Publication 225 (2005), Farmer's Tax Guide

What's New

Increased section 179 deduction dollar limits. The maximum amount you can elect to deduct for most section 179 property you placed in service in 2005 is $105,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $420,000. See Dollar Limits under Section 179 Deduction, later.

Depreciation limits for business cars. The total amount of depreciation (including the section 179 deduction) you can take for a passenger automobile (that is not an electric vehicle or a truck or van) you use in your business and first place in service in 2005 is generally $2,960. Different limits apply to electric vehicles and trucks and vans. See Do the Passenger Automobile Limits Apply under Additional Rules for Listed Property, later.

Limited applicability of special depreciation allowances. The additional special depreciation allowances (including the increased limits for passenger automobiles) do not apply to most property placed in service in 2005. Generally, you can only claim the special depreciation allowances for certain aircraft and certain property with a long production period. See Claiming the Special Depreciation Allowance, later.

Reminders

Section 179 deduction limit for sport utility vehicles. The maximum section 179 expense deduction for certain sport utility vehicles is $25,000. For more information, see Dollar Limits under Section 179 Deduction, later.

Amortization of business start-up costs. You can elect to deduct certain start-up costs. See chapter 4. The remaining costs must be amortized over a 180-month period. See Amortization, later.

Amortization of reforestation costs. . You can elect to deduct certain reforestation costs. See chapter 4. The remaining costs can be amortized over an 84-month period. See Amortization, later.

Marginal production of oil and gas. The suspension of the taxable income limit on percentage depletion from the marginal production of oil and natural gas that was scheduled to expire for tax years beginning after 2003 has been extended to tax years beginning before 2006. For more information on marginal production, see section 613A(c)(6) of the Internal Revenue Code.

Introduction

If you buy farm property such as machinery, equipment, livestock, or a structure with a useful life of more than a year, you generally cannot deduct its entire cost in one year. Instead, you must spread the cost over the time you use the property and deduct part of it each year. For most types of property, this is called depreciation.

This chapter gives information on depreciation methods that generally apply to property placed in service after 1986. For information on depreciating pre-1987 property, see Publication 534, Depreciating Property Placed in Service Before 1987.

To help you understand depreciation and how to complete Form 4562, Depreciation and Amortization, see the filled-in Form 4562 and related discussion in chapter 16.

Topics - This chapter discusses:

Overview of depreciation
Section 179 deduction
Special depreciation allowances
Modified Accelerated Cost Recovery
System (MACRS)
Listed property rules
Basic information on cost depletion (including timber depletion) and percentage depletion
Amortization of the costs of going into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles

Useful Items - You may want to see:

Publication

463 Travel, Entertainment, Gift, and Car Expenses
534 Depreciating Property Placed in Service Before 1987
535 Business Expenses
544 Sales and Other Dispositions of Assets
551 Basis of Assets
946 How To Depreciate Property

Form (and Instructions)

T
Forest Activities Schedule
1040X
Amended U.S. Individual Income Tax Return
3115
Application for Change in Accounting Method
4562
Depreciation and Amortization
4797
Sales of Business Property

Overview of Depreciation

This overview discusses basic information on the following.

What property can be depreciated.
What property cannot be depreciated.
When depreciation begins and ends.
Whether MACRS can be used to figure depreciation.
What is the basis of your depreciable property.
How to treat improvements.
When you must file Form 4562.
How you can correct depreciation claimed incorrectly.

What Property Can Be Depreciated?

You can depreciate most types of tangible property (except land), such as buildings, machinery, equipment, vehicles, certain livestock, and furniture. You can also depreciate certain intangible property, such as copyrights, patents, and computer software. To be depreciable, the property must meet all the following requirements.

It must be property you own.
It must be used in your business or income-producing activity.
It must have a determinable useful life.
It must be expected to last more than one year.

Property You Own

To claim depreciation, you usually must be the owner of the property. You are considered as owning property even if it is subject to a debt.

Leased property. 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 because you do not retain the incidents of ownership. 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. Incidents of ownership of property include the following.

The legal title to the property.
The legal obligation to pay for the property.
The responsibility to pay maintenance and operating expenses.
The duty to pay any taxes on the property.
The risk of loss if the property is destroyed, condemned, or diminished in value through obsolescence or exhaustion.

Life tenant. 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.

Property Used in Your Business or Income-Producing Activity

To claim depreciation on property, you must use it in your business or income-producing activity. If you use property to produce income (investment use), the income must be taxable. You cannot depreciate property that you use solely for personal activities.

Partial business or investment use. If you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the percentage of business or investment use.

Example 1. If you use your car for farm business, you can deduct depreciation based on its percentage of use in farming. If you also use it for investment purposes, you can depreciate it based on its percentage of investment use.

Example 2. 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 4.

Inventory. 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. 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.

Property Having a Determinable Useful Life

To be depreciable, your property must have a determinable useful life. This means it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes.

Irrigation systems and water wells. 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.

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

Property Lasting More Than One Year

To be depreciable, property must have a useful life that extends substantially beyond the year you place it in service.

What Property Cannot Be Depreciated?

Certain property cannot be depreciated. This includes the following.

Land

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. Although you cannot depreciate land, you can depreciate certain costs incurred in preparing land for business use. See chapter 1 of Publication 946.

Excepted Property

Even if the requirements explained in the preceding discussions are met, you cannot depreciate the following property.

Property placed in service and disposed of in the same year. Determining when property is placed in service is explained later.
Equipment used to build capital improvements. You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements.
Intangible property such as section 197 intangibles.
Certain term interests.

Intangible property. This property does not have a determinable useful life and generally cannot be depreciated. Special rules apply to computer software (discussed next). See Amortization, later, and chapter 9 of Publication 535 for more information.

Computer software. 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 that make up a business or a substantial part of a business.

However, computer software is not a section 197 intangible even if acquired in connection with the acquisition of a business, if it meets all of the following tests.

It is readily available for purchase by the general public.
It is subject to a nonexclusive license.
It has not been substantially modified.

If the software meets the tests above, it can be depreciated and may qualify for the section 179 deduction and the special depreciation allowance (if applicable), discussed later.

Certain term interests in property. 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.

When Does Depreciation Begin and End?

You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first.

Placed in Service

Property is placed in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.

Example.

You bought a planter for use in your farm business. The planter was delivered in December 2005 after harvest was over. You begin to depreciate the planter for 2005 because it was ready and available for its specific use in 2005, even though it will not be used until the spring of 2006.

If your planter comes unassembled in December 2005 and is put together in February 2006, it is not placed in service until 2006. You begin to depreciate it in 2006.

If your planter was delivered and assembled in February 2006 but not used until April 2006, it is placed in service in February 2006, because this is when the planter was ready for its specified use. You begin to depreciate it in 2006.

Fruit or nut trees and vines. 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 6 for information about the uniform capitalization rules. Your depreciation begins when the trees and vines reach the income-producing stage (that is, when they bear fruit, nuts, or grapes in quantities sufficient to commercially warrant harvesting).

Immature livestock. Depreciation for livestock begins when the livestock reaches the age of maturity. If you acquire immature livestock for draft, dairy, or breeding purposes, your 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.

Idle Property

Continue to claim a deduction for depreciation on property used in your business or for the production of income even if it is temporarily idle. For example, if you stop using a machine because there is a temporary lack of a market for a product made with that machine, continue to deduct depreciation on the machine.

Cost or Other Basis Fully Recovered

You stop depreciating property when you have fully recovered your cost or other basis. This happens when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property.

Retired From Service

You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events.

You sell or exchange the property.
You convert the property to personal use.
You abandon the property.
You transfer the property to a supplies or scrap account.
The property is destroyed.

For information on abandonment of property, see chapter 8. For information on destroyed property, see chapter 11 and Publication 547, Casualties, Disasters, and Thefts.

Can You Use MACRS To Depreciate Your Property?

You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most business and investment property placed in service after 1986. MACRS is explained later under Figuring Depreciation Under MACRS.

You cannot use MACRS to depreciate the following property.

Property you placed in service before 1987.
Certain property owned or used in 1986.
Intangible property.
Films, video tapes, and recordings.
Certain corporate or partnership property acquired in a nontaxable transfer.
Property you elected to exclude from MACRS.

For more information, see Chapter 1 of Publication 946.

Property You Placed in Service Before 1987

You cannot use MACRS for property you placed in service before 1987 (except property you placed in service after July 31, 1986, if MACRS was elected). Property placed in service before 1987 must be depreciated under the methods discussed in Publication 534, Depreciating Property Placed in Service Before 1987.

