Publication 225 |
2000 Tax Year |
General Information on Depreciation
The first part of this chapter gives you basic information on what
property can and cannot be depreciated, when to begin and end
depreciation, and how to claim depreciation.
What Can Be
Depreciated
You can depreciate property only if it meets all the following
requirements.
- It must be used in business or held for the production of
income.
- It must have a useful life that extends substantially beyond
the year it is placed in service.
- It must be something that wears out, decays, gets used up,
becomes obsolete, or loses value from natural causes.
Depreciable property may be tangible or intangible.
Tangible Property
Tangible property is property you can see or touch and includes
both real and personal property. Tangible personal property includes
machinery or equipment and anything else you can see or touch except
real property. Real property is land, buildings, and generally
anything built or constructed on land, growing on land, or attached to
land. However, land itself is never depreciable.
Livestock.
Livestock purchased for draft, breeding, or dairy purposes that is
not kept in an inventory account can be depreciated.
Raised livestock.
Livestock you raise usually has no depreciable basis because the
costs of raising them are deducted and not added to their basis.
However, if you purchase immature livestock for draft, dairy, or
breeding purposes, you can depreciate your initial costs when the
livestock reach the age when they can be worked, milked, or bred.
Irrigation systems and water wells.
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 make irrigation systems and water
wells composed of these materials. However, land preparation costs for
center pivot irrigation systems are not depreciable.
Partial business use.
If you use tangible property (including your car) for business or
investment purposes and for personal purposes, you can deduct
depreciation on the part used for business or investment.
For example, if you use your car for farm business, you can deduct
depreciation for the part you use in farming. If you also use it for
investment purposes, you can depreciate the part used for investment.
If you use part of your home for business, you may be able to take
a depreciation deduction for its business use. For more information,
see Business Use of Your Home in chapter 5.
Intangible Property
Intangible property is generally any property that has value but
you cannot see or touch. It includes items such as computer software,
copyrights, patents, franchises, trademarks, and trade names.
Computer software.
Computer software includes any program used to cause a computer to
perform a desired function. It also includes any data base or similar
item in the public domain and incidental to the operation of
qualifying software.
Generally, you can depreciate software over 36 months. However, if
you acquired the software in connection with the acquisition of a
substantial portion of a business, you can depreciate it over 36
months only if it meets the following requirements.
- It is readily available for purchase by the general
public.
- It is not subject to an exclusive license.
- It has not been substantially modified.
If you acquire software in connection with the acquisition of a
substantial portion of a business and it does not meet the
previous requirements, you must amortize it over 15 years (rather than
depreciate it). For more information on amortization, see
Amortization, later.
Computer software with a useful life of less than one year is
deductible as a current business expense.
Year 2000 costs.
Year 2000 costs are costs of converting or replacing computer
software to recognize dates beginning in the year 2000. They include
costs of the following.
- Manually converting existing software.
- Developing new software.
- Purchasing or leasing new software to replace existing
software.
- Developing or purchasing software tools to assist you in
converting your existing software.
Treat year 2000 costs as computer software for depreciation
purposes.
Any change in the treatment of year 2000 costs to allow them to be
treated as computer software for depreciation purposes is a change in
accounting method. If you want to make this type of change, follow the
automatic change procedures in Revenue Procedure 99-49 in
Internal Revenue Bulletin No. 1999-52.
Leased software.
If you lease software, treat the rental payments the same as any
other rental payments.
What Cannot Be
Depreciated
To determine if you can depreciate any item, you must know not only
what you can depreciate but what you cannot depreciate.
Property placed in service and disposed of in the same year.
You cannot depreciate property you place in service and dispose of
in the same year. Determining when property is placed in service is
explained later.
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
because these expenses are all part of the cost of the land itself.
For information on land preparation costs you may be able to
depreciate, see chapter 1 of Publication 946.
Dams, ponds, and terraces.
In general, you cannot depreciate earthen dams, ponds, and terraces
unless the structures have a determinable useful life.
Inventory.
You can never depreciate inventory. Inventory is any property you
hold primarily for sale to customers in the ordinary course of your
business.
Equipment used to build capital improvements.
You cannot deduct depreciation on equipment used to build your own
capital improvements. You must add depreciation on equipment used
during the period of construction to the basis of your improvements.
See Uniform Capitalization Rules in chapter 7.
Leased property.
You can depreciate leased property only if you retain the incidents
of ownership for the property (explained later). This means you bear
the burden of exhaustion of the capital investment in the property.
Therefore, if you lease property to use in your trade or business or
for the production of income, you cannot depreciate its cost. You can,
however, depreciate any capital improvements you make to the leased
property. See Additions or improvements to property in
chapter 3 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.
Incidents of ownership.
Incidents of ownership include the following.
- The legal title.
- The legal obligation to pay for it.
- The responsibility to pay its maintenance and operating
expenses.
- The duty to pay any taxes.
- The risk of loss if the property is destroyed, condemned, or
diminished in value through obsolescence or exhaustion.
Intangible property.
The following are two types of intangible property that you can
never depreciate.
Goodwill.
You can never depreciate goodwill because its useful life cannot be
determined.
However, if you acquired a business after August 10, 1993 (July 25,
1991, if elected), and part of the price included goodwill, you may be
able to amortize the cost of the goodwill over 15 years. For more
information, see Amortization, later.
