Section 179 deduction.    The section 179 deduction is treated as a depreciation deduction. If you place a car in service in 2000, use it only for business, and choose the section 179 deduction, the combined section 179 and depreciation deduction for that car for 2000 is limited to $3,060.

Example.   On September 4, 2000, Jack bought a used car for $10,000 and placed it in service. He used it 80% for his business and he chooses to take a section 179 deduction for the car.

Before applying the limit, Jack figures his maximum section 179 deduction to be $8,000. This is the cost of his qualifying property (up to the maximum $20,000 amount) multiplied by his business use ($10,000 × 80%).

Jack then figures that his section 179 deduction for 2000 is limited to $2,448 (80% of $3,060). He then has an unadjusted basis of $5,552 [($10,000 × 80%) - $2,448] for determining his depreciation deduction. Since he has already reached the maximum limit for 2000, Jack will use the unadjusted basis to figure his depreciation deduction for 2001.

Deductions in years after the recovery period.    If the depreciation limits apply to your car, you may have unrecovered basis in your car at the end of the recovery period. If you continue to use your car for business, you can deduct that unrecovered basis after the recovery period ends.

Unrecovered basis.   This is your cost or other basis in the car reduced by any clean-fuel vehicle deduction, electric vehicle credit, and depreciation and section 179 deductions that would have been allowable if you had used the car 100% for business and investment use.

The recovery period.   For 5-year property, your recovery period is 6 calendar years. A part year's depreciation is allowed in the first calendar year, a full year's depreciation is allowed in each of the next 4 calendar years, and a part year's depreciation is allowed in the 6th calendar year.

Your recovery period is the same whether you use MACRS, declining balance, or straight line depreciation. Under MACRS, you determine your unrecovered basis in the 7th year after you placed the car in service.

How to treat unrecovered basis.   If you continue to use your car for business after the recovery period, you can claim a depreciation deduction for that business use in each succeeding tax year until you recover your full basis in the car. The maximum amount you can deduct is determined by the date you placed the car in service and your business-use percentage. For example, no deduction is allowed for a year you use your car 100% for personal purposes.

Example.   In May 1994, Bob bought and placed in service a car that he used exclusively in his business. The car cost $28,600. Bob did not claim a section 179 deduction for the car. He continued to use the car 100% in his business throughout the recovery period (1994 through 1999). For those years, Bob used Table 3 and the Maximum Depreciation Limits for Cars table (as explained earlier) to compute his depreciation deductions as shown in the following table.

Year	MACRS %	MACRS Amount	Maximum Limit	Deprec.  Allowed
'94	20.00	$5,720	$2,960	$ 2,960
'95	32.00	9,152	4,700	4,700
'96	19.20	5,491	2,850	2,850
'97	11.52	3,295	1,675	1,675
'98	11.52	3,295	1,675	1,675
'99	5.76	1,647	1,675	1,647
Total			$15,535	$15,507

$13,093. This was the $28,600 original basis of his car less the $15,507 depreciation deductions allowed during the recovery period.

Bob continued to use the car 100% for business in 2000. He can claim a depreciation deduction of $1,675 (the maximum allowed for each subsequent year) for the year. If he continues to use the car 100% for business in 2001 and later years, Bob can deduct the lesser of $1,675 or his remaining unrecovered basis in each of those years until his deductions total the $11,418 unrecovered basis ($13,093 - $1,675 claimed in 2000).

If Bob's business use of the car was less than 100% during any year, his depreciation deduction would be less than the maximum amount allowable for that year. However, in determining his unrecovered basis in the car, he would still reduce his original basis by the maximum amount allowable. Bob's unrecovered basis at the beginning of 2000 would be $13,065 ($28,600 - $15,535) in this example. This is true even if his actual depreciation deduction for any year was less than the maximum amount shown.

Car Used 50% or Less for Business

If you use your car 50% or less in qualified business use (defined earlier under Depreciation Deduction), the following two special rules apply. (For this purpose, car was defined earlier under Actual Car Expenses.)

1. You cannot take the section 179 deduction.
2. You must figure depreciation using the straight line method over a 5-year recovery period. You must continue to use the straight line method even if your percentage of business use increases to more than 50% in a later year.

