| Publication 225, Farmer's Tax Guide |
2006 Tax Year |
7.
Depreciation, Depletion, and Amortization
This is archived information that pertains only to the 2006 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.
Increased section 179 deduction dollar limits. The maximum amount you can elect to deduct for most section 179 property you placed in service in 2006 is $108,000. This limit
is reduced by the
amount by which the cost of the property placed in service during the tax year exceeds $430,000. For qualified section 179
Gulf Opportunity Zone (GO
Zone) property, the maximum section 179 deduction is increased. See Dollar Limits under Section 179 Deduction, later.
Limited applicability of special depreciation allowances. You may be able to claim the special depreciation allowances for certain aircraft and certain property with a long production
period placed in
service or manufactured before January 1, 2007, in areas affected by Hurricanes Katrina, Rita, or Wilma. See Claiming the Special Depreciation
Allowance, later.
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
-
Claiming the special depreciation allowance
-
Figuring depreciation under MACRS
-
Additional rules for listed property
-
Depletion
-
Amortization
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
-
3115
Application for Change in Accounting Method
-
4562
Depreciation and Amortization
-
4797
Sales of Business Property
See chapter 17 for information about getting publications and forms.
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.
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 repairs and 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 have a useful life that extends substantially beyond the year you place it in service.
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. 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.
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.
See Certain term interests in property, later for an exception.
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. However, 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 for a special rule.
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.
What Property Cannot Be Depreciated?
Certain property cannot be depreciated, even if the requirements explained earlier are met. 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.
-
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. This property does not have a determinable useful life and generally
cannot be
depreciated. However, see Amortization, later. Special rules apply to computer software (discussed below).
-
Certain term interests (discussed below).
Computer software.
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.
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 2006 after harvest was over. You
begin to depreciate the
planter for 2006 because it was ready and available for its specific use in 2006, even though it will not be used until the
spring of 2007.
If your planter comes unassembled in December 2006 and is put together in February 2007, it is not placed in service until
2007. You begin to
depreciate it in 2007.
If your planter was delivered and assembled in February 2007 but not used until April 2007, it is placed in service in February
2007, because this
is when the planter was ready for its specified use. You begin to depreciate it in 2007.
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.
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.
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. Use the methods discussed in Publication 534
-
Certain property owned or used in 1986. See Chapter 1 of Publication 946.
-
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.
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 or other basis.
The basis of property you buy is usually 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.
There are times when you cannot use cost as basis. In these situations, the fair market value (FMV) or the adjusted
basis of the property may be
used.
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.
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).
For more information, see chapter 6.
How Do You Treat Repairs and Improvements?
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. Treat
improvements as separate depreciable property. See chapter 1 of Publication 946 for more information.
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.
-
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.
-
Amortization of costs that began in the current year.
For more information, see the Instructions for Form 4562.
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.
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.
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. See the Instructions for Form 3115.
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.
For more information, see chapter 2 of Publication 946.
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.
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:
-
An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity,
gas, water, or
sewage disposal services,
-
A research facility used in connection with any of the activities in (a) above, or
-
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 that is readily available for purchase by the general public, is subject to a nonexclusive
lease, and has
not been substantially modified.
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.
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, farmers 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.
-
Air conditioning or heating units.
-
Property used by a tax-exempt organization (other than a tax-exempt farmers' cooperative) unless the property is used mainly
in a taxable
unrelated trade or business.
-
Property used by governmental units or foreign persons or entities (except property used under a lease with a term of less
than 6
months).
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.
Use Part I of Form 4562 to figure your section 179 deduction.
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.
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).
The total amount you can elect to deduct under section 179 for most property placed in service in 2006 is $108,000. 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 $108,000. You do not have to claim the full $108,000.
Example.
This year, you bought and placed in service a tractor for $104,000 and a mower for $6,200 for use in your farming business.
You elect to deduct the
entire $6,200 for the mower and $101,800 for the tractor, a total of $108,000. 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, $101,800, from the cost of the tractor, $104,000.