Use of real property changed. 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.

Property Owned or Used in 1986

Under special rules, you may not be able to use MACRS for property you acquired and placed in service after 1986. These rules apply to both personal and real property owned or used before 1987. If you cannot use MACRS, the property must be depreciated under the methods discussed in Publication 534. For specific information, see Property Owned or Used in 1986 in chapter 1 of Publication 946.

Election To Exclude Property From MACRS

If you can properly depreciate any property under a method not based on a term of years, such as the unit-of-production method, you can elect to exclude that property from MACRS. You make the election by reporting your depreciation for the property on line 15 in Part II of Form 4562 and attaching a statement as described in the instructions for Form 4562. You must make this election by the return due date (including extensions) for the year you place your 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 the 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.

Use of standard mileage rate. 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.

What Is the Basis of Your Depreciable Property?

To figure your depreciation deduction, you must determine the basis of your property. To determine basis, you need to know the cost or other basis of your property.

Cost as basis. 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. 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 6 to determine your basis.

Property changed from personal use. 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.

The fair market value (FMV) of the property on the date of the change in use.
Your original cost or other basis adjusted as follows.
1. Increased by the cost of any permanent improvements or additions and other costs that must be added to basis.
2. Decreased by any tax deductions you claimed for casualty and theft losses and other items that reduced your basis.

Property acquired in a nontaxable transaction. Generally, if you receive property in a nontaxable exchange, the basis of the property you receive is the same as the adjusted basis of the property you gave up. Special rules apply in determining the basis and figuring the depreciation deduction for MACRS property acquired in a like-kind exchange or involuntary conversion. See Figuring the Deduction for Property Acquired in a Nontaxable Exchange under Figuring Depreciation Under MACRS, later.

Adjusted basis. 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.

Installing utility lines.
Paying legal fees for perfecting the title.
Settling zoning issues.
Receiving rebates.
Incurring a casualty or theft loss.

For a discussion of adjustments to the basis of your property, see Adjusted Basis in chapter 6.

Basis adjustment for depreciation allowed or allowable. After you place your property in service, you must reduce the basis of the 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).

How Do You Treat Improvements?

If you improve depreciable property, you must treat the improvement as separate depreciable property. For more information on improvements, see Publication 946.

Repairs. 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.

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

Do You Have To File Form 4562?

Use Form 4562 to claim your deduction for depreciation and amortization. You must complete and attach Form 4562 to your tax return if you are claiming any of the following.

A section 179 deduction for the current year or a section 179 carryover from a prior year. The section 179 deduction is discussed later.
Depreciation for property placed in service during the current year.
Depreciation on any vehicle or other listed property, regardless of when it was placed in service. Listed property is discussed later.
Amortization of costs that began in the current year. Amortization is discussed later.

For more information, see the Instructions for Form 4562.

It is important to keep good records for property you depreciate. Do not file these records with your return. Instead, you should keep them as part of the permanent records of the depreciated property. They will help you verify the accuracy of the of the depreciation of assets placed in service in the current and previous tax years. For general information on recordkeeping, see Publication 583, Starting a Business and Keeping Records. For specific information on keeping records for section 179 property and listed property, see Publication 946.

How Do You Correct Depreciation Deductions?

If you deducted an incorrect amount of depreciation in any year, you may be able to make a correction by filing an amended return for that year. If you are not allowed to make the correction on an amended return, you may be able to change your accounting method to claim the correct amount of depreciation.

Filing an Amended Return

You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations.

You claimed the incorrect amount because of a mathematical error made in any year.
You claimed the incorrect amount because of a posting error made in any year (for example, omitting an asset from the depreciation schedule).
You have not adopted a method of accounting for the property.

Generally, you adopt a method of accounting for depreciation by using a permissible method of determining depreciation when you file your first tax return, or by using the same impermissible method of determining depreciation in two or more consecutively filed tax returns. Revenue Procedure 2002-9, which is in Internal Revenue Bulletin 2002-3, as modified by Revenue Procedure 2004-11, which is in Internal Revenue Bulletin 2004-3, provides an exception to this 2-year rule.

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

3 years from the date you filed your original return for the year in which you deducted the incorrect amount. (A return filed before an unextended due date is considered filed on the due date.)
2 years from the time you paid your tax for that year.

Changing Your Accounting Method

Generally, you must get IRS approval to change your method of accounting. File Form 3115, Application for Change in Accounting Method, to request a change in your method of accounting for depreciation.

The following are examples of a change in method of accounting for depreciation.

A change in the treatment of an asset from nondepreciable to depreciable or vice versa.
A change in the depreciation method, period of recovery, or convention of a depreciable asset.
A change from not claiming to claiming the special depreciation allowance or vice versa.
A change from claiming the 50% special depreciation allowance to claiming the 30% special depreciation allowance for qualified property (including property that is included in a class of property for which you elected the 30% special allowance instead of the 50% special allowance).

See section 1.446-1T(e)(2)(ii)(d)(2) of the regulations for additional examples.

Changes in depreciation that are not a change in method of accounting include the following.

An adjustment in the useful life of a depreciable asset for which depreciation is determined under section 167.
A change in use of an asset in the hands of the same taxpayer.
Making a late depreciation election or revoking a timely valid depreciation election.
Any change in the placed-in-service date of a depreciable asset.

See section 1.446-1T(e)(2)(ii)(d)(3) of the regulations for additional examples.

In some instances, you may be able to get an automatic approval from the IRS to change your method of accounting for depreciation. See the Instructions for Form 3115 for more information on getting approval, automatic approval procedures, and a list of exceptions to the automatic approval process. Revenue Procedure 2002-9 and Revenue Procedure 2004-11 provide additional guidance and special procedures for amending your return and filing Form 3115.

Changing your method of accounting for depreciation is discussed in more detail in chapter 1 of Publication 946.

Section 179 Deduction

You can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service. This is the section 179 deduction. You can elect the section 179 deduction instead of recovering the cost by taking depreciation deductions.

This part of the chapter explains the rules for the section 179 deduction. It explains what property qualifies for the deduction, what property does not qualify for the deduction, the limits that may apply, how to elect the deduction, and when you may have to recapture the deduction.

What Property Qualifies?

To qualify for the section 179 deduction, your property must meet all the following requirements.

It must be eligible property.
It must be acquired for business use.
It must have been acquired by purchase.

Eligible Property

To qualify for the section 179 deduction, your property must be one of the following types of depreciable property.

Tangible personal property.
Other tangible property (except buildings and their structural components) used as:
1. An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services,
2. A research facility used in connection with any of the activities in (a) above, or
3. A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities.
Single purpose agricultural (livestock) or horticultural structures.
Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product of petroleum.
Off-the-shelf computer software.

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

Machinery and equipment.
Property contained in or attached to a building (other than structural components), such as milk tanks, automatic feeders, barn cleaners, and office equipment.
Gasoline storage tanks and pumps at retail service stations.
Livestock, including horses, cattle, hogs, sheep, goats, and mink and other fur-bearing animals.

Facility used for the bulk storage of fungible commodities. 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.

Grain bins. 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.

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

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

To house, raise, and feed a particular type of livestock and its produce.
To house the equipment, including any replacements, needed to house, raise, or feed the livestock.

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.

Horticultural structure. A single purpose horticultural structure is either of the following.

A greenhouse specifically designed, constructed, and used for the commercial production of plants.
A structure specifically designed, constructed, and used for the commercial production of mushrooms.

Use of structure. 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.

Stocking, caring for, or collecting livestock or plants or their produce.
Maintaining the enclosure or structure.
Maintaining or replacing the equipment or stock enclosed or housed in the structure.

Off-the-shelf computer software. Off-the-shelf computer software placed in service after 2002 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.

Property Acquired for Business Use

To qualify for the section 179 deduction, your property must have been acquired for use in your trade or business. Property you acquire only for the production of income, such as investment property, rental property (if renting property is not your trade or business), and property that produces royalties, does not qualify.

Partial business use. 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.

Property Acquired by Purchase

To qualify for the section 179 deduction, your property must have been acquired by purchase. For example, property acquired by gift or inheritance does not qualify.

Property is not considered acquired by purchase in the following situations.

It is acquired by one member of a controlled group from another member of the same group.
Its basis is determined either—
1. In whole or in part by its adjusted basis in the hands of the person from whom it was acquired, or
2. Under the stepped-up basis rules for property acquired from a decedent.
It is acquired from a related person. 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.

