Figuring the Deduction for Carried-Over-Basis Property
If your property has a carried-over basis because you acquired it in an exchange or involuntary conversion of other property or in a nontaxable transfer, you may have to figure depreciation for the property as if the exchange, conversion, or transfer had not occurred.
Property Acquired in an Exchange or Involuntary Conversion
You generally must depreciate MACRS property that you acquired in a like-kind exchange or an involuntary conversion of other MACRS property over the remaining recovery period of the exchanged or involuntarily converted property. You also generally continue to use the same depreciation method and convention used for the exchanged or converted property. You can depreciate the part of the acquired property's basis that exceeds its carried-over basis (the adjusted basis of the exchanged or converted property) as newly purchased MACRS property.
If you placed the acquired MACRS property in service before January 3, 2000, you continue to use your original method of depreciating that property.
Property Acquired in a Nontaxable Transfer
You must depreciate MACRS property acquired by a corporation or partnership in certain nontaxable transfers over the property's remaining recovery period in the transferor's hands, as if the transfer had not occurred. You must continue to use the same depreciation method and convention as the transferor. You can depreciate the part of the property's basis that exceeds its carried-over basis (the transferor's adjusted basis in the property) as newly purchased MACRS property.
The nontaxable transfers covered by this rule include the following.
- A distribution in complete liquidation of a subsidiary.
- A transfer to a corporation controlled by the transferor.
- An exchange of property solely for corporate stock or securities in a reorganization.
- A contribution of property to a partnership in exchange for a partnership interest.
- A partnership distribution of property to a partner.
Figuring the Deduction for a Short Tax Year
You cannot use the MACRS percentage tables to determine depreciation for a short tax year. A short tax year is any tax year with less than 12 full months. This section discusses the rules for determining the depreciation deduction for property you place in service or dispose of in a short tax year. It also discusses the rules for determining depreciation when you have a short tax year during the recovery period (other than the year the property is placed in service or disposed of).
For more information on figuring depreciation for a short tax year, see Revenue Procedure 89-15 in Cumulative Bulletin 1989-1.
Using the Applicable Convention in a Short Tax Year
The applicable convention establishes the date property is treated as placed in service and disposed of. Depreciation is allowable only for that part of the tax year the property is treated as in service. The recovery period begins on the placed-in-service date determined by applying the convention. The remaining recovery period at the beginning of the next tax year is the full recovery period less the part for which depreciation was allowable in the first tax year.
The following discussions explain how to use the applicable convention in a short tax year.
Mid-month convention. Under the mid-month convention, you always treat your property as placed in service or disposed of on the midpoint of the month it is placed in service or disposed of. You apply this rule without regard to your tax year.
Half-year convention. Under the half-year convention, you treat property as placed in service or disposed of on the midpoint of the tax year it is placed in service or disposed of.
First or last day of month. For a short tax year beginning on the first day of a month or ending on the last day of a month, the tax year consists of the number of months in the tax year. If the short tax year includes part of a month, you generally include the full month in the number of months in the tax year. You determine the midpoint of the tax year by dividing the number of months in the tax year by 2. For the half-year convention, you treat property as placed in service or disposed of on either the first day or the midpoint of a month.
For example, a short tax year that begins on June 20 and ends on December 31 consists of 7 months. You use only full months for this determination, so you treat the tax year as beginning on June 1 instead of June 20. The midpoint of the tax year is the middle of September (3½ months from the beginning of the tax year).
Example. Tara Corporation, a calendar year taxpayer, was incorporated on March 15. For purposes of the half-year convention, it has a short tax year of 10 months, ending on December 31, 2002. During the short tax year, Tara placed property in service for which it uses the half-year convention. Tara treats this property as placed in service on the first day of the sixth month of the short tax year, or August 1, 2002.
Not on first or last day of month. For a short tax year not beginning on the first day of a month and not ending on the last day of a month, the tax year consists of the number of days in the tax year. You determine the midpoint of the tax year by dividing the number of days in the tax year by 2. For the half-year convention, you treat property as placed in service or disposed of on either the first day or the midpoint of a month. If the result of dividing the number of days in the tax year by 2 is not the first day or the midpoint of a month, you treat the property as placed in service or disposed of on the nearest preceding first day or midpoint of a month.
