Words you may need to know (see Glossary):

• Adjusted basis
• Business/investment use
• Capitalized
• Commuting
• Fair market value (FMV)
• Nonresidential real property
• Placed in service
• Recapture
• Recovery period
• Straight line method

The business-use limits apply to listed property not used predominantly (more than 50% of its total use) for qualified business use. Under this limit, the following rules apply.

• Property not used predominantly for qualified business use during the year it is placed in service does not qualify for the section 179 deduction.
• Any depreciation deduction under MACRS for property not used predominantly for qualified business use during any year must be figured using the straight-line method over the ADS recovery period. This rule applies each year of the recovery period.
• Excess depreciation on property previously used predominantly for qualified business use must be recaptured (included in income) in the first year in which it is no longer used predominantly for qualified business use.
• A lessee must include an amount in income if the leased property is not used predominantly for qualified business use.

Being required to use the straight line method for an item of listed property not used predominantly for qualified business use is not the same as electing the straight line method. It does not mean that you have to use the straight line method for other property in the same class as the item of listed property.

Exception for leased property. The business-use limits generally do not apply to any listed property leased or held for leasing by anyone regularly engaged in the business of leasing listed property.

You are considered regularly engaged in the business of leasing listed property only if you enter into contracts for the leasing of listed property with some frequency over a continuous period of time. This determination is made on the basis of the facts and circumstances in each case and takes into account the nature of your business in its entirety. Occasional or incidental leasing activity is insufficient. For example, if you lease only one passenger automobile during a tax year, you are not regularly engaged in the business of leasing automobiles. An employer who allows an employee to use the employer's property for personal purposes and charges the employee for the use is not regularly engaged in the business of leasing the property used by the employee.

How To Allocate Use

To determine whether the business-use limits apply, you must allocate the use of any item of listed property used for more than one purpose during the year among its various uses.

For passenger automobiles and other means of transportation, allocate the property's use on the basis of mileage. You determine the percentage of qualified business use by dividing the number of miles you drove the vehicle for business purposes during the year by the total number of miles you drove the vehicle for all purposes (including business miles) during the year.

For other items of listed property, allocate the property's use on the basis of the most appropriate unit of time. For example, you can determine the percentage of business use of a computer by dividing the number of hours you used the computer for business purposes during the year by the total number of hours you used the computer for all purposes (including business use) during the year.

Entertainment use. Treat the use of listed property for entertainment, recreation, or amusement purposes as a business use only to the extent you can deduct expenses (other than interest and property tax expenses) due to its use as an ordinary and necessary business expense.

Commuting use. The use of an automobile for commuting is not business use, regardless of whether work is performed during the trip. For example, a business telephone call made on a car telephone while commuting to work does not change the character of the trip from commuting to business. This is also true for a business meeting held in a car while commuting to work. Similarly, a business call made on an otherwise personal trip does not change the character of a trip from personal to business. The fact that an automobile is used to display material that advertises the owner or user's trade or business does not convert an otherwise personal use into business use.

Use of your automobile by another person. If someone else uses your automobile, do not treat that use as business use unless one of the following conditions applies.

1. That use is directly connected with your business.
2. You properly report the value of the use as income to the other person and withhold tax on the income where required.
3. You are paid a fair market rent.

Treat any payment to you for the use of the automobile as a rent payment for purposes of item (3).

Employee deductions. If you are an employee, do not treat your use of listed property as business use unless it is for your employer's convenience and is required as a condition of your employment. See Does the Limit for Employee's Apply, earlier.

Qualified Business Use

Qualified business use of listed property is any use of the property in your trade or business. However, it does not include the following uses.

• The leasing of property to any 5% owner or related person (to the extent the property is used by a 5% owner or person related to the owner or lessee of the property).
• The use of property as pay for the services of a 5% owner or related person.
• The use of property as pay for services of any person (other than a 5% owner or related person), unless the value of the use is included in that person's gross income and income tax is withheld on that amount where required.

