You can depreciate leased property only if you retain the incidents of ownership in the property (explained later). This means you bear the burden of exhaustion of the capital investment in the property. Therefore, if you lease property from someone to use in your trade or business or for the production of income, you generally cannot depreciate its cost. You can, however, depreciate any capital improvements you make to the leased property. See Additions and Improvements under Which Recovery Period Applies? in chapter 4 of Publication 946.

If you lease property to someone, you generally can depreciate its cost even if the lessee (the person leasing from you) has agreed to preserve, replace, renew, and maintain the property. However, you cannot depreciate the cost of the property if the lease provides that the lessee is to maintain the property and return to you the same property or its equivalent in value at the expiration of the lease in as good condition and value as when leased.

Incidents of ownership of property include the following.

Generally, if you hold business or investment property as a life tenant, you can depreciate it as if you were the absolute owner of the property. However, see Certain term interests in property under Excepted Property, later.

If you use property (such as your car) for business or investment purposes and for personal purposes, you can deduct depreciation based only on the business or investment use.

For example, if you use your car for farm business, you can deduct depreciation based on its use in farming. If you also use it for investment purposes, you can depreciate it based on its investment use.

If you use part of your home for business, you may be able to deduct depreciation on that part based on its business use. For more information, see Business Use of Your Home in chapter 5.

You can never depreciate inventory because it is not held for use in your business. Inventory is any property you hold primarily for sale to customers in the ordinary course of your business.

Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account.

Livestock you raise usually has no depreciable basis because the costs of raising them are deducted and not added to their basis. However, see Immature livestock under When Does Depreciation Begin and End, later.

You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping. For information on land preparation costs you may be able to depreciate, see chapter 1 of Publication 946.

Irrigation systems and wells used in a trade or business can be depreciated if their useful life can be determined. You can depreciate irrigation systems and wells composed of masonry, concrete, tile, metal, or wood. In addition, you can depreciate costs for moving dirt to construct irrigation systems and water wells composed of these materials. However, land preparation costs for center pivot irrigation systems are not depreciable.

In general, you cannot depreciate earthen dams, ponds, and terraces unless the structures have a determinable useful life.

The following are two types of intangible property that you can never depreciate.

You can never depreciate goodwill because its useful life cannot be determined. However, if you acquired a business after August 10, 1993 (July 25, 1991, if elected), and part of the price included goodwill, you may be able to amortize the cost of the goodwill over 15 years. For more information, see Amortization, later.

In general, a trademark or trade name does not have a determinable useful life and, therefore, you cannot depreciate its cost. However, you may be able to amortize its cost over 15 years if you acquired it after August 10, 1993 (after July 25, 1991, if elected). For more information, see Amortization, later.

Intangible property that is a section 197 intangible, described later under Amortization, cannot be depreciated but can be amortized over a 15-year period.

Computer software includes all programs designed to cause a computer to perform a desired function. It also includes any data base or similar item in the public domain and incidental to the operation of qualifying software.

Computer software is a section 197 intangible only if you acquired it in connection with the acquisition of assets constituting a business or a substantial part of a business. However, computer software is not a section 197 intangible and can be depreciated, even if acquired in connection with the acquisition of a business, if it meets all of the following tests.

You cannot depreciate a term interest in property created or acquired after July 27, 1989, for any period during which the remainder interest is held, directly or indirectly, by a person related to you. This rule does not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. For more information, see chapter 1 of Publication 946.

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.

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.

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.

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.

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 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 Basis Other Than Cost in chapter 7 to determine your basis.

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.

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.

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

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.

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

You must reduce the basis of property by the depreciation allowed or allowable, whichever is greater. Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). Depreciation allowable is depreciation you are entitled to deduct.

If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable.

If you deduct more depreciation than you should, you must reduce your basis by any amount deducted from which you received a tax benefit (the depreciation allowed).

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

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 Internal Revenue Bulletin No. 1997-21 gives general instructions for getting approval.

You may be able to get automatic approval from the IRS to change your method of accounting if you used an impermissible 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.

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.

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

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

Tangible personal property is any tangible property that is not real property. It includes the following property.

Land and land improvements, such as buildings and other permanent structures and their components, are real property, not personal property. Land improvements include nonagricultural fences, swimming pools, paved parking areas, wharves, docks, bridges, and fences. However, agricultural fences do qualify as section 179 property. Similarly, field drainage tile also qualifies as section 179 property.

