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 1998, Ellen Rye purchased and placed in service a pickup truck that cost $18,000. She used it only for qualified business use for 1998 through 2001. 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. (The pickup truck weighed over 6,000 pounds, so it was not subject to the passenger automobile limits discussed later under Do the Passenger Automobile Limits Apply.) During 2002, she used the truck 50% for business and 50% for personal purposes. She includes $4,018 excess depreciation in her gross income for 2002. 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):
1998 - 10% of $18,000		$1,800
1999 - 20% of $18,000		3,600
2000 - 20% of $18,000		3,600
2001 - 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 2004, there will be no excess depreciation. The total depreciation allowable using Table A-8 through 2004 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, 2000, 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. Larry does not use the computer at a regular business establishment, so it is listed property. His business use of the property (all of which is qualified business use) is 80% in 2000, 60% in 2001, and 40% in 2002. He must add an inclusion amount to gross income for 2002, 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. 2002 is the third tax year of the lease, so 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 2002 is $800.

Larry uses the Inclusion Amount Worksheet for Leased Listed Property to figure the amount he must include in income for 2002. 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, 2001, 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 ADS. The lease is for 5 years. Her business use of the property was 50% in 2001 and 90% in 2002. She paid rent of $3,600 for 2002, of which $3,240 is deductible. She must include $147 in income in 2002. 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 2001 and 2002, 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, 2001, 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 ADS. The lease term was 6 months (ending on March 31, 2002), during which he used the property 45% in business. He must include $71 in income in 2002. 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.)

Do the Passenger Automobile Limits Apply?

• Basis
• Clean-fuel vehicle
• Convention
• Placed in service
• Recovery period

The depreciation deduction, including the section 179 deduction and the special depreciation allowance (or Liberty Zone depreciation allowance), you can claim for a passenger automobile each year is limited. (For the definition of a passenger automobile, see What Is Listed Property, earlier.)

This section describes the maximum depreciation deduction amounts for 2002 and explains how to deduct, after the recovery period, the unrecovered basis of your property that results from applying the passenger automobile limit.

Exception for clean-fuel modifications.   The passenger automobile limits do not apply to any costs you pay to retrofit parts and components to modify an automobile to run on clean fuel. The limits apply only to the cost of the automobile without this modification.

Exception for leased cars.   The passenger automobile limits generally do not apply to passenger automobiles leased or held for leasing by anyone regularly engaged in the business of leasing passenger automobiles. For information on when you are considered regularly engaged in the business of leasing listed property, including passenger automobiles, see Exception for leased property, earlier, under What Is the Business-Use Requirement.

Maximum Depreciation Deduction

Determine the maximum depreciation deduction you can claim for a passenger automobile based on the date you placed the automobile in service. The maximum deduction amounts for most passenger automobiles for 2002 are shown in the following table.

Maximum Depreciation Deduction for Passenger Automobiles

Year Placed in Service	1st Year	2nd Year	3rd Year	4th Year and Later
2002	$7,660*	$4,900	$2,950	$1,775
2001		4,900	2,950	1,775
2000			2,950	1,775
1995 - 1999				1,775
1993 - 1994				1,675
1991 - 1992				1,575
Pre-1991				1,475
*If you elected not to claim the special depreciation allowance for the car or the car is not qualified property, this maximum amount is $3,060.

If your business/investment use of the automobile is less than 100%, you must reduce the maximum deduction amount proportionately.

Example.   On April 15, 2002, Virginia Hart bought a new car for $15,000. She used the car only in her business. She files her tax return based on the calendar year. She does not elect a section 179 deduction. She claimed a special depreciation allowance of $4,500 (30% of $15,000). Under MACRS, a car is 5-year property. She placed her car in service on April 15 and used it only for business, so she uses the percentages in Table A-1 to figure her MACRS depreciation on the car. Virginia multiplies the $10,500 unadjusted basis of her car ($15,000 - $4,500) by 0.20 to get her MACRS depreciation of $2,100 for 2002. Her total depreciation for 2002 is $6,600 ($4,500 plus $2,100). This $6,600 is below the maximum depreciation deduction of $7,660 for passenger automobiles placed in service in 2002. She can deduct the full $6,600.

Electric Vehicles

The maximum depreciation deductions for passenger automobiles that are produced to run primarily on electricity are higher than those for other automobiles. The maximum deduction amounts for electric cars for 2002 are shown in the following table.

Maximum Depreciation Deduction for Electric Vehicles

Year Placed in Service	1st Year	2nd Year	3rd Year	4th Year and Later
2002	$22,980*	$14,700	$8,750	$5,325
2001		14,800	8,850	5,325
2000			8,850	5,325
1999				5,325
1997 - 1998				5,425
*If you elected not to claim the special depreciation allowance for the car or the car is not qualified property, this maximum amount is $9,180.

For more information on electric vehicles, see chapter 12 of Publication 535.

Depreciation Worksheet for Passenger Automobiles

You can use the following worksheet to figure your depreciation deduction using the percentage tables. Then use the information from this worksheet to prepare Form 4562.