For more information on related persons, see Related persons under Property Acquired by Purchase in chapter 2 of Publication 946.

What Property Does Not Qualify?

Land and improvements. Land and land improvements, such as buildings and other permanent structures and their components, are real property, not personal property and do not qualify as section 179 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.

Excepted property. Even if the requirements explained in the preceding discussions are met, you cannot elect the section 179 deduction for the following property.

Certain property you lease to others (if you are a noncorporate lessor).
Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging. (This exception does not apply to property used by a hotel or motel where the predominant portion of the accommodations is used by transients.)
Air conditioning or heating units.
Property used predominantly outside the United States (except property described in section 168(g)(4) of the Internal Revenue Code).
Property used by certain tax-exempt organizations (except property used in connection with the production of income subject to the tax on unrelated trade or business income).
Property used by governmental units or foreign persons or entities (except property used under a lease with a term of less than 6 months).

How Much Can You Deduct?

Your section 179 deduction is generally the cost of the qualifying property. However, the total amount you can elect to deduct under section 179 is subject to a dollar limit and a business income limit. These limits apply to each taxpayer, not to each business. However, see Married individuals under Dollar Limits, later. See also the special rules for applying the limits for partnerships and S corporations, later, under Partnerships and S Corporations.

If you deduct only part of the cost of qualifying property as a section 179 deduction, you can generally depreciate the cost you do not deduct. See Claiming the Special Depreciation Allowance and Figuring Depreciation Under MACRS, later.

Use Part I of Form 4562 to figure your section 179 deduction.

Trade-in of other property. 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.

Example.

J-Bar Farms traded two cultivators having a total adjusted basis of $6,800 for a new cultivator costing $13,200. They received an $8,000 trade-in allowance for the old cultivators and paid $5,200 cash for the new cultivator. J-Bar also traded a used pickup truck with an adjusted basis of $8,000 for a new pickup truck costing $15,000. They received a $5,000 trade-in allowance and paid $10,000 cash for the new pickup truck.

Only the cash paid by J-Bar qualifies for the section 179 deduction. J-Bar's business costs that qualify for a section 179 deduction are $15,200 ($5,200 + $10,000).

Dollar Limits

The total amount you can elect to deduct under section 179 for most property placed in service in 2005 is $105,000. If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 deduction among the items in any way, as long as the total deduction is not more than $105,000. You do not have to claim the full $105,000.

Example.

This year, you bought and placed in service a tractor for $101,000 and a mower for $6,200 for use in your farming business. You elect to deduct the entire $6,200 for the mower and $98,800 for the tractor, a total of $105,000. This is the most you can deduct. Your $6,200 deduction for the mower completely recovered its cost. Your basis for depreciation is zero. The basis of your tractor for depreciation is $2,200. You figure this by subtracting the amount of your section 179 deduction, $98,800, from the cost of the tractor, $101,000.

Reduced dollar limit for cost exceeding $420,000. If the cost of your qualifying section 179 property placed in service in 2005 is over $420,000, you must reduce the dollar limit (but not below zero) by the amount of cost over $420,000. If the cost of your section 179 property placed in service during 2005 is $525,000 or more, you cannot take a section 179 deduction and you cannot carry over the cost that is more than $525,000.

Example.

This year, James Smith placed in service machinery costing $495,000. Because this cost is $75,000 more than $420,000, he must reduce his dollar limit to $30,000 ($105,000 - $75,000).

Limits for sport utility vehicles. The total amount you can elect to deduct for certain sport utility vehicles and certain other vehicles placed in service in 2005 is $25,000. This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, and highways that is rated at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight.

For more information, see chapter 2 of Publication 946.

Limits for passenger automobiles. For a passenger automobile that is placed in service in 2005, the total section 179 and depreciation deduction is limited. See Do the Passenger Automobile Limits Apply under Additional Rules for Listed Property, later.

Married individuals. 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 $420,000. You must allocate the dollar limit (after any reduction) equally between you, 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.

Joint return after separate returns. 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.

The dollar limit (after reduction for any cost of section 179 property over $420,000).
The total cost of section 179 property you and your spouse elected to expense on your separate returns.

Business Income Limit

The total cost you can deduct each year after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Generally, you are considered to actively conduct a trade or business if you meaningfully participate in the management or operations of the trade or business.

Any cost not deductible in one year under section 179 because of this limit can be carried to the next year. See Carryover of disallowed deduction, later.

Taxable income. 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.

Section 1231 gains (or losses) as discussed in chapter 9.
Interest from working capital of your trade or business.
Wages, salaries, tips, or other pay earned as an employee.

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

The section 179 deduction.
The self-employment tax deduction.
Any net operating loss carryback or carryforward.
Any unreimbursed employee business expenses.

Two different taxable income limits. 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.

Step	Action
1	Figure taxable income without the section 179 deduction or the other deduction.
2	Figure a hypothetical section 179 deduction using the taxable income figured in Step 1.
3	Subtract the hypothetical section 179 deduction figured in Step 2 from the taxable income figured in Step 1.
4	Figure a hypothetical amount for the other deduction using the amount figured in Step 3 as taxable income.
5	Subtract the hypothetical other deduction figured in Step 4 from the taxable income figured in Step 1.
6	Figure your actual section 179 deduction using the taxable income figured in Step 5.
7	Subtract your actual section 179 deduction figured in Step 6 from the taxable income figured in Step 1.
8	Figure your actual other deduction using the taxable income figured in Step 7.

Example.

On February 1, 2005, the XYZ farm corporation purchased and placed in service qualifying section 179 property that cost $105,000. It elects to expense the entire $105,000 cost under section 179. In June, the corporation gave a charitable contribution of $10,000. A corporation's limit on charitable contributions is figured after subtracting any section 179 deduction. The business income limit for the section 179 deduction is figured after subtracting any allowable charitable contributions. XYZ's taxable income figured without the section 179 deduction or the deduction for charitable contributions is $125,000. XYZ figures its section 179 deduction and its deduction for charitable contributions as follows.

Step 1. Taxable income figured without either deduction is $125,000.

Step 2. Using $125,000 as taxable income, XYZ's hypothetical section 179 deduction is $105,000.

Step 3. $20,000 ($125,000 - $105,000).

Step 4. Using $20,000 (from Step 3) as taxable income, XYZ's hypothetical charitable contribution (limited to 10% of taxable income) is $2,000.

Step 5. $123,000 ($125,000 - $2,000).

Step 6. Using $123,000 (from Step 5) as taxable income, XYZ figures the actual section 179 deduction. Because the taxable income is at least $105,000, XYZ can take a $105,000 section 179 deduction.

Step 7. $20,000 ($125,000 - $105,000).

Step 8. Using $20,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable income) is $2,000.

Carryover of disallowed deduction. You can carry over for an unlimited number of years 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.

Example.

Last year, Joyce Jones placed in service a machine that cost $8,000 and elected to deduct all $8,000 under section 179. The taxable income from her business (determined without regard to both a section 179 deduction for the cost of the machine and the self-employment tax deduction) was $6,000. Her section 179 deduction was limited to $6,000. The $2,000 cost that was not allowed as a section 179 deduction (because of the business income limit) is carried to this year.

This year, Joyce placed another machine in service that cost $9,000. Her taxable income from business (determined without regard to both a section 179 deduction for the cost of the machine and the self-employment tax deduction) is $10,000. Joyce can deduct the full cost of the machine ($9,000) but only $1,000 of the carryover from last year because of the business income limit. She can carry over the balance of $1,000 to next year.

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

Partnerships and S Corporations

The section 179 deduction limits apply both to the partnership or S corporation and to each partner or shareholder. The partnership or S corporation determines its section 179 deduction subject to the limits. It then allocates the deduction among its partners or shareholders.

If you are a partner in a partnership or shareholder of an S corporation, you add the amount allocated from the partnership or S corporation to any section 179 costs not related to the partnership or S corporation and then apply the dollar limit to this total. To determine any reduction in the dollar limit for costs over $420,000, you do not include any of the cost of section 179 property placed in service by the partnership or S corporation. After you apply the dollar limit, you apply the business income limit to any remaining section 179 costs. For more information, see chapter 2 of Publication 946.

Example.

In 2005, Partnership P placed in service section 179 property with a total cost of $500,000. P must reduce its dollar limit by $80,000 ($500,000 - $420,000). Its maximum section 179 deduction is $25,000 ($105,000 - $80,000), and it elects to expense that amount. Because P's taxable income from the active conduct of all its trades or businesses for the year was $30,000, it can deduct the full $25,000. P allocates $10,000 of its section 179 deduction and $15,000 of its taxable income to John, one of its partners.

