What Can Be Depreciated

You can depreciate many different kinds of property, for example, machinery, buildings, vehicles, patents, copyrights, furniture, and equipment.

You can depreciate property only if it meets all the following requirements.

• It must be used in business or held to produce income.
• It must be expected to last more than one year. In other words, 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 its value from natural causes.

Tangible Property

Words you may need to know (see Glossary):

• Basis
• Business/investment use
• Capitalized
• Commuting
• Useful life

Tangible property is property you can see or touch and includes both real and personal property. You can take a depreciation deduction only for the part of tangible property that wears out, decays, gets used up, becomes obsolete, or loses its value due to natural causes. Because nearly all tangible property loses value due to these causes, this discussion will focus on rules for depreciating property under certain circumstances.

Partial Business Use

If you use tangible property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the business/investment use. Personal use of a car, for example, would include commuting, personal shopping trips, family vacations, and driving children to and from school and other activities.

You must keep records showing the business, investment, and personal use of your property. For more information on the records you must keep for listed property, such as a car, see What Records Must Be Kept in chapter 4.

Special Situations

You can depreciate some property only under certain circumstances. The following discussions will help you determine whether you can depreciate property in these cases.

Land preparation costs. You cannot depreciate land. However, you can depreciate certain costs (such as landscaping) 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. Because these bushes and trees are closely associated with the building, they have a determinable useful life. Therefore, you can depreciate them as land preparation costs. Add your other land preparation costs to the basis of your land because they have no determinable life and you cannot depreciate them.

Repair or improvement. If a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, it is an improvement. You must capitalize and depreciate the cost of the improvement. If the repair or replacement does not increase the value of your property, make it more useful, or lengthen its life, it is a repair. You deduct the cost of the repair in the same way as any other business expense.

Example. If you completely replace the roof of a rental house, it is an improvement because the new roof increases the value and lengthens the life of the property. You must capitalize and depreciate it. However, if you repair a small section on one corner of the roof, deduct the repair expense.

Improvements to rented property. You can depreciate permanent improvements you make to rented business property. For more information, see Additions or improvements to property under Property Classes and Recovery Periods in chapter 3.

Durable containers. You can depreciate containers used to ship your products if the containers meet the following requirements.

• They have a life longer than one year.
• They qualify as property used in your business.
• Title to the containers does not pass to the buyer.

To determine if these requirements apply and whether you can depreciate your containers, 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?

Professional libraries. If you maintain a library for use in your profession, you can depreciate it. However, you can deduct as a business expense the cost of any technical books, journals, or information services you use in your business that have a useful life of one year or less.

Videocassettes. If you are in the business of renting videocassettes, you can depreciate only those videocassettes bought for rental. You depreciate them using one of the following methods.

• Straight line method. (The straight line method is explained later under Intangible Property.)
• Income forecast method.

The income forecast method requires income projections for each videocassette or group of videocassettes. You figure the depreciation by applying a fraction to the cost less the salvage value of the cassette. The numerator is the income from the videocassette for the tax year and the denominator is the total projected income for the cassette. For more information on the income forecast method, see Revenue Ruling 60-358 in Cumulative Bulletin 1960-2.

If the videocassette has a useful life of one year or less, you can deduct the cost as a business expense.

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

Cooperative apartments. If you use your cooperative apartment in your business or for the production of income, you can deduct your share of the cooperative housing corporation's depreciation.

If you bought your stock as part of its first offering, figure your depreciation deduction as a tenant-stockholder as follows.

1. Figure the depreciation for all the depreciable real property owned by the corporation.
2. 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. The result is the reduced yearly depreciation.
3. Divide the number of your shares of stock by the total number of shares outstanding, including any shares held by the corporation.
4. Multiply the reduced yearly depreciation (2) by the percentage you figured in (3). This is your share of the depreciation.

If you bought your cooperative stock after its first offering, figure the basis of the depreciable real property to use in (1) above as follows.