Trademark or trade name.
In general, you cannot depreciate the cost of a trademark or trade
name. However, you may be able to amortize over 15 years the cost of a
trademark or trade name acquired after August 10, 1993 (after July 25,
1991, if elected). For more information, see Amortization,
later.
When Depreciation
Begins and Ends
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
For depreciation purposes, property is placed in service when it is
ready and available for a specific use, whether in a trade or
business, the production of income, 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.
You bought a home and used it as your personal home for 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 claim a depreciation deduction in the year you converted it to
rental property because its use changed to an income-producing use at
that time. The property is residential rental property and is
depreciated over 27.5 years under the General Depreciation System
(GDS) using the straight line method.
Example 2.
You bought a planter for your farm business late in the year after
harvest was over. You can take a depreciation deduction for the
planter for that year because it was ready and available for its
specific use.
Cost or other basis fully recovered.
You have fully recovered your cost or other basis when you have
taken section 179 and depreciation deductions equal to your cost or
investment in the property.
Retired From Service
You stop depreciating property when you retire it from service. You
retire property from service when you permanently withdraw it from use
in a trade or business or in the production of income.
You retire property from service in the following ways.
- Sale or exchange.
- Abandonment.
- Destruction.
For information on abandonment of property, see chapter 10.
For
information on destroyed property, see chapter 13.
Incorrect Amount of Depreciation Deducted
If you deducted an incorrect amount of depreciation in any year,
you may be able to make a correction by filing an amended return. See
Amended Return, later. 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 Changing Your
Accounting Method, later.
Basis adjustment.
Even if you do not claim depreciation you are entitled to deduct,
you must reduce the basis of the property by the full amount of
depreciation you were entitled to deduct. If you deduct more
depreciation than you should have, you must decrease your basis by any
amount deducted from which you received a tax benefit.
Amended Return
If you deducted an incorrect amount of depreciation, you can file
an amended return to correct the following.
- A mathematical error made in any year.
- A posting error made in any year (for example, omitting an
asset from the depreciation schedule).
- The depreciation for property for which you have not adopted
a method of accounting.
You must file the amended return by the later of the following.
- 3 years from the date you filed your original return for the
year in which you deducted the incorrect amount.
- 2 years from the time you paid your tax for that
year.
A return filed early is considered filed on the due date.
Two or more consecutive returns.
If you deducted an incorrect amount of depreciation for the
property on two or more consecutively filed tax returns, you have
adopted a method of accounting for that property. Once you have
adopted a method of accounting, you cannot change the method by filing
amended returns. You must change your method of accounting.
Changing Your
Accounting Method
When you deduct an incorrect amount of depreciation on two or more
consecutively filed tax returns, you can claim the correct amount only
by changing your method of accounting for depreciation. You can then
take into account any unclaimed or excess depreciation from years
before the year of change.
Approval required.
You must get IRS approval to change your method of accounting. File
Form 3115,
Application for Change in
Accounting Method, to request a change to a permissible method
of accounting for the depreciation. Revenue Procedure 97-27 in
Cumulative Bulletin 1997-1 gives general instructions for
getting approval. Cumulative Bulletins are available at many libraries
and IRS offices. There is a user fee for changing your method of
accounting under Revenue Procedure 97-27.
Automatic approval.
You may be able to get automatic approval from the IRS to change
your method of accounting if you used an unallowable method of
accounting for depreciation in at least the 2 years immediately before
the year of change and the property for which you are changing the
method meets all the following conditions.
- It is property for which, under your unallowable method of
accounting, you claimed either no depreciation or an incorrect
amount.
- It is property for which you figured depreciation using one
of the following.
- Pre-1981 rules.
- Accelerated Cost Recovery System (ACRS).
- Modified Accelerated Cost Recovery System (MACRS).
- It is property you owned at the beginning of the year of
change.
File Form 3115 to request a change to a permissible method of
accounting for depreciation. Revenue Procedure 99-49 and section
2.01 of its Appendix, which can be found in Internal Revenue Bulletin
No. 1999-52, have instructions for getting automatic approval
and list exceptions to the automatic approval procedures.
Exceptions.
You generally cannot use the automatic approval procedure in any of
the following situations.
- You are under examination by the IRS.
- You are before a federal court or an appeals office for any
income tax issue and the method of accounting for depreciation to be
changed is an issue under consideration by the federal court or
appeals office.
- You are correcting a mathematical or posting error. See
Amended Return, earlier.
- During the last five years (including the year of change),
you changed the same method of accounting for depreciation (with or
without obtaining IRS approval).
- During the last five years (including the year of change),
you filed a Form 3115 to change the same method of accounting for
depreciation but did not make the change because the Form 3115 was
withdrawn, not perfected, denied, or not granted.
Also, see other exceptions listed in section 4.02 of Revenue
Procedure 99-49 and section 2.01(2)(b) in the Appendix of this
revenue procedure.
How To Claim Depreciation
Use Form 4562 to claim depreciation and amortization
deductions and to elect the section 179 deduction, discussed next.
Amortization is discussed later. For more information on completing
Form 4562, refer to its instructions.
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 records of the depreciated property. They will
help you verify the accuracy of the information on Form 4562. 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.
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