John also conducts a business as a sole proprietor and in 2005, placed in service in that business, section 179 property costing $14,000. John's taxable income from that business was $5,000. He elects to expense the $10,000 allocated from P, plus the $14,000 of his sole proprietorship's section 179 costs. However, John's deduction is limited to his business taxable income of $20,000 ($15,000 from P plus $5,000 from his sole proprietorship). He carries over $4,000 ($24,000 - $20,000) of the elected section 179 costs to 2006.

How Do You Elect the Deduction?

Making an election. You elect to take the section 179 deduction by completing Part I of Form 4562.

If you elect the deduction for listed property (described later), complete Part V of Form 4562 before completing Part I.

For property placed in service in 2005, file Form 4562 with either of the following:

Your original tax return (whether or not you filed it timely), or
An amended return filed within the time prescribed by law. An election made on an amended return must specify the item of section 179 property to which the election applies and the part of the cost of each such item to be taken into account. The amended return must also include any resulting adjustments to taxable income.

Revoking an election. An election (or any specification made in the election) to take a section 179 deduction for 2005 can be revoked without IRS approval by filing an amended return. The amended return must be filed within the time prescribed by law. The amended return must also include any resulting adjustments to taxable income. Once made, the revocation is irrevocable.

For more information on making or revoking a section 179 deduction, see chapter 2 of Publication 946.

When Must You Recapture the Deduction?

You may have to recapture the section 179 deduction if, in any year during the property's recovery period, the percentage of business use drops to 50% or less. In the year the business use drops to 50% or less, you include the recapture amount as ordinary income. You also increase the basis of the property by the recapture amount. Recovery periods for property are discussed later.

If you sell, exchange, or otherwise dispose of the property, do not figure the recapture amount under the rules explained in this discussion. Instead, use the rules for recapturing depreciation explained in chapter 9 under Section 1245 Property .

If the property is listed property (described later), do not figure the recapture amount under the rules explained in this discussion when the percentage of business use drops to 50% or less. Instead, use the rules for recapturing depreciation explained in chapter 5 of Publication 946 under Recapture of Excess Depreciation .

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

Figure the allowable depreciation for the section 179 deduction you claimed. Begin with the year you placed the property in service and include the year of recapture.
Subtract the depreciation figured in (1) from the section 179 deduction you actually claimed. The result is the amount you must recapture.

Example.

In January 2003, Paul Lamb, a calendar year taxpayer, bought and placed in service section 179 property costing $10,000. The property is not listed property. He elected a $5,000 section 179 deduction for the property and also elected not to claim a special depreciation allowance. He used the property only for business in 2003 and 2004. During 2005, he used the property 40% for business and 60% for personal use. He figures his recapture amount as follows.

Section 179 deduction claimed (2003)		$5,000
Minus: Allowable depreciation (instead of section 179 deduction):
2003	$1,250
2004	1,875
2005 ($1,250 × 40% (business))	500	3,625
2005 — Recapture amount		$1,375

Paul must include $1,375 in income for 2005.

Where to report recapture. 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).

Claiming the Special Depreciation Allowance

For qualified property (defined below) placed in service in 2005, you can take an additional 50% (or 30%, if applicable) special depreciation allowance. The allowance is an additional deduction you can take after any section 179 deduction and before you figure regular depreciation under MACRS. This part of the chapter explains what is qualified property, how to figure the allowance, and how to elect not to claim it.

What Is Qualified Property?

For farmers, qualified property is generally certain long production period property. To be qualified property, long production period property must meet the following requirements.

It is new property of one of certain types, including the following.
1. Tangible property depreciated under the modified accelerated cost recovery system (MACRS) with a recovery period of 20 years or less. See Can You Use MACRS To Depreciate Your Property, earlier, and Which Recovery Period Applies, later.
2. Computer software that is not a section 197 intangible as described in Computer software under What Property Cannot Be Depreciated, earlier. (The cost of some computer software is treated as part of the cost of hardware and is depreciated under MACRS.)
3. Qualified leasehold improvement property (defined in chapter 3 of Publication 946).
The property has a recovery period of at least 10 years or is transportation property.
The property is subject to section 263A.
It is property for which either of the following applies.
1. The property has an estimated production period exceeding 2 years.
2. The property has an estimated production period exceeding 1 year and an estimated production cost exceeding $1,000,000.
The property meets all of the tests discussed under Other Tests To Be Met, next.

Qualified property may also be certain noncommercial aircraft placed in service before January 1, 2006. For more information, see chapter 3 of Publication 946.

Other Tests To Be Met

To be qualified property for purposes of the special allowance, the property must meet the following tests.

Acquisition test. To qualify for the 50% special allowance, you must have acquired the property after May 5, 2003, and before January 1, 2005. If a binding contract to acquire the property existed before May 6, 2003, the property does not qualify.

The 30% special allowance applies to qualified property for which the 50% special allowance does not apply. To qualify for the 30% special allowance, you must have acquired the property after September 10, 2001, and before January 1, 2005. If a binding contract to acquire the property existed before September 11, 2001, the property does not qualify.

You can elect to claim the 30% special allowance instead of the 50% allowance for property that qualifies for the 50% allowance. This election applies to all property in the same property class placed in service during the tax year. See How Can You Elect Not To Claim the Allowance , later.

Property you manufacture, construct, or produce for your own use is qualified property if you began the manufacture, construction, or production of the property after May 5, 2003 (after September 10, 2001, if applicable), and before January 1, 2005. Property that is manufactured, constructed, or produced for your own use by another person under a written binding contract is considered to be manufactured, constructed, or produced by you.

Placed in service test. Qualified property must be placed in service before January 1, 2006. For special rules regarding when property involved in certain transactions is treated as placed in service, see chapter 3 of Publication 946 and section 1.168(k)-1T(b)(5) of the regulations.

Original use test. The original use of the property must have begun with you after May 5, 2003 (after September 10, 2001, if applicable). Original use means the first use to which the property is put, whether or not by you. Therefore, property used by any person before May 6, 2003 (before September 11, 2001, if applicable) does not meet the original use test.

For special rules regarding the original use of qualified property, see chapter 3 of Publication 946 and section 1.168(k)-1T(b)(3) of the regulations.

What Property Is Not Qualified Property?

Qualified property does not include any of the following.

Property placed in service and disposed of in the same tax year.
Property converted from business use to personal use in the same tax year it is acquired. (Property converted from personal use to business use in the same or later tax year may be qualified property.)
Property required to be depreciated using ADS. This includes property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect and listed property used 50% or less in a qualified business use.
Property for which you elected not to claim a special depreciation allowance (discussed later).

How Much Can You Deduct?

Figure the special depreciation allowance by multiplying the depreciable basis of the qualified property by 50% (or 30% if applicable).

Depreciable basis. 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.

Any section 179 deduction.
Any deduction for removal of barriers to the disabled and the elderly.
Any disabled access credit, enhanced oil recovery credit, and credit for employer-provided childcare facilities and services.
Basis adjustment to investment credit property under section 50(c) of the Internal Revenue Code.

For long production period property, only the part of the depreciable basis attributable to manufacture, construction, or production before January 1, 2005, is eligible for the special depreciation allowance.

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.

Depreciating the remaining cost. 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 special allowance (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.

Example.

On November 1, 2005, Tom Brown placed in service in his business qualified property costing $205,000. He elects to deduct $105,000 of the property's cost as a section 179 deduction. He uses the remaining $100,000 of cost to figure his special depreciation allowance of $50,000 ($100,000 × 50%). He uses the remaining $50,000 ($100,000 - $50,000) of cost to figure his regular MACRS depreciation deduction for 2005 and later years.

How Can You Elect Not To Claim the Allowance?

You can elect, for any class of property, either:

To deduct the 30% special allowance, instead of the 50%, for all property in such class placed in service during the tax year, or
Not to deduct any special allowances for all property in such class placed in service during the tax year.

To make either election, attach a statement to your return indicating what election you are making and the class of property for which you are making the election.

When to make election. 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.

If you elect not to have any special allowance apply, the property may be subject to an alternative minimum tax adjustment for depreciation.

Figuring Depreciation Under MACRS

The Modified Accelerated Cost Recovery System (MACRS) is used to recover the basis of most business and investment property placed in service after 1986. MACRS consists of two depreciation systems, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Generally, these systems provide different methods and recovery periods to use in figuring depreciation deductions.