Mid-quarter convention. To determine if you must use the mid-quarter convention, compare the basis of property you place in service in the last 3 months of your tax year to that of property you place in service during the full tax year. The length of your tax year does not matter. If you have a short tax year of 3 months or less, use the mid-quarter convention for all applicable property you place in service during that tax year.
You treat property under the mid-quarter convention as placed in service or disposed of on the midpoint of the quarter of the tax year in which it is placed in service or disposed of. Divide a short tax year into 4 quarters and determine the midpoint of each quarter.
For a short tax year of 4 or 8 full calendar months, determine quarters on the basis of whole months. The midpoint of each quarter is either the first day or the midpoint of a month.
To determine the midpoint of a quarter for a short tax year of other than 4 or 8 full calendar months, complete the following steps.
- Determine the number of days in your short tax year.
- Determine the number of days in each quarter by dividing the number of days in your short tax year by 4.
- Determine the midpoint of each quarter by dividing the number of days in each quarter by 2.
If the result of (3) gives you a midpoint of a quarter that is on a day other than the first day or midpoint of a month, treat the property as placed in service or disposed of on the nearest preceding first day or midpoint of that month.
Example. Tara Corporation, a calendar year taxpayer, was incorporated and began business on March 15. It has a short tax year of 9½ months, ending on December 31. During December it placed property in service for which it must use the mid-quarter convention. This is a short tax year of other than 4 or 8 full calendar months, so it must determine the midpoint of each quarter.
- First, it determines that its short tax year beginning March 15 and ending December 31 consists of 292 days.
- Next, it divides 292 by 4 to determine the length of each quarter, 73 days.
- Finally, it divides 73 by 2 to determine the midpoint of each quarter, the 37th day.
The following table shows the quarters of Tara Corporation's short tax year, the midpoint of each quarter, and the date in each quarter that Tara must treat its property as placed in service.
| Quarter |
Midpoint |
Placed in Service |
| 3/15 - 5/26 |
4/20 |
4/15 |
| 5/27 - 8/07 |
7/02 |
7/01 |
| 8/08 - 10/19 |
9/13 |
9/01 |
| 10/20 - 12/31 |
11/25 |
11/15 |
The last quarter of the short tax year begins on October 20, which is 73 days from December 31, the end of the tax year. The 37th day of the last quarter is November 25. The midpoint of the quarter (November 25) is not the first day or the midpoint of November, so Tara Corporation must treat the property as placed in service in the middle of November (the nearest preceding first day or midpoint of that month).
Property Placed in Service in a Short Tax Year
If you place property in service in a short tax year, you can take the full amount of the special depreciation allowance (or Liberty Zone depreciation allowance) for qualified property (or Liberty Zone property). To figure your MACRS depreciation deduction for the short tax year, you must first determine the depreciation for a full tax year. You do this by multiplying your basis in the property by the applicable depreciation rate. Then, determine the depreciation for the short tax year. Do this by multiplying the depreciation for a full tax year by a fraction. The numerator (top number) of the fraction is the number of months (including parts of a month) the property is treated as in service during the tax year (applying the applicable convention). The denominator (bottom number) is 12. See Depreciation After a Short Tax Year, later, for how to figure depreciation in later years.
Example 1 - half-year convention. Tara Corporation, with a short tax year beginning March 15 and ending December 31, placed in service on March 16 an item of 5-year property with a basis of $1,000. This is the only property the corporation placed in service during the short tax year. Tara does not elect to claim a section 179 deduction and elects not to claim a special depreciation allowance. The depreciation method for this property is the 200% declining balance method. The depreciation rate is 40% and Tara applies the half-year convention.
Tara treats the property as placed in service on August 1. Tara is allowed 5 months of depreciation for the short tax year that consists of 10 months. The corporation first multiplies the basis ($1,000) by 40% (the declining balance rate) to get the depreciation for a full tax year of $400. The corporation then multiplies $400 by 5/12 to get the short tax year depreciation of $167.