A facility used for the bulk storage of fungible commodities is qualifying property for purposes of the section 179 deduction if it is used in connection with any of the activities listed earlier in item (2)(a). Bulk storage means the storage of a commodity in a large mass before it is used.

A grain bin is an example of a storage facility that is qualifying section 179 property. It is a facility used in connection with the production of grain or livestock for the bulk storage of fungible commodities.

A single purpose agricultural (livestock) or horticultural structure is qualifying property for purposes of the section 179 deduction.

A single purpose agricultural (livestock) structure is any building or enclosure specifically designed, constructed, and used for both the following reasons.

For this purpose, livestock includes poultry.

Single purpose structures are qualifying property if used, for example, to breed chickens or hogs, produce milk from dairy cattle, or produce feeder cattle or pigs, broiler chickens, or eggs. The facility must include, as an integral part of the structure or enclosure, equipment necessary to house, raise, and feed the livestock.

A single purpose horticultural structure is either of the following.

A structure must be used only for the purpose that qualified it. For example, a hog barn will not be qualifying property if you use it to house poultry. Similarly, using part of your greenhouse to sell plants will make the greenhouse nonqualifying property.

If a structure includes work space, the work space can be used only for the following activities.

Off-the-shelf computer software that is placed in service after 2002 and before 2006 is qualifying property for purposes of the section 179 deduction. This is computer software that is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially modified. It includes any program designed to cause a computer to perform a desired function. However, a database or similar item is not considered computer software unless it is in the public domain and is incidental to the operation of otherwise qualifying software.

When you use property for business and nonbusiness purposes, you can elect the section 179 deduction only if you use it more than 50% for business in the year you place it in service. If you used the property more than 50% for business, multiply the cost of the property by the percentage of business use. Use the resulting business cost to figure your section 179 deduction.

If you buy qualifying property with cash and a trade-in, its cost for purposes of the section 179 deduction includes only the cash you paid. For example, if you buy (for cash and a trade-in) a new tractor for use in your business, your cost for the section 179 deduction is the cash you paid. It does not include the adjusted basis of the old tractor you trade for the new tractor. For more information on figuring your adjusted basis, see Adjusted Basis in chapter 7.

If you deduct only part of the cost of your qualifying property as a section 179 deduction, you can generally take the special depreciation allowance and MACRS depreciation on the cost you do not deduct. To figure your basis for depreciation used to determine the special depreciation allowance, you must subtract the amount of the section 179 deduction from the cost of the qualifying property. The result is then reduced by the amount of your allowance and the remaining cost is used to figure any MACRS depreciation deduction. For information on how to figure basis for depreciation, the special depreciation allowance, and MACRS depreciation, see Claiming the Special Depreciation Allowance and Figuring Depreciation Under MACRS, later.

If the cost of your qualifying section 179 property placed in service in a year is over $400,000, you must reduce the dollar limit (but not below zero) by the amount of cost over $400,000. If the cost of your section 179 property placed in service during 2003 is $500,000 or more, you cannot take a section 179 deduction and you cannot carry over the cost that is more than $500,000.

For a passenger automobile that is qualified property (as explained in What Is Qualified Property? under Claiming the Special Depreciation Allowance, later) placed in service in 2003, the total section 179 and depreciation deductions (including the special depreciation allowance) is limited. See Do the Passenger Automobile Limits Apply? under Additional Rules for Listed Property, later.

If you are married, how you figure your section 179 deduction depends on whether you file jointly or separately.

If you file a joint return, you and your spouse are treated as one taxpayer in determining any reduction to the dollar limit, regardless of which of you purchased the property or placed it in service.

If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit, including the reduction for costs over $400,000. You must allocate the dollar limit (after any reduction) between you. You must allocate 50% to each, unless you both elect a different allocation. If the percentages elected by each of you do not total 100%, 50% will be allocated to each of you.

If you and your spouse elect to amend your separate returns by filing a joint return after the due date for filing your return, the dollar limit on the joint return is the lesser of the following amounts.

In general, figure taxable income for this purpose by totaling the net income and losses from all trades and businesses you actively conducted during the year. In addition to net income or loss from a sole proprietorship, partnership, or S corporation, net income or loss derived from a trade or business also includes the following items.

In addition, figure taxable income without regard to any of the following.