To be sure you can use MACRS to figure depreciation for your property, see Can You Use MACRS To Depreciate Your Property , earlier.

This part explains how to determine which MACRS depreciation system applies to your property. It also discusses the following information that you need to know before you can figure depreciation under MACRS.

Property's recovery class.
Placed-in-service date.
Basis for depreciation.
Recovery period.
Convention.
Depreciation method.

Finally, this part explains how to use this information to figure your depreciation deduction.

Which Depreciation System (GDS or ADS) Applies?

Your use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period you use. You should use GDS unless you are specifically required by law to use ADS or you elect to use ADS.

Required use of ADS. You must use ADS for the following property.

All property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect.
Listed property used 50% or less in a qualified business use. For information on listed property, see Additional Rules for Listed Property, later.
Any tax-exempt use property.
Any tax-exempt bond-financed property.
Any property imported from a foreign country for which an Executive Order is in effect because the country maintains trade restrictions or engages in other discriminatory acts.
Any tangible property used predominantly outside the United States during the year.

If you are required to use ADS to depreciate your property, you cannot claim the special depreciation allowance (discussed earlier).

Electing ADS. 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.

Which Property Class Applies Under GDS?

The following is a list of the nine property classes under GDS.

3-year property.
5-year property.
7-year property.
10-year property.
15-year property.
20-year property.
25-year property.
Residential rental property.
Nonresidential real property.

See Which Property Class Applies Under GDS in chapter 4 of Publication 946 for examples of the types of property included in each class.

What Is the Placed-in-Service Date?

You begin to claim depreciation when your property is placed in service for use either in a trade or business or for the production of income. The placed-in-service date for your property is the date the property is ready and available for a specific use. It is therefore not necessarily the date it is first used. If you converted property held for personal use to use in a trade or business or for the production of income, treat the property as being placed in service on the conversion date. See Placed in Service under When Does Depreciation Begin and End, earlier, for examples illustrating when property is placed in service.

What Is the Basis for Depreciation?

The basis for depreciation of MACRS property is the property's cost or other basis multiplied by the percentage of business/investment use. Reduce that amount by the following items.

Any deduction for section 179 property.
Any deduction for removal of barriers to the disabled and the elderly.
Any disabled access credit, enhanced oil recovery credit, and credit for employer-provided childcare facilities and services.
Any special depreciation allowance.
Basis adjustment for investment credit property under section 50(c) of the Internal Revenue Code.

For information about how to determine the cost or other basis of property, see What Is the Basis of Your Depreciable Property, earlier.

Which Recovery Period Applies?

The recovery period of property is the number of years over which you recover its cost or other basis. It is determined based on the depreciation system (GDS or ADS) used.

Recovery periods. See Table 7-1 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.

House trailers for farm laborers. 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).

A 7-year recovery period under GDS.
A 10-year recovery period under ADS.

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.

A 20-year recovery period under GDS.
A 25-year recovery period under ADS.

Water wells. 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.

A 15-year recovery period under GDS.
A 20-year recovery period under ADS.

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.

Which Convention Applies?

Under MACRS, averaging conventions establish when the recovery period begins and ends. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property. Use one of the following conventions.

The half-year convention.
The mid-month convention.
The mid-quarter convention.

The mid-month convention. 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.

The mid-quarter convention. 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.

For purposes of determining whether the mid-quarter convention applies, the depreciable basis of property you placed in service during the tax year does not reflect any reduction in basis for the special depreciation allowance.

The half-year convention. 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.

Which Depreciation Method Applies?

MACRS provides three depreciation methods under GDS and one depreciation method under ADS.

The 200% declining balance method over a GDS recovery period.
The 150% declining balance method over a GDS recovery period.
The straight line method over a GDS recovery period.
The straight line method over an ADS recovery period.

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

The straight line method over a GDS recovery period.
The straight line method over an ADS recovery period.

Table 7-1. Farm Property Recovery Periods

	Recovery Period in Years
Assets	GDS	ADS
Agricultural structures (single purpose)	10	15
Automobiles	5	5
Calculators and copiers	5	6
Cattle (dairy or breeding)	5	7
Communication equipment ¹	7	10
Computer and peripheral equipment	5	5
Drainage facilities	15	20
Farm buildings ²	20	25
Farm machinery and equipment	7	10
Fences (agricultural)	7	10
Goats and sheep (breeding)	5	5
Grain bin	7	10
Hogs (breeding)	3	3
Horses (age when placed in service)
Breeding and working (12 years or less)	7	10
Breeding and working (more than 12 years)	3	10
Racing horses (more than 2 years)	3	12
Horticultural structures (single purpose)	10	15
Logging machinery and equipment ³	5	6
Nonresidential real property	39 ⁴	40
Office furniture, fixtures, and equipment (not calculators, copiers, or typewriters)	7	10
Paved lots	15	20
Residential rental property	27.5	40
Tractor units (over-the-road)	3	4
Trees or vines bearing fruit or nuts	10	20
Truck (heavy duty, unloaded weight 13,000 lbs. or more)	5	6
Truck (actual weight less than 13,000 lbs)	5	5
Water wells	15	20

¹ Not including communication equipment listed in other classes.

² Not including single purpose agricultural or horticultural structures.

³ Used by logging and sawmill operators for cutting of timber.

⁴ For property placed in service after May 12, 1993; for property placed in service before May 13, 1993,
the recovery period is 31.5 years.

Farming business. 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.

Operating a nursery or sod farm.
Raising or harvesting crops.
Raising or harvesting trees bearing fruit, nuts, or other crops.
Raising ornamental trees. (An evergreen tree is not considered an ornamental tree if it is more than 6 years old when it is severed from its roots.)
Raising, shearing, feeding, caring for, training, and managing animals.

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.

Example 1.

If you are in the trade or business of growing fruits and vegetables, you can harvest, wash, inspect, and package the fruits and vegetables for sale. Such activities are normally part of the raising of these crops by farmers. You are considered to be in the business of farming with respect to the growing of fruits and vegetables and the processing activities that are part of their harvest.

Example 2.

You are in the business of growing and harvesting apples. You also process the apples you have harvested in order to produce applesauce and apple cider. You then sell these products to customers in the course of your business. Although you are in the farming business with respect to the growing and harvesting of apples, you are not in the farming business with respect to the processing of the apples to produce the food products.

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.

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

Depreciation Table. 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.

Depreciation Table

System/Method		Type of Property
GDS using 150% DB	•	All property used in a farming business (except real property)
	•	All 15- and 20-year property
	•	Nonfarm 3-, 5-, 7-, and 10-year property ¹
GDS using SL	•	Nonresidential real property
	•	Residential rental property
	•	Trees or vines bearing fruit or nuts
	•	All 3-, 5-, 7-, 10-, 15-, and 20-year property ¹
ADS using SL	•	Property used predomi- nantly outside the U.S.
	•	Farm property used when an election not to apply the uniform capitalization rules is in effect
	•	Tax-exempt property
	•	Tax-exempt bond-financed property
	•	Imported property ²
	•	Any property for which you elect to use this method ¹
GDS using 200% DB	•	Nonfarm 3-, 5-, 7-, and 10-year property

¹Elective method

²See section 168(g)(6) of the Internal Revenue
Code

Switching to straight line. 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.

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

ADS required for some farmers. If you elect not to apply the uniform capitalization rules to any plant shown in Table 6-1 of chapter 6 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 6 for a discussion of the application of the uniform capitalization rules to farm property. For a definition of farming business for this purpose, see Farming business earlier, under Property used in farming business.

Electing a different method. 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.

Straight line election. 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.

ADS election. 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 7-1. 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.

How Is the Depreciation Deduction Figured?

To figure your depreciation deduction under MACRS, you first determine the depreciation system, property class, placed-in-service date, basis amount, recovery period, convention, and depreciation method that applies to your property. Then you are ready to figure your depreciation deduction. You can figure it in one of two ways.

You can use the percentage tables provided by the IRS.
You can figure your own deduction without using the tables.

Figuring your own MACRS deduction will generally result in a slightly different amount than using the tables.

Using the MACRS Percentage Tables

To help you figure your deduction under MACRS, the IRS has established percentage tables that incorporate the applicable convention and depreciation method. These percentage tables are in Appendix A of Publication 946.

Rules for using the tables. The following rules cover the use of the percentage tables.

