When Does Depreciation Begin and End?

You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first.

Placed in Service

Property is placed in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.

Example 1.   You bought a home and used it as your personal home for several years before you converted it to rental property. Although its specific use was personal and no depreciation was allowable, you placed the home in service when you began using it as your home. You can begin to claim depreciation in the year you converted it to rental property because its use changed to an income-producing use at that time.

Example 2.   You bought a planter for use in your farm business. The planter was delivered in December 2002 after harvest was over. You begin to depreciate the planter for 2002 because it was ready and available for its specific use in 2002, even though it will not be used until the spring of 2003.

Example 3.   If your planter comes unassembled in December 2002 and is put together in February 2003, it is not placed in service until 2003. You begin to depreciate it in 2003.

Example 4.   If your planter was delivered and assembled in February 2003 but not used until April 2003, it is placed in service in February 2003, because this is when the planter was ready for its specified use.

Fruit or nut trees and vines.   If you acquire an orchard, grove, or vineyard before the trees or vines have reached the income-producing stage, and they have a preproductive period of more than 2 years, you must capitalize the preproductive-period costs under the uniform capitalization rules (unless you elect not to use these rules). See chapter 7 for information about the uniform capitalization rules. Your depreciation begins when the trees and vines reach the income-producing stage.

Immature livestock.   If you acquire immature livestock for draft, dairy, or breeding purposes, your depreciation begins when they reach maturity. This means depreciation begins when the livestock reach the age when they can be worked, milked, or bred. When this occurs, your basis for depreciation is your initial cost for the immature livestock.

Idle Property

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

Cost or Other Basis Fully Recovered

You stop depreciating property when you have fully recovered your cost or other basis. This happens when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property.

Retired From Service

You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events.

• You sell or exchange the property.
• You convert the property to personal use.
• You abandon the property.
• You transfer the property to a supplies or scrap account.
• The property is destroyed.

For information on abandonment of property, see chapter 10. For information on destroyed property, see chapter 13.

Can You Use MACRS To Depreciate Your Property?

You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most property. MACRS is explained later under Figuring Depreciation Under MACRS. This part discusses the kinds of property that cannot be depreciated under MACRS and must be depreciated using other methods.

You cannot use MACRS to depreciate the following property.

• Property you placed in service before 1987.
• Certain property owned or used in 1986.
• Intangible property.
• Films, video tapes, and recordings.
• Certain corporate or partnership property acquired in a nontaxable transfer.
• Property you elected to exclude from MACRS.

If your property is not described in the above list, figure the depreciation using MACRS.

Property You Placed in Service Before 1987

You cannot use MACRS for property you placed in service before 1987 (except property you placed in service after July 31, 1986, if MACRS was elected). Property placed in service before 1987 must be depreciated under the methods discussed in Publication 534, Depreciating Property Placed in Service Before 1987.

Use of real property changed.   You generally must use MACRS to depreciate real property you acquired for personal use before 1987 and changed to business or income-producing use after 1986.

Property Owned or Used in 1986

Under special rules, you may not be able to use MACRS for property you acquired and placed in service after 1986. These rules apply to both personal and real property owned or used before 1987. If you cannot use MACRS, the property must be depreciated under the methods discussed in Publication 534. For specific information, see chapter 1 in Publication 946.

Election To Exclude Property From MACRS

If you can properly depreciate any property under a method not based on a term of years, such as the unit-of-production method, you can elect to exclude that property from MACRS. You make the election by reporting your depreciation for the property on line 15 in Part II of Form 4562 and attaching a statement as described in the instructions for Form 4562. You must make this election by the return due date (including extensions) for the year you place your property in service. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Attach the election to the amended return and write Filed pursuant to section 301.9100-2 on the election statement. File the amended return at the same address you filed the original return.

Use of standard mileage rate.   If you use the standard mileage rate to figure your tax deduction for your business automobile, you are treated as having made an election to exclude the automobile from MACRS. See Publication 463 for a discussion of the standard mileage rate.

What Is the Basis of Your Depreciable Property?

To figure your depreciation deduction, you must determine the basis of your property. To determine basis, you need to know the cost or other basis of your property.

Cost as basis.   The basis of property you buy is its cost plus amounts you paid for items such as sales tax, freight charges, and installation and testing fees. The cost includes the amount you pay in cash, debt obligations, other property, or services.

Other basis.   Other basis refers to basis that is determined by the way you received the property. For example, your basis is other than cost if you acquired the property as a gift or as an inheritance. If you acquired property in this or some other way, see chapter 7 to determine your basis.

Property changed from personal use.   If you held property for personal use and later use it in your business or income-producing activity, your depreciable basis is the lesser of the following.

1. The fair market value (FMV) of the property on the date of the change in use.
2. Your original cost or other basis adjusted as follows.
   1. Increased by the cost of any permanent improvements or additions and other costs that must be added to basis.
   2. Decreased by any tax deductions you claimed for casualty and theft losses and other items that reduced your basis.

Adjusted basis.   To find your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service. These events could include the following.