In addition to the business income limit for your section 179 deduction, you may have a taxable income limit for some other deduction (for example, charitable contributions). You may have to figure the limit for this other deduction taking into account the section 179 deduction. If so, complete the following steps.

You can carry over the cost of any section 179 property you elected to expense but were unable to because of the business income limit.

The amount you carry over is used in determining your section 179 deduction in the next year. However, it is subject to the limits in that year. If you place more than one property in service in a year, you can select the properties for which all or a part of the cost will be carried forward. Your selections must be shown in your books and records.

See Carryover of disallowed deduction in chapter 2 of Publication 946 for more information on figuring the carryover.

You can revoke an election (or any specification made in the election) to take a section 179 deduction for any property without IRS approval. The revocation can be made on an amended return.

To figure the amount to recapture, take the following steps.

Report any recapture of the section 179 deduction as ordinary income in Part IV of Form 4797 and include it in income on Schedule F (Form 1040).

Generally, this is any improvement to an interior part of a building that is nonresidential real property, provided all of the following requirements are met.

However, a qualified leasehold improvement does not include any improvement for which the expenditure is attributable to any of the following.

Generally, a binding commitment to enter into a lease is treated as a lease and the parties to the commitment are treated as the lessor and lessee. However, a lease between related persons is not treated as a lease.

A related person generally means a member of your immediate family (including your spouse, an ancestor, and a lineal descendant) or a partnership or corporation in which you hold an interest.

Generally, you must have acquired the property either:

Property you manufacture, construct, or produce for your own use meets this test if you began the manufacture, construction, or production of the property after September 10, 2001, and before January 1, 2005. Property that is manufactured, constructed, or produced for your use by another person under a written binding contract is considered to be manufactured, constructed, or produced by you.

Generally, the property must be placed in service for use in your trade or business or for the production of income after September 10, 2001, and before January 1, 2005.

If you sold property you placed in service after September 10, 2001, and you leased it back within 3 months after the property was originally placed in service, the property is treated as originally placed in service by the lessor no earlier than the date it is used under the leaseback. For special rules explaining when property involved in certain other transactions is treated as originally placed in service, see section 1.168(k)-1T(b)(5) of the regulations.

The original use of the property must have begun with you after September 10, 2001. Original use means the first use to which the property is put, whether or not by you. Therefore, property used by any person before September 11, 2001, does not meet the original use test.

Additional capital expenditures you incurred after September 10, 2001, to recondition or rebuild your property meet the original use test. Property containing used parts will not be treated as reconditioned or rebuilt if the cost of the used parts is not more than 20 percent of the total cost of the property.

If you sold property you placed in service after September 10, 2001, and you leased it back within 3 months after the property was originally placed in service, the lessor is considered to be the original user of the property. For special rules identifying the original user of property involved in certain other transactions and the original user of fractional interests in property, see section 1.168(k)-1T(b)(3) of the regulations.

Generally, you must have acquired the property after May 5, 2003, and before January 1, 2005, but only if no written binding contract for the acquisition was in effect before May 6, 2003.

Property you manufacture, construct, or produce for your own use meets this test if you began the manufacture, construction, or production of the property after May 5, 2003, and before January 1, 2005. Property that is manufactured, constructed, or produced for your use by another person under a written binding contract is considered to be manufactured, constructed, or produced by you.

Generally, the property must be placed in service for use in your trade or business or for the production of income after May 5, 2003, and before January 1, 2005.

If you sold property you placed in service after May 5, 2003, and you leased it back within 3 months after the property was originally placed in service, the property is treated as originally placed in service by the lessor no earlier than the date it is used under the leaseback. For special rules explaining when property involved in certain other transactions is treated as originally placed in service, see section 1.168(k)-1T(b)(5) of the regulations.

The original use of the property must have begun with you after May 5, 2003. Property used by any person before May 6, 2003, does not meet the original use test.

Additional capital expenditures you incurred to recondition or rebuild your property meet the original use test. However, the cost of reconditioned or rebuilt property you acquired does not meet this test. Property containing used parts will not be treated as reconditioned or rebuilt if the cost of the used parts is not more than 20 percent of the total cost of the property.

If you sold property you placed in service after May 5, 2003, and you leased it back within 3 months after the property was originally placed in service, the lessor is considered to be the original user of the property. For special rules identifying the original user of property involved in certain other transactions and the original user of fractional interests in property, see section 1.168(k)-1T(b)(3) of the regulations.