You must apply the rates in the percentage tables to your property's unadjusted basis (defined later).
You cannot use the percentage tables for a short tax year. See chapter 4 of Publication 946 for information on how to figure the deduction for a short tax year.
You generally must continue to use them for the entire recovery period of the property.
You must stop using the tables if you adjust the basis of the property for any reason other than—
1. Depreciation allowed or allowable, or
2. An addition or improvement to the property. (An addition or improvement is depreciated as a separate property.)

Basis adjustment due to casualty loss. 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.

Figuring the unadjusted basis of your property. 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.

Any amortization taken on the property.
Any section 179 deduction claimed on the property.
Any special depreciation allowance.
Any deduction claimed for a clean-fuel vehicle or clean-fuel vehicle refueling property.
Any electric vehicle credit.

The clean-fuel vehicle and clean-fuel vehicle refueling property deductions and the credit for electric vehicles are discussed in 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.

Figuring depreciation using the 150% DB method and half-year convention. Table 7-2 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 7-2.

Example 1.

During the year, you bought an item of 7-year property for $10,000 and placed it in service. You do not elect a section 179 deduction for this property. In addition, the property is not qualified property for purposes of the special depreciation allowance. The unadjusted basis of the property is $10,000. You use the percentages in Table 7-2 to figure your deduction.

Since this is 7-year property, you multiply $10,000 by 10.71% to get this year's depreciation of $1,071. For next year, your depreciation will be $1,913 ($10,000 × 19.13%).

Example 2.

You had a barn constructed on your farm at a cost of $20,000. You placed the barn in service this year. You elect not to claim the special depreciation allowance. The barn is 20-year property and you use the table percentages to figure your deduction. You figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 3.75% to get $750. For next year, your depreciation will be $1,443.80 ($20,000 × 7.219%).

Table 7-2. 150% Declining Balance Method (Half-Year Convention)

Year	3-Year		5-Year		7-Year		20-Year
1	25.0	%	15.00	%	10.71	%	3.750	%
2	37.5		25.50		19.13		7.219
3	25.0		17.85		15.03		6.677
4	12.5		16.66		12.25		6.177
5			16.66		12.25		5.713
6			8.33		12.25		5.285
7					12.25		4.888
8					6.13		4.522

Figuring depreciation using the straight line method and half-year convention. 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.

Table 7-3. Straight Line Method (Half-Year Convention)

Year	3-Year		5-Year		7-Year		20-Year
1	16.67	%	10	%	7.14	%	2.5	%
2	33.33		20		14.29		5.0
3	33.33		20		14.29		5.0
4	16.67		20		14.28		5.0
5			20		14.29		5.0
6			10		14.28		5.0
7					14.29		5.0
8					7.14		5.0

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

Example.

If in Example 2, earlier, you had elected the straight line method, you figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 2.5% to get $500. For next year, your depreciation will be $1,000 ($20,000 × 5%).

Figuring Depreciation Without the Tables

If you are required to or would prefer to figure your own depreciation without using the tables, see Figuring the Deduction Without Using the Tables in chapter 4 of Publication 946.

Figuring the Deduction for Property Acquired in a Nontaxable Exchange

If your property has a carryover basis because you acquired it in an exchange or involuntary conversion of other property or in a nontaxable transfer, you generally figure depreciation for the property as if the exchange, conversion, or transfer had not occurred.

Property acquired in a like-kind exchange or involuntary conversion. You generally must depreciate the carryover basis of MACRS property acquired in a like-kind exchange or involuntary conversion over the remaining recovery period of the property exchanged or involuntarily converted. You also generally continue to use the same depreciation method and convention used for the exchanged or involuntarily converted property. This applies only to acquired property with the same or a shorter recovery period and the same or more accelerated depreciation method than the property exchanged or converted. The excess basis, if any, of the acquired MACRS property is treated as newly placed in service MACRS property.

Election out. You can elect not to use the above rules. The election, if made, applies to both the acquired property and the exchanged or involuntarily converted property. If you make the election, figure depreciation by treating the carryover basis and excess basis, if any, for the acquired property as if placed in service on the date you acquired it. For depreciation purposes, the adjusted basis of the exchanged or involuntarily converted property is treated as if it was disposed of at the time of the exchange or conversion.

When to make the election. You must make the election on a timely filed return (including extensions) for the year of replacement. Once made, the election may not be revoked without IRS consent.

For more information and special rules, see chapter 4 of Publication 946 and the Instructions for Form 4562.

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 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.

How Do You Use General Asset Accounts?

To make it easier to figure MACRS depreciation, you can group separate assets into one or more general asset accounts (GAAs). You can then depreciate all the assets in each account as a single asset. Each account must include only assets with the same asset class (if any), recovery period, depreciation method, and convention. You cannot include an asset if you use it in both a personal activity and a trade or business (or for the production of income) in the year in which you first place it in service.

After you have set up a GAA, you generally figure the depreciation for it by using the applicable depreciation method, recovery period, and convention for the assets in the GAA. For each GAA, record the depreciation allowance in a separate depreciation reserve account.

There are additional rules for grouping assets in a GAA, figuring depreciation for a GAA, disposing of GAA assets, and terminating GAA treatment. Special rules apply in determining the basis and figuring the depreciation deduction for MACRS property in a GAA acquired in a like-kind exchange or involuntary conversion. See chapter 4 in Publication 946.

When Do You Recapture MACRS Depreciation?

When you dispose of property you depreciated using MACRS, any gain on the disposition is generally recaptured (included in income) as ordinary income up to the amount of the depreciation previously allowed or allowable for the property. Depreciation, for this purpose, includes any section 179 deduction claimed on the property, any special depreciation allowance available for the property (unless you elected not to claim it), and any deduction claimed for clean-fuel vehicles and clean-fuel vehicle refueling property. There is no recapture for residential rental property. There is also no recapture for nonresidential real property, unless that property is qualified property for which you claimed a special depreciation allowance (discussed earlier). For more information on depreciation recapture, see chapter 9.

Additional Rules for Listed Property

This part discusses the depreciation deduction limits and other special rules that apply to certain listed property. It also discusses the recordkeeping rules for listed property. Listed property includes cars and other property used for transportation, property used for entertainment, and certain computers and cellular phones.

Deductions for listed property (other than certain leased property) are subject to the following special rules and limits (discussed later).

Deduction for employees.
Business-use requirement.
Passenger automobile limits and rules.

What Is Listed Property?

Listed property is any of the following.

Passenger automobiles weighing 6,000 pounds or less.
Any other property used for transportation, unless it is an excepted vehicle.
Property generally used for entertainment, recreation, or amusement.
Computers and related peripheral equipment unless used only at a regular business establishment and owned or leased by the person operating the establishment.
Cellular telephones (or similar telecommunication equipment).

Passenger automobiles. A passenger automobile is any 4-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. Electric passenger automobiles are vehicles produced by an original equipment manufacturer and designed to run primarily on electricity.

A truck or van that is a qualified nonpersonal use vehicle is not considered a passenger automobile. See Qualified nonpersonal use vehicles under Passenger Automobiles in chapter 5 of Publication 946 for the definition of qualified nonpersonal use vehicles.

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

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

Tractors and other special purpose farm vehicles.
Bucket trucks (cherry pickers), dump trucks, flatbed trucks, and refrigerated trucks.
Combines, cranes and derricks, and forklifts.
Any vehicle designed to carry cargo with a loaded gross vehicle weight of over 14,000 pounds.

Can Employees Claim a Deduction?

If you are an employee, you can claim a depreciation deduction for the use of your listed property (whether owned or rented) in performing services as an employee only if your use is a business use. The use of your property in performing services as an employee is a business use only if both the following requirements are met.

The use is for your employer's convenience.
The use is required as a condition of your employment.

If these requirements are not met, you cannot deduct depreciation (including the section 179 deduction) or rent expenses for your use of the property as an employee.

Employer's convenience. 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.

Condition of employment. 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.

What Is the Business-Use Requirement?

You can claim the section 179 deduction for listed property and depreciate listed property using GDS and a declining balance method, if the property meets the business-use requirement. To meet this requirement, listed property must be used predominantly (more than 50% of its total use) for qualified business use. If this requirement is not met, the following rules apply.

Property not used predominantly for qualified business use during the year it is placed in service does not qualify for the section 179 deduction.
Any depreciation deduction under MACRS for property not used predominantly for qualified business use during any year must be figured using the straight line method over the ADS recovery period. This rule applies each year of the recovery period.
Excess depreciation on property previously used predominantly for qualified business use must be recaptured (included in income) in the first year in which it is no longer used predominantly for qualified business use.
A lessee must include an amount in income if the leased property is not used predominantly for qualified business use.

