Publication 463 (2006), Travel, Entertainment, Gift, and Car Expenses

4. Transportation

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Table of Contents

This chapter discusses expenses you can deduct for business transportation when you are not traveling away from home as defined in chapter 1. These expenses include the cost of transportation by air, rail, bus, taxi, etc., and the cost of driving and maintaining your car.

Transportation expenses include the ordinary and necessary costs of all of the following.

Getting from one workplace to another in the course of your business or profession when you are traveling within the city or general area that is your tax home. Tax home is defined in chapter 1.
Visiting clients or customers.
Going to a business meeting away from your regular workplace.
Getting from your home to a temporary workplace when you have one or more regular places of work. These temporary workplaces can be either within the area of your tax home or outside that area.

Transportation expenses do not include expenses you have while traveling away from home overnight. Those expenses are travel expenses which are discussed in chapter 1. However, if you use your car while traveling away from home overnight, use the rules in this chapter to figure your car expense deduction. See Car Expenses, later.

Illustration of transportation expenses. Figure B illustrates the rules that apply for deducting transportation expenses when you have a regular or main job away from your home. You may want to refer to it when deciding whether you can deduct your transportation expenses.

Temporary work location. If you have one or more regular work locations away from your home and you commute to a temporary work location in the same trade or business, you can deduct the expenses of the daily round-trip transportation between your home and the temporary location, regardless of distance.

If your employment at a work location is realistically expected to last (and does in fact last) for 1 year or less, the employment is temporary unless there are facts and circumstances that would indicate otherwise.

If your employment at a work location is realistically expected to last for more than 1 year or if there is no realistic expectation that the employment will last for 1 year or less, the employment is not temporary, regardless of whether it actually lasts for more than 1 year.

If employment at a work location initially is realistically expected to last for 1 year or less, but at some later date the employment is realistically expected to last more than 1 year, that employment will be treated as temporary (unless there are facts and circumstances that would indicate otherwise) until your expectation changes. It will not be treated as temporary after the date you determine it will last more than 1 year.

If the temporary work location is beyond the general area of your regular place of work and you stay overnight, you are traveling away from home. You may have deductible travel expenses as discussed in chapter 1.

No regular place of work. If you have no regular place of work but ordinarily work in the metropolitan area where you live, you can deduct daily transportation costs between home and a temporary work site outside that metropolitan area.

Generally, a metropolitan area includes the area within the city limits and the suburbs that are considered part of that metropolitan area.

You cannot deduct daily transportation costs between your home and temporary work sites within your metropolitan area. These are nondeductible commuting expenses.

Two places of work. If you work at two places in one day, whether or not for the same employer, you can deduct the expense of getting from one workplace to the other. However, if for some personal reason you do not go directly from one location to the other, you cannot deduct more than the amount it would have cost you to go directly from the first location to the second.

Transportation expenses you have in going between home and a part-time job on a day off from your main job are commuting expenses. You cannot deduct them.

Armed Forces reservists. A meeting of an Armed Forces reserve unit is a second place of business if the meeting is held on a day on which you work at your regular job. You can deduct the expense of getting from one workplace to the other as just discussed under Two places of work.

You usually cannot deduct the expense if the reserve meeting is held on a day on which you do not work at your regular job. In this case, your transportation generally is a nondeductible commuting expense. However, you can deduct your transportation expenses if the location of the meeting is temporary and you have one or more regular places of work.

If you ordinarily work in a particular metropolitan area but not at any specific location and the reserve meeting is held at a temporary location outside that metropolitan area, you can deduct your transportation expenses.

If you travel away from home overnight to attend a guard or reserve meeting, you can deduct your travel expenses. These expenses are discussed in chapter 1.

If you travel more than 100 miles away from home in connection with your performance of services as a member of the reserves, you may be able to deduct some of your reserve-related travel costs as an adjustment to gross income rather than as an itemized deduction. For more information, see Armed Forces Reservists Traveling More Than 100 Miles From Home under Special Rules, in chapter 6.

Commuting expenses. You cannot deduct the costs of taking a bus, trolley, subway, or taxi, or of driving a car between your home and your main or regular place of work. These costs are personal commuting expenses. You cannot deduct commuting expenses no matter how far your home is from your regular place of work. You cannot deduct commuting expenses even if you work during the commuting trip.