This is the property's cost or other basis multiplied by the percentage of business/investment use and then reduced by the following items allocable to the property.

For information about how to determine the cost or other basis of property, see What Is the Basis of Your Depreciable Property, earlier. For a discussion of business/investment use, see Property Used in Your Business or Income-Producing Activity, earlier.

After you figure the special depreciation allowance for your qualified property, you can use the remaining cost to figure your regular MACRS depreciation deduction (discussed later). In the year you claim the allowance (generally the year you place the property in service), you must reduce the depreciable basis of the property by the allowance before figuring your regular MACRS depreciation deduction.

If you acquire qualified property in a like-kind exchange or involuntary conversion, the carried-over basis of the acquired property is eligible for a special depreciation allowance. After you figure your special depreciation allowance, you can use the remaining carried-over basis to figure your regular MACRS depreciation deduction. In the year you claim the allowance (the year you place in service the property received in the exchange or dispose of involuntarily converted property), you must reduce the carried-over basis of the property by the allowance before figuring your regular MACRS depreciation deduction. See Figuring the Deduction for Carried-Over Basis Property, later, under Figuring Depreciation Under MACRS. The excess basis (the part of the acquired property's basis that exceeds its carried-over basis) is also eligible for a special depreciation allowance.

Generally, you must make the election on a timely filed tax return (including extensions) for the year in which you place the property in service.

However, if you timely filed your return for the year without making the election, you still can make the election by filing an amended return within 6 months of the due date of the original return (not including extensions). Attach the election statement to the amended return. On the amended return, write “Filed pursuant to section 301.9100–2.”

Once made, the election may not be revoked without IRS consent.

You must use ADS for the following property.

Although your property may qualify for GDS, you can elect to use ADS. The election generally must cover all property in the same property class you placed in service during the year. However, the election for residential rental property and nonresidential real property can be made on a property-by-property basis. Once you make this election, you can never revoke it.

You make the election by completing line 20 in Part III of Form 4562.

See Table 8–1 for recovery periods under both GDS and ADS for some commonly used assets. For a complete list of recovery periods, see the Table of Class Lives and Recovery Periods in Appendix B of Publication 946.

To depreciate a house trailer you supply as housing for those who work on your farm, use one of the following recovery periods if the house trailer is mobile (it has wheels and a history of movement).

However, if the house trailer is not mobile (its wheels have been removed and permanent utilities and pipes attached to it), use one of the following recovery periods.

Water wells used to provide water for raising poultry and livestock are land improvements. If they are depreciable, use one of the following recovery periods.

The types of water wells that can be depreciated were discussed earlier in Irrigation systems and water wells under Property Having a Determinable Useful Life.

Use this convention for all nonresidential real property and residential rental property.

Under this convention, you treat all property placed in service or disposed of during a month as placed in service or disposed of at the midpoint of the month. This means that a one-half month of depreciation is allowed for the month the property is placed in service or disposed of.

Use this convention if the mid-month convention does not apply and the total depreciable bases of MACRS property you placed in service during the last 3 months of the tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) are more than 40% of the total depreciable bases of all MACRS property you placed in service during the year.

Under this convention, you treat all property placed in service or disposed of during any quarter of the tax year as placed in service or disposed of at the midpoint of that quarter. This means that 1½ months of depreciation is allowed for the quarter the property is placed in service or disposed of.

Use this convention if neither the mid-quarter convention nor the mid-month convention applies.

Under this convention, you treat all property placed in service or disposed of during a tax year as placed in service or disposed of at the midpoint of the year. This means that a one-half year of depreciation is allowed for the year the property is placed in service or disposed of.

For personal property placed in service in a farming business after 1988 you must use the 150% declining balance method over a GDS recovery period or you can elect one of the following methods.

For property placed in service before 1999, you could have elected to use the 150% declining balance method using the ADS recovery periods for certain property classes. If you made this election, continue to use the same method and recovery period for that property.

You can depreciate real property using the straight line method under either GDS or ADS.

The following table lists the types of property you can depreciate under each method. The declining balance method is abbreviated as DB and the straight line method is abbreviated as SL.

If you use a declining balance method, you switch to the straight line method in the year it provides an equal or greater deduction. If you use the MACRS percentage tables, discussed later under How Is the Depreciation Deduction Figured, you do not need to determine in which year your deduction is greater using the straight line method. The tables have the switch to the straight line method built into their rates.