Investment use. 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.

Allocating use. 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.

Do the Passenger Automobile Limits Apply?

The depreciation deduction (including the section 179 deduction) you can claim for a passenger automobile each year is limited. (For the definition of a passenger automobile, see Passenger automobiles under What Is Listed Property, earlier.)

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 permit it to run on a clean-burning fuel. The limits apply only to the cost of the automobile without the 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.

Maximum Depreciation Deduction

The passenger automobile limits are the maximum depreciation amounts you can deduct for a passenger automobile. They are based on the date you placed the automobile in service. The maximum deductions (in dollar amounts) for most passenger automobiles are shown in the following table.

Maximum Depreciation Deduction for Passenger Automobiles

Date				4th &
Placed	1st	2nd	3rd	Later
In Service	Year	Year	Year	Years
2005	$2,960	$4,700	$2,850	$1,675
2004	10,610 ¹	4,800	2,850	1,675
5/06/2003– 12/31/2003	10,710 ²	4,900	2,950	1,775
1/01/2003– 5/05/2003	7,660 ²	4,900	2,950	1,775
2002	7,660 ²	4,900	2,950	1,775
9/11/2001– 12/31/2001	7,660 ³	4,900	2,950	1,775
1/01/2001– 9/10/2001	3,060	4,900	2,950	1,775
2000	3,060	4,900	2,950	1,775
1999	3,060	5,000	2,950	1,775
1998	3,160	5,000	2,950	1,775
1997	3,160	5,000	3,050	1,775
1995–1996	3,060	4,900	2,950	1,775
¹If you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum depreciation is $2,960.
²If you acquired the vehicle before 5/06/03, the maximum deduction is $7,660. If you elect not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $3,060.
³If you acquired the vehicle before 9/11/01, you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $3,060.

If your business/investment use of the automobile is less than 100%, you must reduce the maximum deduction amount by multiplying the maximum amount by the percentage of business/investment use determined on an annual basis during the tax year.

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 deductions (in dollar amounts) for electric vehicles are shown in the following table.

<emphasis role="bold">Maximum Depreciation Deduction For Electric Vehicles</emphasis>

Date				4th &
Placed	1st	2nd	3rd	Later
In Service	Year	Year	Year	Years
2005	$8,880	$14,200	$8,450	$5,125
2004	31,830 ¹	14,300	8,550	5,125
5/06/2003– 12/31/2003	32,030 ²	14,600	8,750	5,225
1/01/2003– 5/05/2003	22,880 ³	14,600	8,750	5,225
2002	22,980 ⁴	14,700	8,750	5,325
9/11/2001– 12/31/2001	23,080 ⁵	14,800	8,850	5,325
1/01/2001– 9/10/2001	9,280	14,800	8,850	5,325
2000	9,280	14,800	8,850	5,325
1999	9,280	14,900	8,950	5,325
1998	9,380	15,000	8,950	5,425
1997	9,480	15,100	9,050	5,425
¹If you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $8,880.
²If you acquired the vehicle before 5/06/03, the maximum deduction is $22,880. If you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $9,080.
³If you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $9,080.
⁴ If you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $9,180.
⁵If you acquired the vehicle before 9/11/01, you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $9,280.

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

Trucks and vans. The maximum depreciation deductions for trucks and vans that are built on a truck chassis are generally higher than those for other passenger automobiles. The maximum deductions (in dollar amounts) for these trucks and vans are shown in the following table.

<emphasis role="bold">Maximum Depreciation Deduction for Trucks and Vans</emphasis>

Date				4th &
Placed	1st	2nd	3rd	Later
In Service	Year	Year	Year	Years
2005	$3,260	$5,200	$3,150	$1,875
2004	10,910 ¹	5,300	3,150	1,875
5/06/2003– 12/31/2003	11,010 ²	5,400	3,250	1,975
1/01/2003– 5/05/2003	7,960 ³	5,400	3,250	1,975
¹If you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $3,260.
²If you acquired the vehicle before 5/06/03, the maximum deduction is $7,960. If you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $3,360.
³If you elected not to claim any special depreciation allowance for the vehicle or the vehicle is not qualified property, the maximum deduction is $3,360.

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

Deductions for passenger automobiles acquired in a trade-in. Special rules apply in figuring the depreciation for a passenger automobile received in a like-kind exchange or involuntary conversion. See chapter 5 of Publication 946 and section 1.168(i)-6T(d)(3) of the regulations.

What Records Must Be Kept?

You cannot take any depreciation or section 179 deduction for the use of listed property unless you can prove business and investment use with adequate records or sufficient evidence to support your own statements.

Adequate records. 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.

How long to keep records. 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.

Depletion

Depletion is the using up of natural resources by mining, quarrying, drilling, or felling. The depletion deduction allows an owner or operator to account for the reduction of a product's reserves.

Who Can Claim Depletion?

If you have an economic interest in mineral property or standing timber (defined below), you can take a deduction for depletion. More than one person can have an economic interest in the same mineral deposit or timber.

You have an economic interest if both the following apply.

You have acquired by investment any interest in mineral deposits or standing timber.
You have a legal right to income from the extraction of the mineral or the cutting of the timber, to which you must look for a return of your capital investment.

A contractual relationship that allows you an economic or monetary advantage from products of the mineral deposit or standing timber is not, in itself, an economic interest. A production payment carved out of, or retained on the sale of, mineral property is not an economic interest.

Mineral property is each separate interest you own in each mineral deposit in each separate tract or parcel of land. You can treat two or more separate interests as one property or as separate properties. See section 614 of the Internal Revenue Code and the related regulations for rules on how to treat separate mineral interests.

Timber property is your economic interest in standing timber in each tract or block representing a separate timber account.

Figuring Depletion

There are two ways of figuring depletion.

Cost depletion.
Percentage depletion.

For mineral property, you generally must use the method that gives you the larger deduction. For standing timber, you must use cost depletion.

Cost Depletion

To figure cost depletion you must first determine the following.

The property's basis for depletion.
The total recoverable units of mineral in the property's natural deposit.
The number of units of mineral sold during the tax year.

You must estimate or determine recoverable units (tons, barrels, board feet, thousands of cubic feet, or other measure) using the current industry method and the most accurate and reliable information you can obtain.

Basis for depletion and total recoverable units are explained in chapter 10 of Publication 535.

Number of units sold. 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.

IF you use ...	THEN the units sold during the year are ...
The cash method of accounting	The units sold for which you receive payment during the tax year (regardless of the year of sale).
An accrual method of accounting	The units sold based on your inventories.

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.

Figuring the cost depletion deduction. 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.

Step	Action	Result
1	Divide your property's basis for depletion by total recoverable units.	Rate per unit.
2	Multiply the rate per unit by units sold during the tax year.	Cost depletion deduction.

Cost depletion for ground water in Ogallala Formation. 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 would be 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.

Timber Depletion

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.

Figuring the timber depletion deduction. To figure your cost depletion allowance, multiply the number of units of standing timber cut by your depletion unit.

Timber units. 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.

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

Determine your cost or the adjusted basis of the timber on hand at the beginning of the year.
Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital.
Figure the number of timber units to take into account by adding the number of timber units acquired during the year to the number of timber units on hand in the account at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account.
Divide the result of (2) by the result of (3). This is your depletion unit.

When to claim timber depletion. 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 8. 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.

Form T. Complete and 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.

Example.

Sam Brown bought a farm that included standing timber. This year Sam determined that the standing timber could produce 300,000 units when cut. At that time, the adjusted basis of the standing timber was $24,000. Sam then cut and sold 27,000 units. (Sam did not elect to treat the cutting of the timber as a sale or exchange.) Sam's depletion for each unit for the year is $.08 ($24,000 ÷ 300,000). His deduction for depletion is $2,160 (27,000 × $.08). If Sam had cut 27,000 units but sold only 20,000 units during the year, his depletion for each unit would have remained at $.08. However, his depletion deduction would have been $1,600 (20,000 × $.08) for this year and he would have included the balance of $560 (7,000 × $.08) in the closing inventory for the year.

Percentage Depletion

You can use percentage depletion on certain mines, wells, and other natural deposits. You cannot use the percentage method to figure depletion for standing timber, soil, sod, dirt, or turf.

To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the year. See Mines and other natural deposits in chapter 10 of Publication 535 for a list of the percentages. You can find a complete list in section 613(b) of the Internal Revenue Code.

Taxable income limit. 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 2006, 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.