Depreciation Worksheet for Passenger Automobiles

Part I
1.	MACRS system (GDS or ADS)
2.	Property class
3.	Date placed in service
4.	Recovery period
5.	Method and convention
6.	Depreciation rate (from tables)
7.	Maximum depreciation deduction for this year from the appropriate table
8.	Business/investment-use percentage
9.	Multiply line 7 by line 8. This is your adjusted maximum depreciation deduction
10.	Section 179 deduction claimed this year (not more than line 9). Enter -0- if this is not the year you placed the car in service.
	Note. 1) If line 10 is equal to line 9, stop here. Your combined section 179 and depreciation deduction (including your special depreciation allowance or Liberty Zone depreciation allowance) is limited to the amount on line 9. 2) If line 10 is less than line 9, complete Part II.
Part II
11.	Subtract line 10 from line 9. This is the limit on the amount you can deduct for depreciation (including the special depreciation allowance or Liberty Zone depreciation allowance)
12.	Cost or other basis (reduced by any section 179A deduction 1 or credit for electric vehicles 2)
13.	Multiply line 12 by line 8. This is your business/investment cost
14.	Section 179 deduction claimed in year you placed the car in service
15.	Subtract line 14 from line 13. This is your tentative basis for depreciation
16.	Multiply line 15 by .30. This is your special depreciation allowance (or Liberty Zone depreciation allowance). Enter -0- if this is not the year you placed the car in service, the car is not qualified property (or Liberty Zone property), or you elected not to claim the special depreciation allowance (or Liberty Zone depreciation allowance).
	Note. 1) If line 16 is equal to line 11, stop here. Your depreciation deduction (including your special depreciation allowance or Liberty Zone depreciation allowance) is limited to the amount on line 11. 2) If line 16 is less than line 11, complete Part III.
Part III
17.	Subtract line 16 from line 11. This is the limit on the amount you can deduct for MACRS depreciation
18.	Subtract line 16 from line 15. This is your basis for depreciation
19.	Multiply line 18 by line 6. This is your tentative MACRS depreciation deduction
20.	Enter the lesser of line 17 or line 19. This is your MACRS depreciation deduction
1The section 179A deduction is for clean-fuel vehicles or clean-fuel vehicle refueling property. When figuring the amount to enter on line 12, do not reduce your cost or other basis by any section 179 deduction you claimed for your car.
2Reduce the basis by the lesser of $4,000 or 10% of the cost of the vehicle even if the credit is less than that amount.

The following example shows how to figure your depreciation deduction using the worksheet.

Example.   On September 26, 2002, Donald Banks bought a new car for $18,000. He used the car 60% for business during 2002. He files his tax return based on the calendar year. Under GDS, his car is 5-year property. Donald is electing a section 179 deduction of $1,000 on the car and claims a special depreciation allowance. He uses Table A-1 to determine the depreciation rate. Donald's MACRS depreciation deduction is limited to $836, as shown in the following worksheet.

Depreciation Worksheet for Passenger Automobiles

Part I
1.	MACRS system (GDS or ADS)	GDS
2.	Property class	5-year
3.	Date placed in service	9/26/02
4.	Recovery period	5-Year
5.	Method and convention	200% DB/Half-Year
6.	Depreciation rate (from tables)	.20
7.	Maximum depreciation deduction for this year from the appropriate table	$7,660
8.	Business/investment-use percentage	60%
9.	Multiply line 7 by line 8. This is your adjusted maximum depreciation deduction		$4,596
10.	Section 179 deduction claimed this year (not more than line 9). Enter -0- if this is not the year you placed the car in service.		$1,000
Note. 1) If line 10 is equal to line 9, stop here. Your combined section 179 and depreciation deduction (including your special depreciation allowance or Liberty Zone depreciation allowance) is limited to the amount on line 9. 2) If line 10 is less than line 9, complete Part II.
Part II
11.	Subtract line 10 from line 9. This is the limit on the amount you can deduct for depreciation (including the special depreciation allowance or Liberty Zone depreciation allowance)		$3,596
12.	Cost or other basis (reduced by any section 179A deduction 1 or credit for electric vehicles 2)	$18,000
13.	Multiply line 12 by line 8. This is your business/investment cost	$10,800
14.	Section 179 deduction claimed in year you placed the car in service	$1,000
15.	Subtract line 14 from line 13. This is your tentative basis for depreciation	$9,800
16.	Multiply line 15 by .30. This is your special depreciation allowance (or Liberty Zone depreciation allowance). Enter -0- if this is not the year you placed the car in service, the car is not qualified property (or Liberty Zone property), or you elected not to claim the special depreciation allowance (or Liberty Zone depreciation allowance)		$2,940
	Note. 1) If line 16 is equal to line 11, stop here. Your depreciation deduction (including your special depreciation allowance or Liberty Zone depreciation allowance) is limited to the amount on line 11. 2) If line 16 is less than line 11, complete Part III.
Part III
17.	Subtract line 16 from line 11. This is the limit on the amount you can deduct for MACRS depreciation	$656
18.	Subtract line 16 from line 15. This is your basis for depreciation	$6,860
19.	Multiply line 18 by line 6. This is your tentative MACRS depreciation deduction		$1,372
20.	Enter the lesser of line 11 or line 16. This is your MACRS depreciation deduction		$656
1The section 179A deduction is for clean-fuel vehicles or clean-fuel vehicle refueling property. When figuring the amount to enter on line 12, do not reduce your cost or other basis by any section 179 deduction you claimed for your car.
2Reduce the basis by the lesser of $4,000 or 10% of the cost of the vehicle even if the credit is less than that amount.

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