Property does not stop being used predominantly for qualified business use because of a transfer at death.

Exception for leasing or compensatory use of aircraft. Treat the leasing or compensatory use of any aircraft by a 5% owner or related person as a qualified business use if at least 25% of the total use of the aircraft during the year is for a qualified business use.

5% owner. Generally, a 5% owner is any person who owns more than 5% of the capital or profits interest in the business.

A 5% owner of a corporation is any person who owns, or is considered to own, either of the following.

• More than 5% of the outstanding stock of the corporation.
• Stock possessing more than 5% of the total combined voting power of all stock in the corporation.

Related persons. For a description of related persons, see the discussion on pre-1987-use property under Can You Use MACRS To Depreciate Your Property? in chapter 1. For this purpose, however, treat as related persons only the relationships listed in items (1) through (9) of that discussion and substitute "50%" for "10%" each place it appears.

Examples. The following examples illustrate whether the use of business property is qualified business use.

Example 1. John Maple is the sole proprietor of a plumbing contracting business. John employs his brother, Richard, in the business. As part of Richard's pay, he is allowed to use one of the company automobiles for personal use. The company includes the value of the personal use of the automobile in Richard's gross income and properly withholds tax on it. Because the use of the automobile is pay for the performance of services by a related person, it is not a qualified business use.

Example 2. John, in Example 1, allows unrelated employees to use company automobiles for personal purposes. He does not include the value of the personal use of the company automobiles as part of their compensation and he does not withhold tax on the value of the use of the automobiles. This use of company automobiles by employees is not a qualified business use.

Example 3. James Company Inc., owns several automobiles that its employees use for business purposes. The employees are also allowed to take the automobiles home at night. The fair market value of each employee's use of an automobile for any personal purpose, such as commuting to and from work, is reported as income to the employee and James Company withholds tax on it. This use of company automobiles by employees, even for personal purposes, is a qualified business use for the company.

Investment Use

The use of property to produce income in a nonbusiness activity (investment use) is not a qualified business use. However, you can treat the investment use as business use to figure the depreciation deduction for the property in a given year.

Example 1. Sarah Bradley uses a home computer 50% of the time to manage her investments. She also uses the computer 40% of the time in her part-time consumer research business. Sarah's home computer is listed property because it is not used at a regular business establishment. Because she does not use the computer predominantly for qualified business use, she cannot elect a section 179 deduction for the computer and must depreciate it using the straight line method over the ADS recovery period. (Her combined rate of business/investment use for determining her depreciation deduction is 90%.)

Example 2. If Sarah uses her computer 30% of the time to manage her investments and 60% of the time in her consumer research business, it is used predominantly for qualified business use. She can elect a section 179 deduction and, if she does not deduct all the computer's cost, she can depreciate it using the 200% declining balance method over the GDS recovery period. (Her combined business/investment use for determining her depreciation deduction is 90%.)

Recapture of Excess Depreciation

If you used listed property predominantly for qualified business use in the year you placed it in service, you must recapture (include in income) excess depreciation in the first year you do not use it predominantly for qualified business use. You also increase the adjusted basis of your property by the same amount.

Excess depreciation is:

1. The depreciation allowable for the property (including any section 179 deduction claimed) for years before the first year you do not use the property predominantly for qualified business use, minus
2. The depreciation that would have been allowable for those years if you had not used the property predominantly for qualified business use in the year you placed it in service.

To determine the amount in (2) above, you must refigure the depreciation using the straight line method and the ADS recovery period.

Example. In June 1997, Ellen Rye purchased and placed in service a pickup truck that cost $18,000. She used it only for qualified business use for 1997 through 2000. Ellen claimed a section 179 deduction of $10,000 based on the purchase of the truck. She began depreciating it using the 200% DB method over a 5-year GDS recovery period. (Because the pickup truck weighed over 6,000 pounds, it was not subject to the passenger automobile limits discussed later under Do the Passenger Automobile Limits Apply.) During 2001, she used the truck 50% for business and 50% for personal purposes. She includes $4,018 excess depreciation in her gross income for 2001. The excess depreciation is determined as follows.