Example.

You had a telephone installed in your car. You sometimes use that telephone to make business calls while commuting to and from work. Sometimes business associates ride with you to and from work, and you have a business discussion in the car. These activities do not change the trip from personal to business. You cannot deduct your commuting expenses.

Parking fees. Fees you pay to park your car at your place of business are nondeductible commuting expenses. You can, however, deduct business-related parking fees when visiting a customer or client.

Advertising display on car. Putting display material that advertises your business on your car does not change the use of your car from personal use to business use. If you use this car for commuting or other personal uses, you still cannot deduct your expenses for those uses.

Car pools. You cannot deduct the cost of using your car in a nonprofit car pool. Do not include payments you receive from the passengers in your income. These payments are considered reimbursements of your expenses. However, if you operate a car pool for a profit, you must include payments from passengers in your income. You can then deduct your car expenses (using the rules in this publication).

Hauling tools or instruments. Hauling tools or instruments in your car while commuting to and from work does not make your car expenses deductible. However, you can deduct any additional costs you have for hauling tools or instruments (such as for renting a trailer you tow with your car).

Union members' trips from a union hall. If you get your work assignments at a union hall and then go to your place of work, the costs of getting from the union hall to your place of work are nondeductible commuting expenses. Although you need the union to get your work assignments, you are employed where you work, not where the union hall is located.

Office in the home. If you have an office in your home that qualifies as a principal place of business, you can deduct your daily transportation costs between your home and another work location in the same trade or business. (See Publication 587, Business Use of Your Home, for information on determining if your home office qualifies as a principal place of business.)

Examples of deductible transportation. The following examples show when you can deduct transportation expenses based on the location of your work and your home.

Example 1.

You regularly work in an office in the city where you live. Your employer sends you to a one-week training session at a different office in the same city. You travel directly from your home to the training location and return each day. You can deduct the cost of your daily round-trip transportation between your home and the training location.

Example 2.

Your principal place of business is in your home. You can deduct the cost of round-trip transportation between your qualifying home office and your client's or customer's place of business.

Example 3.

You have no regular office, and you do not have an office in your home. In this case, the location of your first business contact is considered your office. Transportation expenses between your home and this first contact are nondeductible commuting expenses. Transportation expenses between your last business contact and your home are also nondeductible commuting expenses. Although you cannot deduct the costs of these trips, you can deduct the costs of going from one client or customer to another.

Car Expenses

If you use your car for business purposes, you ordinarily can deduct car expenses. You generally can use one of the two following methods to figure your deductible expenses.

Standard mileage rate.
Actual car expenses.

If you use actual expenses to figure your deduction for a car you lease, there are rules that affect the amount of your lease payments that you can deduct. See Leasing a Car, later.

In this publication, “car” includes a van, pickup, or panel truck. For the definition of “car” for depreciation purposes, see Car defined under Actual Car Expenses, later.

You may be entitled to a tax credit for an electric vehicle, or an alternative motor vehicle that you place in service during the year. The vehicle must meet certain requirements, and you do not have to use it in your business to qualify for the credit. However, you must reduce your basis for depreciation of the electric vehicle or alternative motor vehicle by the amount of the credit you claim. See Depreciation Deduction, later, under Actual Car Expenses.

For more information on alternative motor vehicles, see Form 8910, Alternative Motor Vehicle Credit. For more information on electric vehicles, see Form 8834, Qualified Electric Vehicle Credit.

Rural mail carriers. If you are a rural mail carrier, you may be able to treat the qualified reimbursement you received as your allowable expense. Because the qualified reimbursement is treated as paid under an accountable plan, your employer should not include the reimbursement in your income.

If your vehicle expenses are more than the amount of your reimbursement, you can deduct the unreimbursed expenses as an itemized deduction on Schedule A (Form 1040). You must complete Form 2106 and attach it to your Form 1040.

A “qualified reimbursement” is the reimbursement you receive that meets both of the following conditions.

It is given as an equipment maintenance allowance (EMA) to employees of the U.S. Postal Service.
It is at the rate contained in the 1991 collective bargaining agreement. Any later agreement cannot increase the qualified reimbursement amount by more than the rate of inflation.