Example 2 - mid-quarter convention. Tara Corporation, with a short tax year beginning March 15 and ending on December 31, placed in service on October 16 an item of 5-year property with a basis of $1,000. Tara does not elect to claim a section 179 deduction and elects not to claim a special depreciation allowance. The depreciation method for this property is the 200% declining balance method. The depreciation rate is 40%. The corporation must apply the mid-quarter convention because the property was the only item placed in service that year and it was placed in service in the last 3 months of the tax year.
Tara treats the property as placed in service on September 1. Under MACRS, Tara is allowed 4 months of depreciation for the short tax year that consists of 10 months. The corporation first multiplies the basis ($1,000) by 40% to get the depreciation for a full tax year of $400. The corporation then multiplies $400 by 4/12 to get the short tax year depreciation of $133.
Property Placed in Service Before a Short Tax Year
If you have a short tax year after the tax year in which you began depreciating property, you must change the way you figure depreciation for that property. If you were using the percentage tables, you can no longer use them. You must figure depreciation for the short tax year and each later tax year as explained next.
Depreciation After a Short Tax Year
You can use either of the following methods to figure the depreciation for years after a short tax year.
- The simplified method.
- The allocation method.
You must use the method you choose consistently.
Using the simplified method for a 12-month year. Under the simplified method, you figure the depreciation for a later 12-month year in the recovery period by multiplying the adjusted basis of your property at the beginning of the year by the applicable depreciation rate.
Example. Tara Corporation had a short tax year of 10 months, ending on December 31. During that year, it placed in service an item of 5-year property with a basis of $1,000. It did not elect to claim a section 179 deduction and elected not to claim a special depreciation allowance. It claimed depreciation of $167 using a depreciation rate of 40% and the half-year convention. The adjusted basis on January 1 of the next year is $833 ($1,000 - $167). Tara's depreciation for that next year is 40% of $833, or $333.
Using the simplified method for a short year. If a later tax year in the recovery period is a short tax year, you figure depreciation for that year by multiplying the adjusted basis of the property at the beginning of the tax year by the applicable depreciation rate, and then by a fraction. The fraction's numerator (top number) is the number of months (including parts of a month) in the tax year. Its denominator (bottom number) is 12.
Using the simplified method for an early disposition. If you dispose of property in a later tax year before the end of the recovery period, determine the depreciation for the year of disposition by multiplying the adjusted basis of the property at the beginning of the tax year by the applicable depreciation rate and then multiplying the result by a fraction. The fraction's numerator (top number) is the number of months (including parts of a month) the property is treated as in service during the tax year (applying the applicable convention). Its denominator (bottom number) is 12.
Using the allocation method for a 12-month or short tax year. Under the allocation method, you figure the depreciation for each later tax year by allocating to that year the depreciation attributable to the parts of the recovery years that fall within that year. Whether your tax year is a 12-month or short tax year, you figure the depreciation by determining which recovery years are included in that year. For each recovery year included, multiply the depreciation attributable to that recovery year by a fraction. The fraction's numerator (top number) is the number of months (including parts of a month) that are included in both the tax year and the recovery year. Its denominator (bottom number) is 12. The allowable depreciation for the tax year is the sum of the depreciation figured for each recovery year.
Example. Assume the same facts as in Example 1 under Property Placed in Service in a Short Tax Year. The Tara Corporation's first tax year after the short tax year is a full year of 12 months, beginning January 1 and ending December 31. The first recovery year for the 5-year property placed in service during the short tax year extends from August 1 to July 31. Tara deducted 5 months of the first recovery year on its short-year tax return. Seven months of the first recovery year and 5 months of the second recovery year fall within the next tax year. The depreciation for the next tax year is $333, which is the sum of the following.
- $233 - The depreciation for the first recovery year
($400 × 7/12).
- $100 - The depreciation for the second recovery year. This is figured by multiplying the adjusted basis of $600 ($1,000 - $400) by 40%, then multiplying the $240 result by 5/12.
Using the allocation method for an early disposition. If you dispose of property before the end of the recovery period in a later tax year, determine the depreciation for the year of disposition by multiplying the depreciation figured for each recovery year or part of a recovery year included in the tax year by a fraction. The numerator (top number) of the fraction is the number of months (including parts of months) the property is treated as in service in the tax year (applying the applicable convention). The denominator (bottom number) is 12. If there is more than one recovery year in the tax year, you add together the depreciation for each recovery year.
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