Reduced dollar limit for cost exceeding $430,000.
If the cost of your qualifying section 179 property placed in service in 2006 is over $430,000, you must reduce the
dollar limit (but not below
zero) by the amount of cost over $430,000. If the cost of your section 179 property placed in service during 2006 is $538,000
or more, you cannot take
a section 179 deduction and you cannot carry over the cost that is more than $538,000.
Example.
This year, James Smith placed in service machinery costing $508,000. Because this cost is $78,000 more than $430,000, he must
reduce his dollar
limit to $30,000 ($108,000 - $78,000).
Limits for qualified section 179 GO Zone property.
If you placed in service qualified section 179 GO Zone property (described below) in 2006, the amount of property
for which you can make the
election under section 179 is increased by the smaller of:
The amount for which you can make the election is reduced if the cost of all section 179 property placed in service
during the year exceeds
$430,000 increased by the smaller of:
Qualified section 179 GO Zone property is section 179 property that is also qualified GO Zone property (described later under
Claiming the Special Depreciation Allowance).
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 2006 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 2006, the total section 179 and depreciation deduction is
limited. See Do the
Passenger Automobile Limits Apply, 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 $430,000. 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 $430,000).
-
The total cost of section 179 property you and your spouse elected to expense on your separate returns.
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, 2006, the XYZ farm corporation purchased and placed in service qualifying section 179 property that cost $108,000.
It elects to
expense the entire $108,000 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 $128,000. XYZ figures its section 179 deduction and its deduction for charitable contributions
as follows.
| Step 1. Taxable income figured without either deduction is $128,000.
|
| Step 2. Using $128,000 as taxable income, XYZ's hypothetical section 179 deduction is $108,000.
|
| Step 3. $20,000 ($128,000 - $108,000).
|
| 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. $126,000 ($128,000 - $2,000).
|
| Step 6. Using $126,000 (from Step 5) as taxable income, XYZ figures the actual section 179 deduction. Because the taxable income
is at least $108,000, XYZ can take a $108,000 section 179 deduction.
|
| Step 7. $20,000 ($128,000 - $108,000).
|
| 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.
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 $430,000, 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 2006, Partnership P placed in service section 179 property with a total cost of $510,000. P must reduce its dollar limit
by $80,000 ($510,000
- $430,000). Its maximum section 179 deduction is $28,000 ($108,000 - $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 $28,000. P
allocates $10,000 of its
section 179 deduction and $18,000 of its taxable income to John, one of its partners.
John also conducts a business as a sole proprietor and in 2006, 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 2007.
How Do You Elect the Deduction?
You elect to take the section 179 deduction by completing Part I of Form 4562.
If you elect the deduction for listed property, complete Part V of
Form 4562 before completing Part I.
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 2006 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 (for example, allowable depreciation in that tax year for the item of section 179 property for which the election
pertains.) Once made,
the revocation is irrevocable.
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, 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 2004, 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 2004 and 2005. During 2006, he used the property 40% for business and 60% for personal use.
He figures his recapture
amount as follows.
|
Section 179 deduction claimed (2004)
|
$5,000
|
Minus: Allowable depreciation
(instead of section 179 deduction):
|
|
|
2004
|
$1,250
|
|
|
2005
|
1,875
|
|
|
2006 ($1,250 × 40% (business))
|
500
|
3,625
|
| 2006 — Recapture amount |
$1,375 |
| |
|
Paul must include $1,375 in income for 2006.
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).
Recapture for qualified section 179 GO Zone property.
If any qualified section 179 GO Zone property ceases to be used in the GO Zone in a later year, you must recapture
the benefit of the increased
section 179 deduction as “ other income.”
Claiming the Special Depreciation Allowance
For qualified property (defined below) placed in service in 2006, you can take an additional 50% 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.
Figure the special
depreciation allowance by multiplying the depreciable basis of the qualified property
by 50%.
What Is Qualified Property?