See your employer for information on your reimbursement.

If you are a rural mail carrier and received a qualified reimbursement, you cannot use the standard mileage rate.

Standard Mileage Rate

You may be able to use the standard mileage rate to figure the deductible costs of operating your car for business purposes. For 2006, the standard mileage rate for the cost of operating your car for business use is 44½ cents per mile.

If you use the standard mileage rate for a year, you cannot deduct your actual car expenses for that year. You cannot deduct depreciation, lease payments, maintenance and repairs, gasoline (including gasoline taxes), oil, insurance, or vehicle registration fees. See Choosing the standard mileage rate and Standard mileage rate not allowed, later.

You generally can use the standard mileage rate whether or not you are reimbursed and whether or not any reimbursement is more or less than the amount figured using the standard mileage rate. See chapter 6 for more information on reimbursements.

Choosing the standard mileage rate. If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then in later years, you can choose to use either the standard mileage rate or actual expenses.

If you want to use the standard mileage rate for a car you lease, you must use it for the entire lease period. For leases that began on or before December 31, 1997, the standard mileage rate must be used for the entire portion of the lease period (including renewals) that is after 1997.

You must make the choice to use the standard mileage rate by the due date (including extensions) of your return. You cannot revoke the choice. However, in later years, you can switch from the standard mileage rate to the actual expenses method. If you change to the actual expenses method in a later year, but before your car is fully depreciated, you have to estimate the remaining useful life of the car and use straight line depreciation.

For more information about depreciation included in the standard mileage rate, see Exception under Methods of depreciation under Depreciation Deduction, later.

Standard mileage rate not allowed. You cannot use the standard mileage rate if you:

Use the car for hire (such as a taxi),
Use five or more cars at the same time (as in fleet operations),
Claimed a depreciation deduction for the car using any method other than straight line, for example, MACRS (as discussed later under Depreciation Deduction),
Claimed a section 179 deduction (discussed later) on the car,
Claimed the special depreciation allowance on the car,
Claimed actual car expenses after 1997 for a car you leased, or
Are a rural mail carrier who received a qualified reimbursement. (See Rural mail carriers under Car Expenses, earlier.)

Five or more cars. If you own or lease five or more cars that are used for business at the same time, you cannot use the standard mileage rate for the business use of any car. However, you may be able to deduct your actual expenses for operating each of the cars in your business. See Actual Car Expenses, later, for information on how to figure your deduction.

You are not using five or more cars for business at the same time if you alternate using (use at different times) the cars for business.

The following examples illustrate the rules for when you can and cannot use the standard mileage rate for five or more cars.

Example 1.

Marcia, a salesperson, owns three cars and two vans that she alternates using for calling on her customers. She can use the standard mileage rate for the business mileage of the three cars and the two vans because she does not use them at the same time.

Example 2.

Tony and his employees use his four pickup trucks in his landscaping business. During the year, he traded in two of his old trucks for two newer ones. Tony can use the standard mileage rate for the business mileage of all six of the trucks he owned during the year.

Example 3.

Chris owns a repair shop and an insurance business. He and his employees use his two pickup trucks and van for the repair shop. Chris alternates using his two cars for the insurance business. No one else uses the cars for business purposes. Chris can use the standard mileage rate for the business use of the pickup trucks, van, and the cars because he never has more than four vehicles used for business at the same time.

Example 4.

Maureen owns a car and four vans that are used in her housecleaning business. Her employees use the vans and she uses the car to travel to various customers. Maureen cannot use the standard mileage rate for the car or the vans. This is because all five vehicles are used in Maureen's business at the same time. She must use actual expenses for all vehicles.

Interest. If you are an employee, you cannot deduct any interest paid on a car loan. This applies even if you use the car 100% for business as an employee.

However, if you are self-employed and use your car in your business, you can deduct that part of the interest expense that represents your business use of the car. For example, if you use your car 60% for business, you can deduct 60% of the interest on Schedule C (Form 1040). You cannot deduct the rest of the interest expense.

If you use a home equity loan to purchase your car, you may be able to deduct the interest. See Publication 936, Home Mortgage Interest Deduction, for more information.

