To deduct the proper amount of depreciation each year, first determine your basis in the property you intend to depreciate. The basis used for figuring depreciation is the same as the basis that would be used for figuring the gain on a sale. Your original basis is usually the purchase price. However, if you acquire property in some other way, such as inheriting it, getting it as a gift, or building it yourself, you have to figure your original basis in a different way.

The useful life of a piece of property is an estimate of how long you can expect to use it in your trade or business, or to produce income. It is the length of time over which you will make yearly depreciation deductions of your basis in the property. It is how long it will continue to be useful to you, not how long the property will last.

Many things affect the useful life of property, such as:

The useful life can also be affected by technological improvements, progress in the arts, reasonably foreseeable economic changes, shifting of business centers, prohibitory laws, and other causes. Consider all these factors before you arrive at a useful life for your property.

The useful life of the same type of property varies from user to user. When you determine the useful life of your property, keep in mind your own experience with similar property. You can use the general experience of the industry you are in until you are able to determine a useful life of your property from your own experience.

It is important for you to accurately determine the correct salvage value of the property you want to depreciate. You generally cannot depreciate property below a reasonable salvage value.

Before 1981, you could use any reasonable method for every kind of depreciable property. One of these methods was the straight line method. This method was also used for intangible property. It lets you deduct the same amount of depreciation each year.

To figure your deduction, determine the adjusted basis of your property, its salvage value, and its estimated useful life. Subtract the salvage value, if any, from the adjusted basis. The balance is the total amount of depreciation you can take over the useful life of the property.

Divide the balance by the number of years remaining in the useful life. This gives you the amount of your yearly depreciation deduction. Unless there is a big change in adjusted basis, or useful life, this amount will stay the same throughout the time you depreciate the property. If, in the first year, you use the property for less than a full year, you must prorate your depreciation deduction for the number of months in use.

The declining balance method allows you to recover a larger amount of the cost of the property in the early years of your use of the property. The rate cannot be more than twice the straight line rate.

The income forecast method requires income projections for each videocassette or group of videocassettes. You can group the videocassettes by title for making this projection. You determine the depreciation by applying a fraction to the cost less salvage value of the cassette. The numerator is the income from the videocassette for the tax year and the denominator is the total projected income for the cassette. For more information on the income forecast method, see Revenue Ruling 60-358 in Cumulative Bulletin 1960, Volume 2, on page 68.

Change to the straight line method.   You can change from the declining balance method to the straight line method at any time during the useful life of your property without IRS consent. However, if you have a written agreement with the IRS that prohibits a change, you must first get IRS permission. When the change is made, figure depreciation based on your adjusted basis in the property at that time. Your adjusted basis takes into account all previous depreciation deductions. Use the estimated remaining useful life of your property at the time of change and its estimated salvage value.

  You can change from the declining balance method to straight line only on the original tax return for the year you first use the straight line method. You cannot make the change on an amended return filed after the due date of the original return (including extensions).

  When you make the change, attach a statement to your tax return showing:

  After you change to straight line, you cannot change back to the declining balance method or to any other method for a period of 10 years without written permission from the IRS.

Changes that require permission.   For most other changes in method of depreciation, you must get permission from the IRS. To request a change in method of depreciation, file Form 3115. File the application within the first 180 days of the tax year the change is to become effective. In most cases, there is a user fee that must accompany Form 3115. See the instructions for Form 3115 to determine if a fee is required.

Changes granted automatically.   The IRS automatically approves certain changes of a method of depreciation. But, you must file Form 3115 for these automatic changes.

  However, IRS can deny permission if Form 3115 is not filed on time. For more information on automatic changes, see Revenue Procedure 74-11, 1974-1 C.B. 420.

Changes for which approval is not automatic.   The automatic change procedures do not apply to:

  You must request and receive permission for these changes. To make the request, file Form 3115 during the first 180 days of the tax year for which you want the change to be effective.

Change from an improper method.   If the IRS disallows the method you are using, you do not need permission to change to a proper method. You can adopt the straight line method, or any other method that would have been permitted if you had used it from the beginning. If you file your tax return using an improper method, but later file an amended return, you can use a proper method on the amended return without getting IRS permission. However, you must file the amended return before the filing date for the next tax year.

Normal retirement.   A normal retirement is a permanent withdrawal of depreciable property from use if the following apply: A retirement is generally considered normal unless you can show that you retired the property because of a reason you did not consider when you originally estimated the useful life of the property.

Abnormal retirement.   A retirement can be abnormal if you withdraw the property early or under other circumstances. For example, if the property is damaged by a fire or suddenly becomes obsolete and is now useless.

Gain or loss on retirement.   There are special rules for figuring the gain or loss on retirement of property. The gain or loss will depend on several factors. These include the type of withdrawal, if the withdrawal was from a single property or multiple property account, and if the retirement was normal or abnormal. A single property account contains only one item of property. A multiple property account is one in which several items have been combined with a single rate of depreciation assigned to the entire account.

Sale or exchange.   If property is retired by sale or exchange, you figure gain or loss by the usual rules that apply to sales or other dispositions of property. See Publication 544.

Property not disposed of or abandoned.   If property is retired permanently, but not disposed of or physically abandoned, you do not recognize gain. You are allowed a loss in such a case, but only if the retirement is:

  To figure your loss, subtract the estimated salvage or fair market value of the property at the date of retirement, whichever is more, from its adjusted basis.

Special rule for normal retirements from item accounts.   You can generally deduct losses upon retirement of a few depreciable items of property with similar useful lives, if: However, you cannot deduct losses if you use the average useful life to figure depreciation and they have a wide range of useful lives.

  If you have a large number of depreciable property items and use average useful lives to figure depreciation, you cannot deduct the losses upon normal retirements from these accounts.

Abandoned property.   If you physically abandon property, you can deduct as a loss the adjusted basis of the property at the time of its abandonment. However, your intent must be to discard the property so that you will not use it again or retrieve it for sale, exchange, or other disposition.

Basis of property retired.   The basis for figuring gain or loss on the retirement of property is its adjusted basis at the time of retirement, as determined in the following discussions.

Single item accounts.   If an item of property is accounted for in a single item account, the adjusted basis is the basis you would use to figure gain or loss for a sale or exchange of the property. This is generally the cost or other basis of the item of property less depreciation. See Publication 551.

Multiple property account.   For a normal retirement from a multiple property account, if you figured depreciation using the average expected useful life, the adjusted basis is the salvage value estimated for the item of property when it was originally acquired. If you figured depreciation using the maximum expected useful life of the longest lived item of property in the account, you must use the depreciation method used for the multiple property account and a rate based on the maximum expected useful life of the item of property retired.

  You make the adjustment for depreciation for an abnormal retirement from a multiple property account at the rate that would be proper if the item of property was depreciated in a single property account. The method of depreciation used for the multiple property account is used. You base the rate on either the average expected useful life or the maximum expected useful life of the retired item of property, depending on the method used to determine the depreciation rate for the multiple property account.