• Installing utility lines.
• Paying legal fees for perfecting the title.
• Settling zoning issues.
• Receiving rebates.
• Incurring a casualty or theft loss.

For a discussion of adjustments to the basis of your property, see Adjusted Basis in chapter 7.

How Do You Treat Improvements?

If you improve depreciable property, you must treat the improvement as separate depreciable property. For more information on improvements, see Publication 946.

Repairs.   You generally deduct the cost of repairing business property in the same way as any other business expense. However, if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it.

Improvements to rented property.   You can depreciate permanent improvements you make to business property you rent from someone else.

Do You Have To File Form 4562?

You must complete and attach Form 4562 to your tax return if you are claiming certain items, including any of the following.

• A section 179 deduction for the current year or a section 179 carryover from a prior year. The section 179 deduction is discussed later.
• Depreciation for property placed in service during the current year.
• Depreciation on any vehicle or other listed property, regardless of when it was placed in service. Listed property is discussed later.
• Amortization of costs that began in the current year. Amortization is discussed later.

For more information on whether you must file Form 4562, refer to its instructions.

It is important to keep good records for property you depreciate. Do not file these records with your return. Instead, you should keep them as part of the records of the depreciated property. They will help you verify the accuracy of the information on Form 4562. For general information on recordkeeping, see Publication 583, Starting a Business and Keeping Records. For specific information on keeping records for section 179 property and listed property, see Publication 946.

How Do You Correct Depreciation Deductions?

If you deducted an incorrect amount of depreciation in any year, you may be able to make a correction by filing an amended return for that year. See Filing an Amended Return, later. If you are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of depreciation. See Changing Your Accounting Method, later.

Basis adjustment.   Even if you do not claim depreciation you are entitled to deduct, you must reduce the basis of the property by the full amount of depreciation you were entitled to deduct. If you deduct more depreciation than you should have, you must reduce your basis by any amount deducted from which you received a tax benefit.

Filing an Amended Return

You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations.

• You claimed the incorrect amount because of a mathematical error made in any year.
• You claimed the incorrect amount because of a posting error made in any year (for example, omitting an asset from the depreciation schedule).
• You have not adopted a method of accounting for the property.

You have adopted a method of accounting for the property if you deducted an incorrect amount of depreciation for it on two or more consecutively filed tax returns for reasons other than a mathematical or posting error.

When to file.   If an amended return is allowed, you must file it by the later of the following dates.

• 3 years from the date you filed your original return for the year in which you deducted the incorrect amount. (A return filed early is considered filed on the due date.)
• 2 years from the time you paid your tax for that year.

Changing Your Accounting Method

If you deducted an incorrect amount of depreciation for property on two or more consecutively filed tax returns, you have adopted a method of accounting for that property. You can claim the correct amount of depreciation only by changing your method of accounting for depreciation for that property. You can then take into account any unclaimed or excess depreciation from years before the year of change.

Approval required.   You must get IRS approval to change your method of accounting. File Form 3115, Application for Change in Accounting Method, to request a change to a permissible method of accounting for the depreciation. Revenue Procedure 97-27 in Cumulative Bulletin 1997-1 gives general instructions for getting approval.

Automatic approval.   You may be able to get automatic approval from the IRS to change your method of accounting if you used an unallowable method of accounting for depreciation in at least the 2 years immediately before the year of change and the property for which you are changing the method meets all the following conditions.

1. It is property for which, under your unallowable method of accounting, you claimed either no depreciation or an incorrect amount.
2. It is property for which you figured depreciation using one of the following.
   1. Pre-1981 rules.
   2. Accelerated Cost Recovery System (ACRS).
   3. Modified Accelerated Cost Recovery System (MACRS).
3. It is property you owned at the beginning of the year of change.

File Form 3115 to request a change to a permissible method of accounting for depreciation. File Form 3115 with your return for the year of change by the due date of the return (including extensions). Revenue Procedure 2002-9 and section 2.01 of its Appendix in Internal Revenue Bulletin No. 2002-3 have additional instructions for getting automatic approval and list exceptions to the automatic approval procedures.

Example.   In March 2002, you placed in service for your farming business, property that was qualified for the special depreciation allowance. On April 15, 2003, you filed your 2002 income tax return and paid taxes you owed for 2002. You did not claim the special depreciation allowance for the property and did not make the election not to claim the allowance. You can claim the special allowance by filing an amended 2002 return before or at the same time you file your 2003 return. If you do not file an amended 2002 return at that time, you can claim the special depreciation allowance only by filing a Form 3115 with your 2004 return under the automatic approval procedures (assuming you qualify).

Exceptions.   You generally cannot use the automatic approval procedures in any of the following situations.

• You are under examination by the IRS.
• During the last 5 years (including the year of change), you changed the same method of accounting for depreciation (with or without obtaining IRS approval).
• During the last 5 years (including the year of change), you filed a Form 3115 to change the same method of accounting for depreciation but did not make the change because the Form 3115 was withdrawn, not perfected, denied, or not granted.

Also, see other exceptions listed in section 4.02 of Revenue Procedure 2002-9 and section 2.01(2)(c) in the Appendix of this revenue procedure.

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