Personal property taxes. If you itemize your deductions on Schedule A (Form 1040), you can deduct on line 7 state and local personal property taxes on motor vehicles. You can take this deduction even if you use the standard mileage rate or if you do not use the car for business.

If you are self-employed and use your car in your business, you can deduct the business part of state and local personal property taxes on motor vehicles on Schedule C, Schedule C-EZ, or Schedule F (Form 1040). If you itemize your deductions, you can include the remainder of your state and local personal property taxes on the car on Schedule A (Form 1040).

Parking fees and tolls. In addition to using the standard mileage rate, you can deduct any business-related parking fees and tolls. (Parking fees that you pay to park your car at your place of work are nondeductible commuting expenses.)

Sale, trade-in, or other disposition. If you sell, trade in, or otherwise dispose of your car, you may have a gain or loss on the transaction or an adjustment to the basis of your new car. See Disposition of a Car, later.

Actual Car Expenses

If you do not use the standard mileage rate, you may be able to deduct your actual car expenses.

If you qualify to use both methods, you may want to figure your deduction both ways to see which gives you a larger deduction.

Actual car expenses include:

Depreciation Licenses	Lease payments	Registration fees
Gas	Insurance	Repairs
Oil	Garage rent	Tires
Tolls	Parking fees

If you have fully depreciated a car that you still use in your business, you can continue to claim your other actual car expenses. Continue to keep records, as explained later in chapter 5.

Business and personal use. If you use your car for both business and personal purposes, you must divide your expenses between business and personal use. You can divide your expense based on the miles driven for each purpose.

Example.

You are a sales representative for a clothing firm and drive your car 20,000 miles during the year: 12,000 miles for business and 8,000 miles for personal use. You can claim only 60% (12,000 ÷ 20,000) of the cost of operating your car as a business expense.

Employer-provided vehicle. If you use a vehicle provided by your employer for business purposes, you can deduct your actual unreimbursed car expenses. You cannot use the standard mileage rate. See Vehicle Provided by Your Employer in chapter 6.

Interest on car loans. If you are an employee, you cannot deduct any interest paid on a car loan. This interest is treated as personal interest and is not deductible. If you are self-employed and use your car in that business, see Interest, earlier, under Standard Mileage Rate.

Taxes paid on your car. If you are an employee, you can deduct personal property taxes paid on your car if you itemize deductions. Enter the amount paid on line 7 of Schedule A (Form 1040).

Sales taxes. You cannot deduct sales taxes on your car even if you use your car 100% for business. Sales taxes on your car are part of your car's basis and are recovered through depreciation, discussed later.

At the time this publication went to print, Congress was considering legislation that would extend the deduction for state and local general sales taxes (affecting basis) that expired at the end of 2005. To find out if this legislation was enacted, and for more details, go to www.irs.gov, click on More Forms and Publications , and then on What's Hot in forms and publications , or see Publication 553, Highlights of 2006 Tax Changes.

Fines and collateral. You cannot deduct fines you pay or collateral you forfeit for traffic violations.

Casualty and theft losses. If your car is damaged, destroyed, or stolen, you may be able to deduct part of the loss that is not covered by insurance. See Publication 547, Casualties, Disasters, and Thefts, for information on deducting a loss on your car.

Depreciation and section 179 deductions. Generally, the cost of a car, plus sales tax and improvements, is a capital expense. Because the benefits last longer than one year, you generally cannot deduct a capital expense. However, you can recover this cost through the section 179 deduction (the deduction allowed by section 179 of the Internal Revenue Code) and depreciation deductions. Depreciation allows you to recover the cost over more than one year by deducting part of it each year. The section 179 deduction and the depreciation deduction are discussed later.

Generally, there are limits on these deductions. Special rules apply if you use your car 50% or less in your work or business.

You can claim a section 179 deduction and use a depreciation method other than straight line only if you do not use the standard mileage rate to figure your business-related car expenses in the year you first place a car in service.

If you claim either a section 179 deduction or use a depreciation method other than straight line in the year you first place a car in service, you cannot use the standard mileage rate on that car in any future year.

Car defined. For depreciation purposes, a car is any four-wheeled vehicle (including a truck or van) that is made primarily for use on public streets, roads, and highways. Its unloaded gross vehicle weight (gross vehicle weight in the case of a truck or van) must not be more than 6,000 pounds. A car includes any part, component, or other item that is physically attached to it or is usually included in the purchase price.