Depreciate trees and vines bearing fruit or nuts under GDS using the straight line method over a 10-year recovery period.

If you elect not to apply the uniform capitalization rules to any plant shown in Table 7–1 of chapter 7 and produced in your farming business, you must use ADS for all property you place in service in any year the election is in effect. See chapter 7 for a discussion of the application of the uniform capitalization rules to farm property.

A farming business is any trade or business involving cultivating land or raising or harvesting any agricultural or horticultural commodity. A farming business includes the following.

In general, a farming business includes processing activities that are normally part of the growing, raising, or harvesting of agricultural products. However, a farming business generally does not include the processing of commodities or products beyond those activities that are normally part of the growing, raising, or harvesting of such products.

As shown in the Depreciation Table, you can elect a different method for depreciation for certain types of property. You must make the election by the due date of the return (including extensions) for the year you placed the 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 your 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. Once you make the election, you cannot change it.

If you elect to use a different method for one item in a property class, you must apply the same method to all property in that class placed in service during the year of the election. However, you can make the election on a property-by-property basis for residential rental and nonresidential real property.

Instead of using the declining balance method, you can elect to use the straight line method over the GDS recovery period. Make the election by entering “S/L” under column (f) in Part III of Form 4562.

As explained earlier under Which Depreciation System (GDS or ADS) Applies, you can elect to use ADS even though your property may come under GDS. ADS uses the straight line method of depreciation over the ADS recovery periods, which are generally longer than the GDS recovery periods. The ADS recovery periods for many assets used in the business of farming are listed in Table 8–1. Additional ADS recovery periods for other classes of property may be found in the Table of Class Lives and Recovery Periods in Appendix B of Publication 946.

Make the election by completing line 20 in Part III of Form 4562.

The following rules cover the use of the percentage tables.

If you reduce the basis of your property because of a casualty, you cannot continue to use the percentage tables. For the year of the adjustment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year. See Figuring the Deduction Without Using the Tables in chapter 4 of Publication 946.

You must apply the table rates to your property's unadjusted basis each year of the recovery period. Unadjusted basis is the same basis amount you would use to figure gain on a sale but figured without reducing your original basis by any MACRS depreciation taken in earlier years. However, you do reduce your original basis by the following amounts.

The clean-fuel vehicle and clean-fuel vehicle refueling property deductions and the credit for electric vehicles are discussed in chapter 12 of Publication 535.

For business property you purchase during the year, the unadjusted basis is its cost minus these adjustments. If you trade property, your unadjusted basis in the property received is the cash paid plus the adjusted basis of the property traded minus these adjustments.

Table 8–2 has the percentages for 3-, 5-, 7-, and 20-year property. The percentages are based on the 150% declining balance method with a change to the straight line method. This table covers only the half-year convention and the first 8 years for 20-year property. See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention.

The following examples show how to figure depreciation under MACRS using the percentages in Table 8–2.

The following table has the straight line percentages for 3-, 5-, 7-, and 20-year property using the half-year convention. The table covers only the first 8 years for 20-year property. See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention.

The following example shows how to figure depreciation under MACRS using the straight line percentages in the table.

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 in excess of its carried-over basis (the adjusted basis of the exchanged or converted property) as newly purchased MACRS property. If the MACRS property you acquired in the exchange or involuntary conversion is qualified property (discussed earlier under Claiming the Special Depreciation Allowance), you can claim a special depreciation allowance on the carried-over basis. For an illustration of how to figure depreciation for a tractor acquired in a like-kind exchange, see chapter 20. For information on like-kind exchanges, see chapter 10. For information on involuntary conversions, see chapter 1 in Publication 544.

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 in excess of its carried-over basis (the transferor's adjusted basis in the property) as newly purchased MACRS property. For information on the kinds of nontaxable transfers covered by this rule, see chapter 4 of Publication 946.

A passenger automobile is any four-wheeled vehicle made primarily for use on public streets, roads, and highways and rated at 6,000 pounds or less of unloaded gross vehicle weight (6,000 pounds or less of gross vehicle weight for trucks and vans). It includes any part, component, or other item physically attached to the automobile or usually included in the purchase price of an automobile.

This includes trucks, buses, boats, airplanes, motorcycles, and other vehicles used for transporting persons or goods.