Total section 179 deduction ($10,000) and depreciation claimed ($6,618). (Depreciation is from Table A-1.)			$16,618
Minus: Depreciation allowable (Table A-8):
1997 - 10% of $18,000		$1,800
1998 - 20% of $18,000		3,600
1999 - 20% of $18,000		3,600
2000 - 20% of $18,000		3,600	12,600
Excess depreciation			$4,018

If Ellen's use of the truck does not change to 50% for business and 50% for personal purposes until 2003, there will be no excess depreciation. The total depreciation allowable using Table A-8 through 2003 will be $18,000, which equals the total of the section 179 deduction and depreciation she will have claimed.

Where to figure and report recapture. Use Form 4797, Part IV, to figure the recapture amount. Report the recapture amount as "other income" on the same form or schedule on which you took the depreciation deduction. For example, report the recapture amount as "other income" on Schedule C (Form 1040) if you took the depreciation deduction on Schedule C. If you took the depreciation deduction on Form 2106, report the recapture amount as "other income" on Form 1040, line 21.

Lessee's Inclusion Amount

If you use leased listed property other than a passenger automobile for business/investment use, you must include an amount in your income in the first year your qualified business-use percentage is 50% or less. Your qualified business-use percentage is the part of the property's total use that is qualified business use (defined earlier).

For the inclusion amount rules for a leased passenger automobile, see Leasing a Car in chapter 4 of Publication 463.

The inclusion amount is the sum of amount A and amount B, described next. However, see the special rules for the inclusion amount, later, if your lease begins in the last 9 months of your tax year or is for less than one year.

Amount A. Amount A is:

1. The fair market value of the property, multiplied by
2. The business/investment use for the first tax year the qualified business-use percentage is 50% or less, multiplied by
3. The applicable percentage from Table A-19 in Appendix A.

The fair market value of the property is the value on the first day of the lease term. If the capitalized cost of an item of listed property is specified in the lease agreement, you must treat that amount as the fair market value.

Amount B. Amount B is:

1. The fair market value of the property, multiplied by
2. The average of the business/investment use for all tax years the property was leased that precede the first tax year the qualified business-use percentage is 50% or less, multiplied by
3. The applicable percentage from Table A-20 in Appendix A.

Maximum inclusion amount. The inclusion amount cannot be more than the sum of the deductible amounts of rent for the tax year in which the lessee must include the amount in gross income.

Inclusion amount worksheet. The following worksheet is provided to help you figure the inclusion amount for leased listed property.

Inclusion Amount Worksheet
for Leased Listed Property

1.	Fair market value
2.	Business/investment use for first year business use is 50% or less
3.	Multiply line 1 by line 2.
4.	Rate (%) from Table A-19
5.	Multiply line 3 by line 4. This is Amount A.
6.	Fair market value
7.	Average business/investment use for years property leased before the first year business use is 50% or less
8.	Multiply line 6 by line 7
9.	Rate (%) from Table A-20
10.	Multiply line 8 by line 9. This is Amount B.
11.	Add line 5 and line 10. This is your inclusion amount. Enter here and as "Other income" on the form or schedule on which you originally took the deduction (for example, Schedule C or F (Form 1040), Form 1040, Form 1120, etc.)

Example. On February 1, 1999, Larry House, a calendar year taxpayer, leased and placed in service a computer with a fair market value of $3,000. The lease is for a period of five years. Because Larry does not use the computer at a regular business establishment, it is listed property. His business use of the property (all of which is qualified business use) is 80% in 1999, 60% in 2000, and 40% in 2001. He must add an inclusion amount to gross income for 2001, the first tax year his qualified business-use percentage is 50% or less. The computer has a 5-year recovery period under both GDS and ADS. Because 2001 is the third tax year of the lease, the applicable percentage from Table A-19 is -19.8%. The applicable percentage from Table A-20 is 22.0%. Larry's deductible rent for the computer for 2001 is $800.