A car does not include:

An ambulance, hearse, or combination ambulance-hearse used directly in a business,
A vehicle used directly in the business of transporting persons or property for pay or hire, or
A truck or van that is a qualified nonpersonal use vehicle.

Qualified nonpersonal use vehicles. These are vehicles that by their nature are not likely to be used more than a minimal amount for personal purposes. They include trucks and vans that have been specially modified so that they are not likely to be used more than a minimal amount for personal purposes, such as by installation of permanent shelving and painting the vehicle to display advertising or the company's name. Delivery trucks with seating only for the driver, or only for the driver plus a folding jump seat are qualified nonpersonal use vehicles.

Electric car. For purposes of depreciation, the term “electric car” refers to passenger automobiles designed to be propelled primarily by electricity and built by an original equipment manufacturer.

More information. See Depreciation Deduction, later, for more information on how to depreciate your vehicle.

Section 179 Deduction

The section 179 deduction allows you to treat part or all of the business cost of a car as a current expense rather than taking depreciation deductions over a number of years.

The limit on total section 179 and depreciation deductions (discussed later) may reduce or eliminate any benefit from claiming the section 179 deduction.

You can claim the section 179 deduction only in the year you place the car in service. For this purpose, a car is placed in service when it is ready and available for a specific use, whether in a trade or business, a tax-exempt activity, a personal activity, or for the production of income. Even if you are not using the property, it is in service when it is ready and available for its specific use.

A car first used for personal purposes cannot qualify for the deduction in a later year when its use changes to business.

Example.

In 2005 you bought a new car and placed it in service for personal purposes. This year, you began to use it for business. Changing its use to business use does not qualify the cost of your car for a section 179 deduction this year. However, you can claim a depreciation deduction for the business use of the car. See Depreciation Deduction, later.

More than 50% business use requirement. You must use the property more than 50% for business to claim any section 179 deduction. If you used the property more than 50% for business, multiply the cost of the property by the percentage of business use. The result is the cost of the property that can qualify for the section 179 deduction.

Example.

Peter purchased a car in April 2006 for $19,500 and he used it 60% for business. The total cost of Peter's car that qualifies for the section 179 deduction is $11,700 ($19,500 cost × 60% business use). But see Limit on total section 179 and depreciation deductions, discussed later.

Limits. There are limits on:

The amount of the section 179 deduction,
The section 179 deduction for sport utility and certain other vehicles, and
The total amount of the section 179 deduction plus the depreciation deduction (discussed later) you can claim for a qualified property.

Limit on the amount of the section 179 deduction. For 2006, the total amount you can choose to deduct under section 179 generally cannot be more than $108,000.

If the cost of your qualifying section 179 property placed in service in 2006 is over $430,000, you must reduce the $108,000 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.

The total amount you can deduct under section 179 each year after you apply the limits listed above cannot be more than the taxable income from the active conduct of any trade or business during the year.

If you are married and 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. You must allocate the dollar limit (after any reduction) between you.

For more information on the above section 179 deduction limits, see Publication 946.

Limit for sport utility and certain other vehicles. For sport utility and certain other vehicles placed in service in 2006, the portion of the vehicle's cost taken into account in figuring your section 179 deduction is limited to $25,000. This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, or highways, that is not subject to any of the passenger automobile limits explained under Depreciation Limits, later, and that is rated at no more than 14,000 pounds gross vehicle weight. However, the $25,000 limit does not apply to any vehicle:

Designed to have a seating capacity of more than nine persons behind the driver's seat,
Equipped with a cargo area of at least 6 feet in interior length that is an open area or is designed for use as an open area but is enclosed by a cap and is not readily accessible directly from the passenger compartment, or
That has an integral enclosure, fully enclosing the driver compartment and load carrying device, does not have seating rearward of the driver's seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield.

Limit on total section 179 and depreciation deductions. Generally, the total amount of section 179 and depreciation deductions that you can claim for a qualified car that you placed in service in 2006 is $2,960. The limit is reduced if your business use of the car is less than 100%. See Depreciation Limits, later, for more information.

