Dispositions

Words you may need to know (see Glossary):

• Exchange

A disposition is the permanent withdrawal of property from use in your trade or business or in the production of income. A withdrawal can be made by sale, exchange, retirement, abandonment, involuntary conversion, or destruction. You generally recognize gain or loss when you sell property. However, nonrecognition rules may allow you to postpone some gain. See Publication 544.

For information on dispositions from a general asset account, see Dispositions and Conversions under General Asset Accounts, later.

Early Dispositions

Words you may need to know (see Glossary):

• Clean-fuel vehicle
• Clean-fuel vehicle refueling property
• Convention
• Nonresidential real property
• Placed in service
• Recovery period
• Residential rental property

If you dispose of your property before the end of its recovery period, it is called an early disposition. If you dispose of property depreciated under MACRS, you are allowed a depreciation deduction for the year of disposition. Determine your depreciation deduction for the year of disposition by using the convention (discussed earlier) used when the property was placed in service.

Mid-Month Convention Used

If you dispose of residential rental or nonresidential real property, you base your depreciation deduction for the year of disposition on the number of months in the year of disposal that the property was in service. Under the mid-month convention, you treat property disposed of anytime during a month as disposed of in the middle of that month. Count the month of disposition as half a month of service.

You determine the depreciation to claim by determining the depreciation for the year and then multiplying it by a fraction. The numerator of the fraction is the number of months (including partial months) in the year that the property is considered in service. The denominator is 12.

Example. On July 2, 1998, you purchased and placed in service residential rental property. The property cost $100,000, not including the cost of land. You file your tax return based on the calendar year. You used Table A-6 to figure your MACRS depreciation for this property. You sold the property on March 2, 2000.

A full year of depreciation for 2000 is $3,636. This is $100,000 multiplied by .03636 (the percentage for the seventh month of the third recovery year) from Table A-6. You then apply the mid-month convention for the 2 1/2 months of use in 2000. Multiply $3,636 by 2.5 and divide by 12 to get your 2000 depreciation deduction of $757.50.

Property placed in service in short tax year. If you placed property in service in a short tax year, how you figure depreciation in the year of disposal depends on whether you are using the simplified method or the allocation method.

Simplified method. If you are using the simplified method, you figure depreciation in the year of disposal by figuring depreciation for an entire year and then multiplying that amount by a fraction. The numerator of the fraction is the number of months (including parts of months) the property is in service in the year. The denominator is 12.

Allocation method. If you are using the allocation method, you figure depreciation for each recovery year that is included in the tax year. You multiply the depreciation figured for each recovery year by a fraction. The numerator of the fraction is the number of months (including parts of months) the property was in service in the tax year. The denominator is 12. If there is more than one recovery year in the tax year, you add together the depreciation for each recovery year.

Half-Year Convention Used

For property for which you used a half-year convention, the deduction for the year of disposition is half the depreciation determined for the full year.

Property placed in service in full tax year and disposed of in short tax year. If you dispose of property in a short tax year, you must determine the midpoint of the year. See Half-year convention, earlier, under MACRS Deduction in Short Tax Year for how to determine the midpoint of a short tax year applying the half-year convention.

Property placed in service in a short tax year and disposed of in a later short tax year. If you dispose of property in a short tax year that you had placed in service in an earlier short tax year, how you figure depreciation in the year of disposal depends on whether you are using the simplified method or the allocation method. First you must figure the midpoint of the tax year of disposal. See Half-year convention, earlier, under MACRS Deduction in Short Tax Year for how to determine the midpoint of a short tax year applying the half-year convention. See Simplified method or Allocation method, earlier, for how to figure depreciation for the tax year of disposal.

Mid-Quarter Convention Used

For property for which you used the mid-quarter convention, you must first determine the depreciation for the full year. Then you multiply the depreciation by the applicable percentage for the quarter of the tax year you disposed of the property. The percentages to use for each quarter of the tax year are shown in the following table.

Property placed in service in full tax year and disposed of in short tax year. If you dispose of property in a short tax year, you must determine both the quarter in which you dispose of the property and the midpoint of that quarter. See Mid-quarter convention, earlier, under MACRS Deduction in Short Tax Year for how to determine the midpoint of a quarter in a short tax year.

Property placed in service in a short tax year and disposed of in a later short tax year. If you dispose of property in a short tax year that you had placed in service in an earlier short tax year, how you figure depreciation in the year of disposal depends on whether you are using the simplified method or the allocation method. First you must figure the quarter in which you disposed of the property and the midpoint of that quarter. See Mid-quarter convention, earlier, under MACRS Deduction in Short Tax Year for how to determine the midpoint of a quarter in a short tax year. See Simplified method or Allocation method, earlier, for how to figure depreciation for the tax year of disposal.

Example. On December 2, 1998, you placed an item of 5-year property in service in your business. The property cost $10,000 and you did not claim a section 179 deduction. Your basis for the property is $10,000. You must use the mid-quarter convention because this is the only item of business property you placed in service in 1998 and it was placed in service during the last 3 months of your tax year. Because your property is in the 5-year property class, you used Table A-5 to figure your depreciation deduction. Your deductions for 1998 and 1999 were $500 (5% of $10,000) and $3,800 (38% of $10,000). If you dispose of the property on April 6, 2000, figure your 2000 depreciation using the mid-quarter convention. First figure the deduction for the full year, which is $2,280 (22.8% of $10,000). Since April is in the second quarter of the year, you multiply $2,280 by 37.5% to get your depreciation deduction of $855 for 2000.

Depreciation Recapture

With the exception of gain on the disposition of residential rental and nonresidential real property, all gain on the disposition of property depreciated under MACRS is recaptured (included in income) as ordinary income up to the amount of previously allowed depreciation deducted for the property. Depreciation for this purpose includes any section 179 deduction claimed on the property and any deduction claimed for clean-fuel vehicles and clean-fuel vehicle refueling property. There is no recapture for residential rental and nonresidential real property. For more information on depreciation recapture, see Publication 544.

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