Instead of making the computation yourself, you can use column (c) of Table 3 to find the percentage to use.

Example.   On May 22, 2000, Dan bought a car for $15,000. He used it 40% for his consulting business. Because he did not use the car more than 50% for business, Dan cannot take any section 179 deduction, and he must use the straight line method over a 5-year recovery period to recover the cost of his car.

Dan deducts $600 in 2000. This is the lesser of:

1. $600 [($15,000 cost × 40% business use) × 10% recovery percentage (from column (c), Table 3)], or
2. $1,224 ($3,060 maximum limit × 40% business use).

Business use drops to 50% or less in a later year.   If you use your car more than 50% in qualified business use in the tax year it is placed in service but the business use drops to 50% or less in a later year, you can no longer use an accelerated depreciation method for that car. For the year the business use drops to 50% or less and all later years in the recovery period, you must use the straight line depreciation method over a 5-year recovery period. In addition, for the year your business use drops to 50% or less, you must determine and include in your gross income any excess depreciation (discussed later).

Example.   In June 1997, you purchased a car for exclusive use in your business. You met the more-than-50%-use test for the first 3 years of the recovery period (1997 through 1999) but failed to meet it in the fourth year (2000). You determine your depreciation for 2000 using 20% (from column (c) of Table 3). You also will have to determine and include in your gross income any excess depreciation, discussed next.

Excess depreciation.    You must include any excess depreciation in your gross income and add it to your car's adjusted basis for the first tax year in which you do not use the car more than 50% in qualified business use. Use Form 4797, Sales of Business Property, to report the excess depreciation in your gross income.

Excess depreciation is:

1. The amount of the depreciation deductions allowable for the car (including any section 179 deduction claimed) for tax years in which you used the car more than 50% in qualified business use, minus
2. The amount of the depreciation deductions that would have been allowable for those years if you had not used the car more than 50% in qualified business use for the year you placed it in service. This means the amount of depreciation figured using the straight line method.

Example.   On June 25, 1997, you bought a car for $11,000 and placed it in service. You did not claim the section 179 deduction. You used the car exclusively in qualified business use for 1997, 1998, and 1999. For those years, you used the appropriate MACRS Depreciation Chart to figure depreciation deductions totaling $7,832 ($2,200 for 1997, $3,520 for 1998, and $2,112 for 1999) under the 200% DB method.

During 2000, you used the car 50% for business and 50% for personal purposes. Since you did not meet the more-than-50%-use test, you must include in gross income for 2000 your excess depreciation determined as follows.

Total depreciation claimed:  (MACRS 200% DB method)		$7,832
Total depreciation allowable:  (Straight line method)
1997 - 10% of $11,000	$1,100
1998 - 20% of $11,000	2,200
1999 - 20% of $11,000	2,200	5,500
Excess depreciation		$2,332

In 2000, you must include $2,332 in your gross income using Form 4797. Your adjusted basis in the car is also increased by $2,332. Your 2000 depreciation deduction is $1,100 [$11,000 (unadjusted basis) × 50% (business use percentage) × 20% (from column (c) of Table 3 on the line for Jan. 1 - Sept. 30, 1997)].

Disposition of a Car

If you dispose of your car, you may have a taxable gain or a deductible loss. The portion of any gain that is due to depreciation (including any section 179 or clean-fuel vehicle deduction) that you claimed on the car will be treated as ordinary income. However, you may not have to recognize a gain or loss if you dispose of the car because of a casualty, theft, or trade-in.

This section gives some general information about dispositions of cars. For information on how to report the disposition of your car, see Publication 544.

Casualty or theft.   For a casualty or theft, a gain results when you receive insurance or other reimbursement that is more than your adjusted basis in your car. If you then spend all of the proceeds to acquire replacement property (a new car or repairs to the old car) within a specified period of time, you do not recognize any gain. Your basis in the replacement property is its cost minus any gain that is not recognized. See Publication 547 for more information.

