What Cannot Be Depreciated

To determine if you are entitled to depreciation, 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. When you place property in service is explained later.

Tangible Property

Words you may need to know (see Glossary):

• Basis
• Remainder interest
• Term interest
• Useful life

The following are types of tangible property that you generally cannot depreciate, even though you use them in your business or hold them to produce income.

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 Land preparation costs under What Can Be Depreciated, earlier.

Inventory. You can never depreciate inventory. Inventory is any property you hold primarily for sale to customers in the ordinary course of your business.

In some cases, it is not clear whether property is inventory or depreciable business property. If it is unclear, examine carefully all the facts in the operation of the particular business. The following example shows two similar situations where a careful examination of the facts in each situation 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.

If you are a rent-to-own dealer, see Rent-to-own dealer under Property Classes and Recovery Periods in chapter 3.

Containers. Generally, containers are part of inventory and you cannot depreciate them. For information on containers you can depreciate, see Durable containers under What Can Be Depreciated, earlier.

More information. For more information on inventory, see Inventories in Publication 538.

Equipment used to build capital improvements. You cannot deduct depreciation on equipment you are using 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 Publication 551.

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 from someone to use in your trade or business or for the production of income, you generally 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 Additions or improvements to property in chapter 3.

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, 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 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.

Term interests in property. Generally, you cannot take a deduction for depreciation on 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 person related to you includes the following.

• Your spouse, child, parent, brother, sister, half-brother, half-sister, ancestor, or lineal descendant.
• A corporation in which you or a family member own (directly or indirectly) more than 50% of the outstanding stock.
• Certain educational and charitable organizations controlled (directly or indirectly) by you or a family member.
• A partnership in which you or a family member own (directly or indirectly) any capital or profits interests.
• An S corporation in which you or a family member own (directly or indirectly) any stock.

You cannot take a deduction for depreciation or amortization for a life or term interest acquired by gift, bequest, or inheritance.

Basis adjustments. If, except for this provision, you would be allowed a depreciation deduction for any term interest in property, reduce your basis in the property by any depreciation or amortization not allowed.

The holder of the remainder interest generally increases his or her basis in a remainder interest in property by the depreciation not allowed. However, do not increase the basis of a remainder interest for depreciation not allowed for periods during which either of the following apply.

• It is held by an organization exempt from tax.
• It 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.

The basis adjustment rules do not apply to any term or life interest acquired by gift, bequest, or inheritance.

Exceptions. The above rules do not apply to the holder of dividend rights which were separated from any stripped preferred stock 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 that purchaser.

Intangible Property

Words you may need to know (see Glossary):

• Goodwill
• Useful life

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 (after 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 chapter 9 in Publication 535.

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 you acquired after August 10, 1993 (after July 25, 1991, if elected). For more information, see chapter 9 in Publication 535.

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