Cost Recovery

You can usually "recover" your cost for capital expenses--subtract them from income--over a number of years. Each year a part of your basis is recovered through depreciation or amortization. Use depreciation to recover capital expenses for most tangible business assets. Use amortization to recover the cost of intangible assets, such as start-up costs. Amortization is discussed further in chapter 9 of Publication 535.

Under certain circumstances, you may be able to treat a limited amount of the cost of qualifying property as a current expense rather than a capital expense. This is called the "section 179 deduction," discussed next.

Form 4562. Generally, use Form 4562 to report depreciation, amortization, and the section 179 deduction. Form 4562 is illustrated in an example in Publication 946.

Section 179 Deduction

You can elect to deduct all or part of the cost of certain qualifying property in the year you place it in service. Property is placed in service when it is ready and available for a specific use.

Qualifying property. Qualifying property includes tangible personal property for which depreciation is allowable. See chapter 2 in Publication 946 for more information.

Maximum dollar limit. The total section 179 cost you can choose to deduct for 2000 is $20,000.

If the total cost of qualifying property is less than $20,000, your section 179 deduction cannot be more than the cost of the property.

The maximum section 179 deduction increases to $24,000 in 2001 and $25,000 in 2003.

Taxable income limit. The total cost you can deduct each year is further limited to the taxable income from the active conduct of any trade or business during the year.

Any cost not deductible in one year because of this limit can be carried to the next tax year.

More information. For more information, see chapter 2 in Publication 946.

Depreciation

If you do not choose a section 179 deduction or you choose a section 179 deduction and do not recover all your cost, you can take a depreciation deduction for part or all of the cost you did not claim as a section 179 deduction.

Property whose cost can be recovered through depreciation is depreciable property. Depreciable property may be tangible or intangible. Intangible property is commonly amortized.

1. Tangible property is property you can see or touch and includes both real and personal property.
   1. Real property is land and generally anything built on land, growing on land, or attached to land. However, land itself is never depreciable.
   2. Personal property is property that is not real property, such as a car, truck, or office equipment.
2. Intangible property generally has value but you cannot see or touch it. Intangible property includes items such as copyrights, franchises, trademarks, and trade names.

You can depreciate property if it meets the following requirements.

• It is used in business or held for the production of income.
• It is something that wears out, decays, gets used up, becomes obsolete, or loses value from natural causes.
• It is expected to last more than one year. In other words, it has a useful life that extends substantially beyond the year it is placed in service.

You must use the modified accelerated cost recovery system (MACRS) for most tangible depreciable property placed in service after 1986.

For more information about the depreciation of property placed in service after 1986, see Publication 946. It contains a detailed discussion of MACRS.

For more information about property placed in service before 1987, see Publication 534, Depreciating Property Placed in Service Before 1987.

Listed Property

Listed property includes property which lends itself to personal use such as transportation or entertainment equipment, certain computers and cellular phones. There are additional recordkeeping requirements and rules you must follow when depreciating listed property. If listed property is not used more than 50% for a qualified business use during any tax year, special rules apply to the section 179 deduction and the depreciation deduction. See chapter 4 in Publication 946.

Passenger automobiles. For passenger automobiles, the total depreciation deduction (including the section 179 deduction) you can claim is limited.

For automobiles placed in service during 2000, your depreciation, including the section 179 deduction, cannot be more than $3,060. For 2001 and 2002, the maximum depreciation deduction is $4,900 and $2,950, respectively. The maximum depreciation deduction for each year after 2002 is $1,775.

You must reduce these limits further if your business/investment use is less than 100%.

Example. Peter purchases a car this year for $4,500 and he uses it 60% for business. He chooses to take a section 179 deduction for the car. The cost of Peter's car that qualifies for the section 179 deduction is $2,700 ($4,500 x 60%). However, Peter's section 179 deduction is limited to $1,836 ($3,060 x 60%).

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