Larry uses the Inclusion Amount Worksheet for Leased Listed Property to figure the amount he must include in income for 2001. His inclusion amount is $224, which is the sum of -$238 (Amount A) and $462 (Amount B).

Inclusion Amount Worksheet
for Leased Listed Property

1.	Fair market value	$3,000
2.	Business/investment use for first year business use is 50% or less	40	%
3.	Multiply line 1 by line 2.	1,200
4.	Rate (%) from Table A-19	-19.8	%
5.	Multiply line 3 by line 4. This is Amount A.	-238
6.	Fair market value	3,000
7.	Average business/investment use for years property leased before the first year business use is 50% or less	70	%
8.	Multiply line 6 by line 7	2,100
9.	Rate (%) from Table A-20	22.0	%
10.	Multiply line 8 by line 9. This is Amount B.	462
11.	Add line 5 and line 10. This is your inclusion amount. Enter here and as "Other income" on the form or schedule on which you originally took the deduction (for example, Schedule C or F (Form 1040), Form 1040, Form 1120, etc.)	$224

Lease beginning in the last 9 months of your tax year. Add the inclusion amount to income in the next tax year if all the following apply.

• The lease term begins within 9 months before the close of your tax year.
• You do not use the property predominantly for qualified business use during that part of the tax year.
• The lease term continues into your next tax year.

Figure the inclusion amount by taking into account the average of the business/investment use for both tax years (line 2 of the Inclusion Amount Worksheet for Leased Listed Property) and the applicable percentage for the tax year the lease term begins. (Skip lines 6 through 9 of the worksheet and enter zero on line 10.)

Example 1. On August 1, 2000, Julie Rule, a calendar year taxpayer, leased and placed in service an item of listed property. The property is 5-year property with a fair market value of $10,000. Her property has a recovery period of 5 years under the ADS method. The lease is for 5 years. Her business use of the property was 50% in 2000 and 90% in 2001. She paid rent of $3,600 for 2001, of which $3,240 is deductible. She must include $147 in income in 2001. The $147 is the sum of Amount A and Amount B. Amount A is $147 ($10,000 × 70% × 2.1%), the product of the fair market value, the average business use for 2000 and 2001, and the applicable percentage for year one from Table A-19. Amount B is zero.

Lease for less than one year. If the lease term is less than one year and you do not use the property predominantly for qualified business use, the amount included in income is the inclusion amount (figured as described in the preceding discussions) multiplied by a fraction. The numerator of the fraction is the number of days in the lease term and the denominator is 365.

The lease term for listed property other than residential rental or nonresidential real property includes options to renew. If you have two or more successive leases that are part of the same transaction (or a series of related transactions) for the same or substantially similar property, treat them as one lease.

Example 2. On October 1, 2000, John Joyce, a calendar year taxpayer, leased and placed in service an item of listed property that is 3-year property. This property had a fair market value of $15,000 and a recovery period of 5 years under the ADS method. The lease term was 6 months (ending on March 31, 2001), during which he used the property 45% in business. He must include $71 in income in 2001. The $71 is the sum of Amount A and Amount B. Amount A is $71 ($15,000 × 45% × 2.1% × 182/365), the product of the fair market value, the average business use for both years, and the applicable percentage for year one from Table A-19, prorated for the length of the lease. Amount B is zero.

Where to report inclusion amount. Report the inclusion amount figured as described in the preceding discussions as "other income" on the same form or schedule on which you took the deduction for your rental costs. For example, report the inclusion amount as "other income" on Schedule C (Form 1040) if you took the deduction on Schedule C. (If you took the deduction for rental costs on Form 2106, report the inclusion amount as "other income" on Form 1040, line 21.)

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