1. Multiply your cost per share by the total number of outstanding shares.
2. Add to the amount figured in (1) any mortgage debt on the property on the date you bought the stock.
3. Subtract from the amount figured in (2) any mortgage debt that is not for the depreciable real property, such as the part for the land.

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.

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 year cannot be more than $25,000, which is 1/2 of $50,000.

Change to business use. If you change your cooperative apartment to business use, figure your allowable depreciation as explained earlier. If you bought the stock as part of its first offering, your depreciable basis in all the depreciable real property owned by the cooperative housing corporation is the smaller of the following.

• The fair market value on the date you change your apartment to business use.
• The corporation's adjusted basis on that date.

Do not subtract depreciation when figuring the adjusted basis. The fair market value is normally the same as the corporation's adjusted basis minus straight line depreciation, unless this value is unrealistic. See Straight Line Method, later.

For a discussion of fair market value and adjusted basis, see Publication 551.

Intangible Property

Words you may need to know (see Glossary):

• Adjusted basis
• Basis
• Capitalized
• Goodwill
• Patent
• Salvage value
• Straight line method
• Useful life

Intangible property is property that has value but cannot be seen or touched. Generally, you can either amortize or depreciate intangible property.

You must amortize certain intangible property over 15 years if you meet the following conditions.

• You acquired the property after August 10,1993, (after July 25, 1991, if elected).
• You use the property in connection with a business or for the production of income.

If you meet these conditions, amortize the following intangibles.

1. Patents and copyrights.
2. Customer or subscription lists, location contracts, and insurance expirations.
3. Designs and patterns.
4. Franchises.
5. Agreements not to compete.

If you created any of the intangibles listed in items (1) through (3), you can amortize them only if you created them in connection with the acquisition of assets constituting a trade or business or a substantial part of a trade or business.

For more information on amortizing these and other intangibles, see chapter 9 in Publication 535.

Generally, you can depreciate any of these intangibles acquired before August 11, 1993, or that do not qualify for amortization. However, they must have a determinable useful life.

Agreements not to compete, lists, contracts, and expirations are sometimes confused with goodwill, which is not depreciable. Therefore, you must be able to determine their value separately from the value of any goodwill that goes with the business.

If you can depreciate the cost of a patent or copyright, you can use the straight line method over the useful life. The useful life of a patent or copyright is the lesser of the life granted to it by the government or the remaining life. If it becomes valueless before the end of its useful life, you can deduct in that year any of its remaining cost or other basis.

Computer software. Computer software includes all programs designed to cause a computer to perform a desired function. Computer software 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 all 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 acquired it in connection with the acquisition of a substantial portion of a business and it does not meet all the requirements listed above, you must amortize it over 15 years (rather than depreciate it).

Software leased. If you lease software, you can treat the rental payments in the same manner you treat any other rental payments.

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 in accounting method provisions of Revenue Procedure 99-49 in Internal Revenue Bulletin No. 1999-52.

Straight Line Method

Generally, if you can depreciate intangible property, you use the straight line method of depreciation. It lets you deduct the same amount of depreciation each year.

To figure your deduction, first determine the adjusted basis, salvage value, and estimated useful life of your property. Subtract the salvage value, if any, from the adjusted basis. The balance is the total depreciation you can take over the useful life of the property.

Divide the balance by the number of years in the useful life. This gives you your yearly depreciation deduction. Unless there is a big change in adjusted basis or useful life, this amount will stay the same throughout the time you depreciate the property. If, in the first year, you use the property for less than a full year, you must prorate your depreciation deduction for the number of months in use.

Example. In April, Frank bought a patent for $5,100. It was not acquired in connection with the acquisition of any part of a trade or business. He depreciates the patent under the straight line method, using a 17-year useful life and no salvage value. He divides the $5,100 basis by 17 years ($5,100 x 17 = $300) to get his yearly depreciation deduction. Because he only used the patent for 9 months during the year, he multiplies $300 by 9/12 to get his deduction of $225. Next year, Frank can deduct $300 for the full year.

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