Example.

In the earlier example under More than 50% business use requirement, Peter had a car with a qualifying cost (for purposes of the section 179 deduction) of $11,700. However, Peter's total section 179 and depreciation deduction is limited to $1,776 ($2,960 limit x 60% business use).

Cost of car. For purposes of the section 179 deduction, the cost of the car does not include any amount figured by reference to any other property held by you at any time. For example, if you buy (for cash and a trade-in) a new car to use in your business, your cost for purposes of the section 179 deduction does not include your adjusted basis in the car you trade in for the new car. Your cost includes only the cash you paid.

Basis of car for depreciation. The amount of the section 179 deduction reduces your basis in your car. If you choose the section 179 deduction, you must subtract the amount of the deduction from the cost of your car. The resulting amount is the basis in your car that you use to figure your depreciation deduction.

When to choose. If you want to take the section 179 deduction, you must make the choice in the tax year you both purchase the car and place it in service for business or work.

How to choose. Employees use Form 2106 to make this choice and report the section 179 deduction. All others use Form 4562.

File the appropriate form with either of the following.

Your original tax return filed for the year the property was placed in service (whether or not you file it timely).
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.

You must keep records that show the specific identification of each piece of qualifying section 179 property. These records must show how you acquired the property, the person you acquired it from, and when you placed it in service.

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 adjustment to taxable income. Once made, the revocation is irrevocable.

Reduction in business use. To be eligible to claim the section 179 deduction, you must use your car more than 50% for business or work in the year you acquired it. If your business use of the car is 50% or less in a later tax year during the recovery period, you have to recapture (include in income) in that later year any excess depreciation. Any section 179 deduction claimed on the car is included in calculating the excess depreciation. For information on this calculation, see Excess depreciation later in this chapter under Car Used 50% or Less for Business.

Dispositions. If you dispose of a car on which you had claimed the section 179 deduction, the amount of that deduction is treated as a depreciation deduction for recapture purposes. You treat any gain on the disposition of the property as ordinary income up to the amount of the section 179 deduction and any allowable depreciation (unless you establish the amount actually allowed). For information on the disposition of a car, see Disposition of a Car, later.

Gulf Opportunity (GO) Zone Special Depreciation Allowance

You may be able to claim the special depreciation allowance for your car if it qualifies as Gulf Opportunity (GO) Zone property and was placed in service in 2006. The allowance is an additional depreciation deduction of 50% of the car's depreciable basis (after any section 179 deduction, but before figuring your regular depreciation deduction under MACRS). The GO Zone special depreciation allowance applies only for the first year the car is placed in service. To qualify for the allowance more than 50% of the use of the car must be in the active conduct of your trade or business.

See Publication 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita, and Wilma, for the definition of the GO Zone.

Your combined section 179 deduction, GO Zone special depreciation allowance, and regular MACRS depreciation deduction is limited to the maximum allowable depreciation deduction for cars ($2,960), trucks and vans ($3,260), or electric cars ($8,980). See Depreciation Limits, later in this chapter.

You can elect not to claim the GO Zone special depreciation allowance for your car. If you make this election for your car, it applies to all property in the same class placed in service during the year.

Qualified GO Zone car. To be a qualified GO Zone car, the car must meet all of the following tests.

You purchased the car on or after August 28, 2005, but only if no binding written contract to acquire the car existed before August 28, 2005,
You placed the car in service in your trade or business in 2006,
Substantially all of the use of the car is in the GO Zone, and
The original use of the car in the GO Zone began with you after August 28, 2005. Used cars can be qualified GO Zone property if not previously used within the GO Zone. Also, additional capital expenditures you incurred after August 25, 2005, to recondition or rebuild your car meet the original use test if the original use of the car in the GO Zone began with you.

Example.

Dan purchased a new car for $13,500 in June 2006, and used it 100% in his business. The car qualifies as GO Zone property. Dan's unadjusted basis is $13,500. Dan chooses not to claim any section 179 deduction but he does choose to claim the GO Zone special depreciation allowance. Dan figures his special allowance as $6,750 ($13,500 x 50%)

Dan chooses the MACRS 200% declining balance method but does not need to figure his regular depreciation deduction under MACRS (discussed later) because his special allowance ($6,750) exceeds the maximum depreciation deduction allowed ($2,960) for the first year the car is placed in service. Dan reports $2,960 as depreciation for his car in 2006. See Depreciation Limits later.

