordan must use the mid-quarter convention instead of the half-year convention for all three items.

Taxmap/pub17/p17-050.htm#TXMP4d56dc4d MACRS Depreciation Under GDS

MACRS Depreciation Under GDS

You can figure your MACRS depreciation deduction under GDS in one of two ways. The deduction is substantially the same both ways. (The difference, if any, is slight.) You can either:

• Use the percentage from the optional MACRS tables, see Table 10-2, or
• Actually figure the deduction using the depreciation method and convention that apply over the recovery period of the property.

Publication 946 discusses computing depreciation using the proper method and convention.

Taxmap/pub17/p17-050.htm#TXMP3272d48a Using the Optional Tables

You can use the tables in Table 10-2 to compute annual depreciation under MACRS. The tables show the percentages for the first 6 years. The percentages in Tables 10-2-A, 10-2-B, and 10-2-C make the change from declining balance to straight line in the year that straight line will yield a larger deduction. See Appendix A of Publication 946 for complete tables.

If you elect to use the straight line method for 5-, 7-, or 15-year property, or the 150% declining balance method for 5- or 7-year property, use the tables in Appendix A of Publication 946.

Figure any special depreciation allowance on qualified property before using Table 10-2-A, 10-2-B, or 10-2-C, or the 5-, 7-, or 15-year property tables in Appendix A of Publication 946.

Taxmap/pub17/p17-050.htm#TXMP481b250d How to use the tables.

The following section explains how to use the optional tables.

Figure the depreciation deduction by multiplying your unadjusted basis in the property by the percentage shown in the appropriate table. Your unadjusted basis is your depreciable basis without reduction for MACRS depreciation previously claimed.

Once you begin using an optional table to figure depreciation, you must continue to use it for the entire recovery period unless there is an adjustment to the basis of your property for a reason other than:

1. Depreciation allowed or allowable, or
2. An addition or improvement that is depreciated as a separate item of property.

If there is an adjustment for a reason other than (1) or (2) (for example, because of a deductible casualty loss), you can no longer use the table. For the year of the adjustment and for the remaining recovery period, figure depreciation using the property's adjusted basis at the end of the year and the appropriate depreciation method, as explained in MACRS Depreciation Under GDS in Publication 527.

Taxmap/pub17/p17-050.htm#TXMP2c1211d0 Tables 10-2-A, 10-2-B, and 10-2-C.

The percentages in these tables take into account the half-year and mid-quarter conventions. Use Table 10-2-A for 5-year property, Table 10-2-B for 7-year property, and Table 10-2-C for 15-year property. Use the percentage in the second column (half-year convention) unless you must use the mid-quarter convention (explained earlier). If you must use the mid-quarter convention, use the column that corresponds to the calendar year quarter in which you placed the property in service.

Taxmap/pub17/p17-050.htm#TXMP12609011
Example 1.

You purchased a stove and refrigerator and placed them in service in June. Your basis in the stove is $600 and your basis in the refrigerator is $1,000. After figuring the 50% special depreciation allowance your basis in the stove is $300 and your basis in the refrigerator is $500. Both are 5-year property. Using the half-year convention column in Table 10-2-A, you find the depreciation percentage for year 1 is 20%. For that year, your depreciation deduction is $60 ($300 × .20) for the stove and $100 ($500 × .20) for the refrigerator.

For year 2, you find your depreciation percentage is 32%. That year's depreciation deduction will be $96 ($300 × .32) for the stove and $160 ($500 × .32) for the refrigerator.

Taxmap/pub17/p17-050.htm#TXMP2ef6a5ad
Example 2.

Assume the same facts as in Example 1, except you buy the refrigerator in October instead of June. You must use the mid-quarter convention to figure depreciation on the stove and refrigerator. The refrigerator was placed in service in the last 3 months of the tax year and its basis ($1,000) is more than 40% of the total basis of all property placed in service during the year ($1,600 × .40 = $640).

Because you placed the refrigerator in service in October, you use the fourth quarter column of Table 10-2-A and find that the depreciation percentage for year 1 is 5%. Your depreciation deduction for the refrigerator (after figuring the special depreciation allowance) is $25 ($500 × .05).

Because you placed the stove in service in June, you use the second quarter column of Table 10-2-A and find that the depreciation percentage for year 1 is 25%. For that year, your depreciation deduction for the stove (after figuring the special depreciation allowance) is $75 ($300 × .25).

Taxmap/pub17/p17-050.htm#TXMP7a76933c Table 10-2-D.

Use this table for residential rental property. Find the row for the month that you placed the property in service. Use the percentages listed for that month to figure your depreciation deduction. The mid-month convention is taken into account in the percentages shown in the table.

Taxmap/pub17/p17-050.htm#TXMP498f9629
Example.

You purchased a single family rental house and placed it in service in February. Your basis in the house is $160,000. Using Table 10-2-D, you find that the percentage for property placed in service in February of year 1 is 3.182%. That year's depreciation deduction is $5,091 ($160,000 × .03182).

Taxmap/pub17/p17-050.htm#TXMP16128bed MACRS Depreciation   Under ADS

MACRS Depreciation Under ADS

If you choose, you can use the ADS method for most property. Under ADS, you use the straight line method of depreciation.

Table 10-1 shows the recovery periods for property used in rental activities that you depreciate under ADS. See Appendix B in Publication 946 for other property. If your property is not listed, it is considered to have no class life. Under ADS, personal property with no class life is depreciated using a recovery period of 12 years.

Use the mid-month convention for residential rental property and nonresidential real property. For all other property, use the half-year or mid-quarter convention.

Taxmap/pub17/p17-050.htm#TXMP64102709 Election.

Election.

For property placed in service during 2004, you choose to use ADS by entering the depreciation on Form 4562, Part III, line 20.

The election of ADS for one item in a class of property generally applies to all property in that class that is placed in service during the tax year of the election. However, the election applies on a property-by-property basis for residential rental property and nonresidential real property.

Once you choose to use ADS, you cannot change your election.

Taxmap/pub17/p17-050.htm#TXMP06fd4a80 Other Rules About   Depreciable Property

Rules About Depreciable Property

In addition to the rules about what methods you can use, there are other rules you should be aware of with respect to depreciable property.

Taxmap/pub17/p17-050.htm#TXMP64f87fb2 Gain from disposition.

Gain from disposition.

If you dispose of depreciable property at a gain, you may have to report, as ordinary income, all or part of the gain. See Publication 544, Sales and Other Dispositions of Assets.

Taxmap/pub17/p17-050.htm#TXMP33fcea8a Alternative minimum tax.

Alternative Minimum Tax

If you use accelerated depreciation, you may have to file Form 6251. Accelerated depreciation can be determined under MACRS, ACRS, and any other method that allows you to deduct more depreciation than you could deduct using a straight line method.

Previous Page:  Publication 17 - Your Federal Income Tax - Personal Use of Dwelling Unit (Including Vacation Home) Next Page:  Publication 17 - Your Federal Income Tax - Limits on Rental Losses Use     to find additional instances of index items.