Trade-in.   When you trade in an old car for a new one, the transaction is considered a like-kind exchange. Generally, no gain or loss is recognized. (For exceptions, see chapter 1 of Publication 544.) In a trade-in situation, your basis in the new property is generally your adjusted basis in the old property plus any additional amount you pay. (See Unadjusted basis, earlier.)

Depreciation adjustment when you used the standard mileage rate.    If you used the standard mileage rate for the business use of your car, depreciation was included in that rate. The rate of depreciation that was allowed in the standard mileage rate is shown in the chart that follows. You must reduce your basis in your car (but not below zero) by the amount of this depreciation.

These rates do not apply for any year in which the actual expenses method was used.

Year(s)	Depreciation  Rate per Mile
2000	$ .14
1994 - 1999	.12
1992 - 1993	.11½
1989 - 1991	.11
1988	.10½
1987	.10
1986	.09
1983 - 1985	.08
1982	.07½
1980 - 1981	.07

For tax years after 1989, the depreciation rates apply to all business miles. For tax years before 1990, the depreciation rates apply to the first 15,000 miles.

Example.   In 1995, you bought a car for exclusive use in your business. The car cost $14,000. From 1995 through 2000, you used the standard mileage rate to figure your car expense deduction. You drove your car 14,100 miles in 1995, 16,300 miles in 1996, 15,600 miles in 1997, 16,700 miles in 1998, 15,100 miles in 1999, and 14,900 miles in 2000. Your depreciation is figured as follows.

Year	Miles x Rate	Depreciation
1995	14,100 × .12	$ 1,692
1996	16,300 × .12	1,956
1997	15,600 × .12	1,872
1998	16,700 × .12	2,004
1999	15,100 × .12	1,812
2000	14,900 × .14	2,086
Total depreciation		$11,422

($14,000 - $11,422).

Depreciation deduction for the year of disposition.    If you deduct actual car expenses and you dispose of your car before the end of its recovery period, you are allowed a reduced depreciation deduction for the year of disposition.

To figure the reduced depreciation deduction for a car disposed of in 2000, first determine the depreciation deduction for the full year using Table 3.

If you used a Date Placed in Service line for Jan. 1 - Sept. 30, you can deduct one-half of the regular depreciation amount for the year of disposition. Figure your depreciation deduction for the full year using the rules explained in this chapter and deduct 50% of that amount with your other actual car expenses.

If you used a Date Placed in Service line for Oct. 1 - Dec. 31, you can deduct a percentage of the regular depreciation amount. The percentage you use is determined by the month you disposed of the car. Figure your depreciation deduction for the full year using the rules explained in this chapter and multiply the result by the percentage from the following table for the month that you disposed of the car.

Month	Percentage
Jan., Feb., March	12.5%
April, May, June	37.5%
July, Aug., Sept.	62.5%
Oct., Nov., Dec.	87.5%

Do not use this table if you are a fiscal year filer. See Dispositions in chapter 3 of Publication 946.

Leasing a Car

If you lease a car that you use in your business, you can use the standard mileage rate or actual expenses to figure your deductible car expense. This section explains how to figure actual expenses for a leased car.

Deductible payments.   You can deduct the part of each lease payment that is for the use of the car in your business. You cannot deduct any part of a lease payment that is for personal use of the car, such as commuting.

You must spread any advance payments over the entire lease period. You cannot deduct any payments you make to buy a car, even if the payments are called lease payments.

If you lease a car for 30 days or more, you may have to reduce your lease payment deduction by an inclusion amount.

Inclusion Amounts

If you lease a car that you use in your business for a lease term of 30 days or more, you may have to include an inclusion amount in your income for each tax year you lease the car. To do this, you do not add an amount to income. Instead, you reduce your deduction for your lease payment. (This reduction has an effect similar to the limit on the depreciation deduction you would have on the car if you owned it.)

The inclusion amount is a percentage of part of the fair market value of the leased car multiplied by the percentage of business and investment use of the car for the tax year. It is prorated for the number of days of the lease term in the tax year.

The inclusion amount applies to each tax year that you lease the car if the fair market value (defined next) of the car when the lease began was more than the amounts shown in the following table.