Other property used for transportation does not include the following vehicles.

Whether the use of listed property is for your employer's convenience must be determined from all the facts. The use is for your employer's convenience if it is for a substantial business reason of the employer. The use of listed property during your regular working hours to carry on your employer's business is generally for the employer's convenience.

Whether the use of listed property is a condition of your employment depends on all the facts and circumstances. The use of property must be required for you to perform your duties properly.

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 depreciable basis of the property.

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

The passenger automobile limits do not apply to any costs you pay to retrofit parts and components to modify an automobile to permit it to run on a clean-burning fuel. The limits apply only to the cost of the automobile without the modification.

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.

The maximum depreciation deductions for passenger automobiles that are produced to run primarily on electricity are higher than those for other automobiles. The maximum deductions (in dollar amounts) for electric vehicles are shown in the following table.

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

The maximum depreciation deductions for passenger automobiles such as minivans and sport utility vehicles that are built on a truck chassis, are generally higher than those for other automobiles. The maximum deductions (in dollar amounts) for these trucks and vans for 2003 are shown in the following table.

For information about deducting expenses for the business use of your passenger automobile, see chapter 4 in Publication 463.

To meet the adequate records requirement, you must maintain an account book, diary, log, statement of expense, trip sheet, or similar record or other documentary evidence that, together with the receipt, is sufficient to establish each element of an expenditure or use. You do not have to record information in an account book, diary, or similar record if the information is already shown on the receipt. However, your records should back up your receipts in an orderly manner.

For listed property, you must keep records for as long as any excess depreciation can be recaptured (included in income). Recapture can occur in any tax year of the recovery period.

For more information on records, see chapter 5 in Publication 946.

You determine the number of units sold during the tax year based on your method of accounting. Use the following table to make this determination.

The number of units sold during the tax year does not include any units for which depletion deductions were allowed or allowable in earlier years.

Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you can figure your cost depletion deduction by taking the following steps.

Farmers who extract ground water from the Ogallala Formation for irrigation are allowed cost depletion. Cost depletion is allowed when it can be demonstrated the ground water is being depleted and the rate of recharge is so low that, once extracted, the water is lost to the taxpayer and immediately succeeding generations.

To figure your cost depletion deduction, use the guidance provided in Revenue Procedure 66-11 in Cumulative Bulletin 1966-1.

For tax years ending before December 13, 1982, those extracting ground water for irrigation farming from the Ogallala Formation in areas outside the Southern High Plains were not required to reduce their basis in ground water by any allowable cost depletion not claimed.

Depletion takes place when you cut standing timber (including Christmas trees). You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation.

To figure timber depletion, you multiply the number of units of standing timber cut by your depletion unit.

When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. You measure the timber using board feet, log scale, cords, or other units. If you later determine that you have more or less units of timber, you must adjust the original estimate.

You figure your depletion unit each year by taking the following steps.

Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you elect to treat the cutting of timber as a sale or exchange as explained in chapter 10. Include allowable depletion for timber products not sold during the tax year the timber is cut, as a cost item in the closing inventory of timber products for the year. The inventory is your basis for determining gain or loss in the tax year you sell the timber products.

Attach Form T to your income tax return if you are claiming a deduction for timber depletion or electing to treat the cutting of timber as a sale or exchange.

The percentage depletion deduction cannot be more than 50% (100% for oil and gas property) of your taxable income from the property figured without the depletion deduction. For tax years beginning after 1997 and before 2004, the 100 percent taxable income limit does not apply to percentage depletion on the marginal production of oil or natural gas. For information on marginal production, see section 613A(c)(6) of the Internal Revenue Code.

The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit.

Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Start-up costs include any amounts paid or incurred in connection with any activity engaged in for profit and for the production of income before the trade or business begins, in anticipation of the activity becoming an active trade or business.

For more information, see Going Into Business in chapter 9 of Publication 535.

Qualifying costs include only those costs you must capitalize and include in the adjusted basis of the property. They include costs for the following items.

If the government reimburses you for reforestation costs under a cost-sharing program, you can amortize these costs only if you include the reimbursement in your income.

Qualified timber property is property that contains trees in significant commercial quantities. It can be a woodlot or other site that you own or lease. The property qualifies only if it meets all the following requirements.

Qualified timber property does not include property on which you have planted shelter belts or ornamental trees, such as Christmas trees.