For farmers, qualified property generally is qualified GO Zone property. This is depreciable property that meets the following
requirements.
-
The property must be acquired by purchase after August 27, 2005. If a binding contract to acquire the property existed before
August 28,
2005, the property does not qualify.
-
The property must be placed in service in the GO Zone during the tax year.
-
Substantially all of the use of the property must be in the GO Zone in the active conduct of your trade or business.
-
The original use of the property within the GO Zone must begin with you.
For more information, including a description of the areas in the GO Zone, and a list of qualified GO Zone property, see chapter
3 of Publication
946.
Extension of placed in service date for certain property.
Certain property with a long production period or certain noncommercial aircraft that is either placed in service
or manufactured in the GO Zone,
the Rita GO Zone, or the Wilma GO Zone, and you were unable to meet the original December 31, 2005, placed-in-service date
as a result of Hurricane
Katrina, Rita, or Wilma, is qualified property for purposes of the 50% special allowance if it is placed in service before
January 1, 2007. For more
information, see the Instructions for
Form 4562.
How Can You Elect Not To Claim the Allowance?
You can elect, for any class of property, not to deduct the special allowance for all property in such class placed in service
during the tax year.
To make the election, attach a statement to your return indicating the class of property for which you are making the 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 the 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.
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. 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.
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. Also see chapter 6.
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. 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).
However, if the house trailer is not mobile (its wheels have been removed and permanent utilities and pipes attached
to it), use one of the
following recovery periods.
Water wells.
Water wells used to provide water for raising poultry and livestock are land improvements. If they are depreciable,
use one of the following
recovery periods.
The types of water wells that can be depreciated were discussed earlier in Irrigation systems and water wells under Property Having
a Determinable Useful Life.
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.
For a detailed explanation of each convention, see Which Convention Applies in chapter 4 of Publication 946. Also see the Instructions
for Form 4562.
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.
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.
| 1Elective method
|
2See section 168(g)(6) of the Internal Revenue
Code
|
Property used in farming business.
For personal property placed in service after 1988 in a farming business, you must use the 150% declining balance
method over a GDS recovery period
or you can elect one of the following methods.
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.
|
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.
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.
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.
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.
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. 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.
-
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—
-
Depreciation allowed or allowable, or
-
An addition or improvement to the property, which 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 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 the later of on the date you acquired it, or the time of the disposition of the exchanged or involuntarily
converted property. 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.
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. For more information on depreciation
recapture, see
chapter 9. Also see chapter 4 of Publication 946.
Additional 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.
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.
For more information, see chapter 5 of Publication 946.
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. 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.
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 vehicle in
service. See chapter 5 of Publication 946 for tables that show the maximum depreciation deduction for passenger automobiles.
Also see the
Instructions for
Form 4562.
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 Regulations section 1.168(i)-6T(d)(3).
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.
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 Internal Revenue Code section 614 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.
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.
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 9 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.
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.
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.
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, electing
to treat the cutting of timber
as a sale or exchange, or making an outright sale of timber. See the Instructions for Form T (Timber).
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.
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 9 of Publication 535 for a list of the percentages. You can find a complete list in
Internal Revenue Code section 613(b).
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 and the domestic production activities deduction.
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 Regulations
section 1.613-5(b)(1) for information on how to figure the ordinary gain allocable to the property.
For more information on depletion, see chapter 9 in Publication 535.
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 8 in Publication 535 for more information
on these topics.
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 during the tax year. 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, is 60 months or more.
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 Instructions for Form 4562.
For more information, see Starting a Business in chapter 8 of Publication 535.
You can elect to currently deduct a limited amount of qualifying reforestation costs for each qualified timber property. See
Capital
Expenses in chapter 4. 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.
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 Instructions for Form 4562.
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 8 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 8 of Publication 535 and Internal
Revenue Code section 169
and the related regulations.
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.
See chapter 8 in Publication 535 for more information, including a complete list of assets that are section 197 intangibles
and special rules.
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