Year Lease Began	Fair Market Value*
1999-2000	$ 15,500
1997-1998	15,800
1995-1996	15,500
1994	14,600
1993	14,300
1992	13,700
1991	13,400
1987-1990	12,800

*These amounts are higher for electric cars.

Fair market value.    Fair market value is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all the necessary facts. Sales of similar property around the same date may be helpful in figuring the fair market value of the property.

Figure the fair market value on the first day of the lease term. If the capitalized cost of a car is specified in the lease agreement, use that amount as the fair market value.

Figuring the inclusion amount.   Inclusion amounts are listed in Appendix B and, for electric cars leased after August 5, 1997, in Appendix C. If the fair market value of the car is $100,000 or less, use the appropriate appendix (depending on the year you first placed the car in service) to determine the inclusion amount. If the fair market value is more than $100,000, see the Revenue Procedure(s) identified in the footnote of the appendices for the inclusion amount. Revenue Procedures are available at most IRS offices and many local libraries.

For each tax year during which you lease the car for business, determine your inclusion amount by following these three steps.

1. Locate the appendix that applies to you. To find the inclusion amount, do the following.
   1. Find the line that includes the fair market value of the car on the first day of the lease term.
   2. Go across the line to the column for the tax year in which the car is used under the lease to find the dollar amount. For the last tax year of the lease, use the dollar amount for the preceding year.
2. Prorate the dollar amount from (1)(b) for the number of days of the lease term included in the tax year.
3. Multiply the prorated amount from (2) by the percentage of business and investment use for the tax year. This is your inclusion amount.

Example.   On January 17, 1998, you leased a car for 3 years and placed it in service for use in your business. The car had a fair market value of $32,250 on the first day of the lease term. You use the car 75% for business and 25% for personal purposes during each year of the lease. Assuming you continue to use the car 75% for business, you use Appendix B-3 to arrive at the following inclusion amounts for each year of the lease:

Tax  year	Dollar amount	Proration	Business  use	Inclusion amount
1998	$137	349/365	75%	$ 98
1999	301	365/365	75%	226
2000	446	366/366	75%	335
2001	536	16/365	75%	18

must reduce your deduction by the inclusion amount computed for that year.

Leased car changed from business to personal use.    If you lease a car for business use and, in a later year, change it to personal use, follow the rules explained earlier under Figuring the inclusion amount. For the tax year in which you stop using the car for business, use the dollar amount for the previous tax year. Prorate the dollar amount for the number of days in the lease term that fall within the tax year.

Example.   On August 16, 1999, Will leased an electric car with a fair market value of $58,600 for 3 years. He used the car exclusively in his own data processing business. On November 5, 2000, Will closed his business and went to work for a company where he is not required to use a car for business. Using Appendix C-2, Will computed his inclusion amount for 1999 and 2000 as shown in the following table and reduced his deductions for lease payments by those amounts.

Tax  year	Dollar amount	Proration	Business  use	Inclusion amount
1999	$ 95	138/365	100%	$ 36
2000	95	309/366	100%	80

Leased car changed from personal to business use.   If you lease a car for personal use and, in a later year, change it to business use, you must determine the car's fair market value on the date of conversion. Then figure the inclusion amount using the rules explained earlier under Figuring the inclusion amount. Use the fair market value on the date of conversion.

Example.   In March 1998, Janice leased a car for 4 years for personal use. On June 1, 2000, she started working as a self-employed advertising consultant and started using the leased car for business purposes. Her records show that her business use for June 1 through December 31 was 60%. To figure her inclusion amount for 2000, Janice obtained an appraisal from an independent car leasing company that showed the fair market value of her 1998 car on June 1, 2000, was $18,650. Using Appendix B-1, Janice computed her inclusion amount for 2000 as shown in the following table.

Tax  year	Dollar amount	Proration	Business  use	Inclusion amount
2000	$ 22	214/366	60%	$ 8

Reporting inclusion amounts.   For information on reporting inclusion amounts, employees should see Car rentals under Completing Forms 2106 and 2106-EZ in chapter 6. Sole proprietors should see the instructions for Schedule C (Form 1040) and farmers should see the instructions for Schedule F (Form 1040).

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