Do not deduct any net operating loss deduction from the gross income from the property.
Corporations do not deduct charitable contributions from the gross income from the property.
If, during the year, you disposed of an item of section 1245 property used in connection with the mineral property, reduce any allowable deduction for mining expenses by the part of any gain you must report as ordinary income that is allocable to the mineral property. See section 1.613-5(b)(1) of the regulations for information on how to figure the ordinary gain allocable to the property.

For more information on depletion, see chapter 10 in Publication 535.

Amortization

Amortization is a method of recovering (deducting) certain capital costs over a fixed period of time. It is similar to the straight line method of depreciation. The amortizable costs discussed in this section include the start-up costs of going into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles. See chapter 9 in Publication 535 for more information on these topics.

Business Start-Up Costs

When you go into business, treat all costs you incur to get your business started as capital expenses. Capital expenses are a part of your basis in the business. Generally, you recover costs for particular assets through depreciation deductions. However, you generally cannot recover other costs until you sell the business or otherwise go out of business.

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.

You can elect to currently deduct up to $5,000 of business start-up costs paid or incurred after October 22, 2004. See Capital Expenses in chapter 4. If this election is made, any costs that are not currently deducted can be amortized.

Amortization period. The amortization period for business start-up costs paid or incurred before October 23, 2004, cannot be less than 60 months. For start-up costs paid or incurred after October 22, 2004, the amortization period is 180 months. The period starts with the month your active trade or business begins.

Reporting requirements. To amortize your start-up costs that are not currently deductible under the election to deduct, complete Part VI of Form 4562 and attach a statement containing any required information. See the Form 4562 instructions.

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

Reforestation Costs

You can elect to currently deduct up to $10,000 ($5,000 if married filing separately) of qualifying reforestation costs for each qualified timber property. You can elect to amortize over 84 months any amount not deducted. There is no annual limit on the amount you can elect to amortize. Reforestation costs are the direct costs of planting or seeding for forestation or reforestation.

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

Site preparation.
Seeds or seedlings.
Labor.
Tools.
Depreciation on equipment used in planting and seeding.

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. 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.

It is located in the United States.
It is held for the growing and cutting of timber you will either use in, or sell for use in, the commercial production of timber products.
It consists of at least one acre planted with tree seedlings in the manner normally used in forestation or reforestation.

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

Amortization period. 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.

How to make the election. To elect to amortize qualifying reforestation costs, enter your deduction in Part VI of Form 4562. Attach a statement containing any required information. See the Form 4562 instructions.

Generally, you must make the election 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 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 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.

For additional information on reforestation costs, see chapter 9 of Publication 535.

Pollution Control Facilities

You can elect to amortize the cost of a certified pollution control facility generally over a 60-month period, beginning either the month following the month the facility is completed or acquired or with the tax year following the year the facility was completed or acquired.

You can claim a special depreciation allowance on a certified pollution control facility that is qualified property even if you elect to amortize its cost rather than capitalize the costs and depreciate the facility. You must reduce its cost (amortizable basis) by the amount of any special allowance you claim.

Certified pollution control facility. A certified pollution control facility is a new identifiable treatment facility used in connection with a plant or other property generally 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 also 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.

Example.

This year, you purchase a new $75,000 manure control facility for use in connection with a dairy plant on your farm. The farm has been in operation since you bought it in 1976 and all of the dairy plant was in operation before that date. You have no intention of recovering the cost of the facility through sale of the waste and a federal certifying authority has so certified.

Your manure control facility qualifies for amortization. You can elect to amortize its cost over 60 months. Otherwise, you can capitalize the cost and depreciate the facility.

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.

Example.

This year, you converted your 100-sow farrow-to-finish swine operation, which has existed on your farm since 1975, to a 5,000-head finishing swine operation. Even though you are in a similar business after the conversion, you cannot amortize the cost of a new manure control facility used in connection with your swine operation because you have significantly increased its output or capacity. You can, however, recover the cost of the facility by claiming depreciation deductions.

More information. For more information on the amortization of pollution control facilities, see chapter 9 of Publication 535 and section 169 of the Internal Revenue Code and the related regulations.

Section 197 Intangibles

You must generally amortize over 15 years the capitalized costs of section 197 intangibles you acquired after August 10, 1993. You must amortize these costs if you hold the section 197 intangible in connection with your farming business or in an activity engaged in for the production of income. Your amortization deduction each year is the applicable part of the intangible's adjusted basis (for purposes of determining gain), figured by amortizing it ratably over 15 years (180 months). You are not allowed any other depreciation or amortization deduction for an amortizable section 197 intangible.

Section 197 intangibles include the following assets.

Goodwill.
Patents.
Copyrights.
Designs.
Formulas.
Licenses.
Permits.
Covenants not to compete.
Franchises.
Trademarks.

See chapter 9 in Publication 535 for more information, including a complete list of assets that are section 197 intangibles.

Amortization period. The amortization period begins with the later of:

The month the intangible is acquired, or
The month the farming business or activity engaged in for the production of income begins.

You cannot deduct amortization for the month you dispose of the intangible.

If you pay or incur an amount that increases the basis of a section 197 intangible after the 15-year period begins, amortize it over the remainder of the 15-year period beginning with the month the basis increase occurs.

Cost attributable to other property. 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.

Assets that 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.

Interest in land. 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.

See chapter 9 in Publication 535 for more information, including a complete list of assets that are not section 197 intangibles.

Dispositions. A section 197 intangible is treated as depreciable property used in your trade or business. If you held the intangible for more than one year, any gain on its disposition, up to the amount of allowable amortization, is ordinary income (section 1245 gain). Any remaining gain or loss is a section 1231 gain or loss. If you held the intangible one year or less, any gain or loss on its disposition is an ordinary gain or loss.

If multiple section 197 intangibles are disposed of after August 8, 2005, in a single transaction or a series of related transactions, you must generally figure any gain as if all of the intangibles were a single asset. For more information on dispositions of intangible property, see chapter 2 in Publication 544.

7. Depreciation, Depletion, and Amortization

What's New

Reminders

Introduction

Topics - This chapter discusses:

Useful Items - You may want to see:

Overview of Depreciation

What Property Can Be Depreciated?

Property You Own

Property Used in Your Business or Income-Producing Activity

Property Having a Determinable Useful Life

Property Lasting More Than One Year

What Property Cannot Be Depreciated?

Land

Excepted Property

When Does Depreciation Begin and End?

Placed in Service

Idle Property

Cost or Other Basis Fully Recovered

Retired From Service

Can You Use MACRS To Depreciate Your Property?

Property You Placed in Service Before 1987

Property Owned or Used in 1986

Election To Exclude Property From MACRS

What Is the Basis of Your Depreciable Property?

How Do You Treat Improvements?

Do You Have To File Form 4562?

How Do You Correct Depreciation Deductions?

Filing an Amended Return

Changing Your Accounting Method

Section 179 Deduction

What Property Qualifies?

Eligible Property

Property Acquired for Business Use

Property Acquired by Purchase

What Property Does Not Qualify?

How Much Can You Deduct?

Dollar Limits

Business Income Limit

Partnerships and S Corporations

How Do You Elect the Deduction?

When Must You Recapture the Deduction?

Claiming the Special Depreciation Allowance

What Is Qualified Property?

Other Tests To Be Met

What Property Is Not Qualified Property?

How Much Can You Deduct?

How Can You Elect Not To Claim the Allowance?

Figuring Depreciation Under MACRS

Which Depreciation System (GDS or ADS) Applies?

Which Property Class Applies Under GDS?

What Is the Placed-in-Service Date?

What Is the Basis for Depreciation?

Which Recovery Period Applies?

Which Convention Applies?

Which Depreciation Method Applies?

How Is the Depreciation Deduction Figured?

Using the MACRS Percentage Tables

Figuring Depreciation Without the Tables

Figuring the Deduction for Property Acquired in a Nontaxable Exchange

How Do You Use General Asset Accounts?

When Do You Recapture MACRS Depreciation?

Additional Rules for Listed Property

What Is Listed Property?

Can Employees Claim a Deduction?

What Is the Business-Use Requirement?

Do the Passenger Automobile Limits Apply?

Maximum Depreciation Deduction

What Records Must Be Kept?

Depletion

Who Can Claim Depletion?

Figuring Depletion

Cost Depletion

Timber Depletion

Percentage Depletion

Amortization

Business Start-Up Costs

Reforestation Costs

Pollution Control Facilities

Section 197 Intangibles