The 84-month amortization period starts on the first day of the first month of the second half of the tax year you incur the costs (July 1 for a calendar year taxpayer), regardless of the month you actually incur the costs. You can claim amortization deductions for no more than 6 months of the first and last (eighth) tax years of the period.

Each year you can choose to amortize up to $10,000 ($5,000 if you are married filing separately) of qualifying costs you pay or incur during the year. You cannot carry over or carry back qualifying costs over the annual limit. If your qualifying costs are more than $10,000 for more than one piece of qualified timber property, you can divide the annual limit among the properties in any manner you wish.

The maximum annual deduction for costs incurred in any year is $1,428.57 ($10,000 ÷ 7) or $714.29 ($5,000 ÷ 7) if married filing separately. The maximum deduction in the first and last year of the 84-month period is one half (½) of the maximum annual deduction or $714.29 ($357.15 if married filing separately).

Estates can choose to amortize up to $10,000 of qualifying reforestation costs each year. These amortizable costs are divided between the income beneficiary and the estate based on the income of the estate allocable to each. The amortizable cost allocated to the beneficiary is subject to the beneficiary's annual limit.

If you dispose of qualified timber property within 10 years after the tax year you incur qualifying reforestation expenses, report any gain as ordinary income up to the amortization taken. For information on recapture, see Depreciation Recapture in chapter 11.

Amortizable reforestation costs qualify for the investment credit, whether or not they are amortized. See Investment Credit in chapter 9.

To choose to amortize qualifying reforestation costs, enter your deduction in Part VI of Form 4562. Attach a statement containing the following information.

Attach a separate statement for each property for which you amortize reforestation costs.

Generally, you must make the choice on a timely filed return (including extensions) for the year in which you incurred the costs. However, if you timely filed your return for the year without making the choice, you can still make the choice by filing an amended return within 6 months of the due date of your return (excluding extensions). Attach Form 4562 and the statement to the amended return and write “Filed pursuant to section 301.9100-2” on Form 4562. File the amended return at the same address you filed the original return.

A certified pollution control facility is a new identifiable treatment facility used in connection with a plant or other property in operation before 1976 to reduce or control water or atmospheric pollution or contamination. The facility must do so by removing, changing, disposing, storing, or preventing the creation or emission of pollutants, contaminants, wastes, or heat. The facility must be certified by the state and federal certifying authorities. Examples of such a facility include septic tanks and manure control facilities.

The federal certifying authority will not certify your property to the extent it appears you will recover (over the property's useful life) all or part of its cost from the profit based on its operation (such as through sales of recovered wastes). The federal certifying authority will describe the nature of the potential cost recovery. You must then reduce the amortizable basis of the facility by this potential recovery.

In addition, to amortize its cost over 60 months, the facility must not significantly increase the output or capacity, extend the useful life, or reduce the total operating costs of the plant or other property. Also, it must not significantly change the nature of the manufacturing or production process or facility.

For more information on the amortization of pollution control facilities, see section 169 of the Internal Revenue Code and the related regulations.

The rules for section 197 intangibles do not apply to any amount included in determining the cost of property that is not a section 197 intangible. For example, if the cost of computer software is not separately stated from the cost of the hardware or other tangible property and you consistently treat it as part of the cost of the hardware or other tangible property, these rules do not apply. Similarly, none of the cost of acquiring real property held for the production of rental income is considered the cost of goodwill, going concern value, or any other section 197 intangible.

The following assets are not section 197 intangibles.

Intangible property not amortizable under the rules for section 197 intangibles can be depreciated if it meets certain requirements. You generally must use the straight line method over its useful life. For certain intangibles, the depreciation period is specified in the law and regulations. For example, the depreciation period for computer software that is not a section 197 intangible is 36 months.

Section 197 intangibles do not include any interest in land. An interest in land includes a fee interest, life estate, remainder, easement, mineral right, timber right, grazing right, riparian right, air right, zoning variance, and any other similar right, such as a farm allotment, quota for farm commodities, or crop acreage base.

Section 197 intangibles do not include the following types of computer software.

You cannot deduct any loss on the disposition or worthlessness of a section 197 intangible you acquired in the same transaction (or series of related transactions) as other section 197 intangibles you still have. Instead, increase the adjusted basis of each remaining amortizable section 197 intangible by a proportionate part of the nondeductible loss. See chapter 9 in Publication 535 for more information.