Claiming the GO Zone special depreciation allowance may result in a larger depreciation deduction in the year the car is placed in service, but subsequent year depreciation deductions may be smaller than if you had not claimed the GO Zone special depreciation allowance.

Depreciation Deduction

If you use actual car expenses to figure your deduction for a car you own and use in your business, you can claim a depreciation deduction: that is, you can deduct a certain amount each year as a recovery of your cost or other basis in your car.

You generally need to know the following things about the car you intend to depreciate.

Your basis in the car.
The date you place the car in service.
The method of depreciation and recovery period you will use.

Basis. Your basis in a car for figuring depreciation is generally its cost. This includes any amount you borrow or pay in cash, other property, or services.

Generally, you figure depreciation using your basis. However, in some situations (such as use of the straight line method) you will use your adjusted basis (your basis reduced by depreciation allowed or allowable in earlier years). For one of these situations see Exception under Methods of depreciation, later.

If you change the use of a car from personal to business, your basis for depreciation is the lesser of the fair market value or your adjusted basis in the car on the date of conversion. Additional rules concerning basis are discussed later in this chapter under Unadjusted basis.

Placed in service. You generally place a car in service when it is available for use in your work or business, in an income-producing activity, or in a personal activity. Depreciation begins when the car is placed in service for use in your work or business or for the production of income.

For purposes of computing depreciation, if you first start using the car only for personal use and later convert it to business use, you place the car in service on the date of conversion.

Car placed in service and disposed of in the same year. If you place a car in service and dispose of it in the same tax year, you cannot claim any depreciation deduction for that car.

Methods of depreciation. Generally, you figure depreciation on cars using the Modified Accelerated Cost Recovery System (MACRS). MACRS is discussed later in this chapter.

Exception. If you used the standard mileage rate in the first year of business use and change to the actual expenses method in a later year, you cannot depreciate your car under the MACRS rules. You must use straight line depreciation over the estimated remaining useful life of the car.

To figure depreciation under the straight line method, you must reduce your basis in the car (but not below zero) by a set rate per mile for all miles for which you used the standard mileage rate. The rate per mile varies depending on the year(s) you used the standard mileage rate. For the rate(s) to use, see Depreciation adjustment when you used the standard mileage rate under Disposition of a Car, later.

This reduction of basis is in addition to those basis adjustments described later under Unadjusted basis. You must use your adjusted basis in your car to figure your depreciation deduction. For additional information on the straight line method of depreciation, see Publication 946.

More-than-50%-use test. Generally, you must use your car more than 50% for qualified business use (defined next) during the year to use MACRS. You must meet this more-than-50%-use test each year of the recovery period (6 years under MACRS) for your car.

If your business use is 50% or less, you must use the straight line method to depreciate your car. This is explained later under Car Used 50% or Less for Business.

Qualified business use. A qualified business use is any use in your trade or business. It does not include use for the production of income (investment use). However, you do combine your business and investment use to compute your depreciation deduction for the tax year.

Use of your car by another person. Do not treat any use of your car by another person as use in your trade or business unless that use meets one of the following conditions.

It is directly connected with your business.
It is properly reported by you as income to the other person (and, if you have to, you withhold tax on the income).
It results in a payment of fair market rent. This includes any payment to you for the use of your car.

Business use changes. If you used your car more than 50% in qualified business use in the year you placed it in service, but 50% or less in a later year (including the year of disposition), you have to change to the straight line method of depreciation. See Qualified business use 50% or less in a later year under Car Used 50% or Less for Business, later.

Property does not cease to be used more than 50% in qualified business use by reason of a transfer at death.

Use for more than one purpose. If you use your car for more than one purpose during the tax year, you must allocate the use to the various purposes. You do this on the basis of mileage. Figure the percentage of qualified business use by dividing the number of miles you drive your car for business purposes during the year by the total number of miles you drive the car during the year for any purpose.

Change from personal to business use. If you change the use of a car from 100% personal use to business use during the tax year, you may not have mileage records for the time before the change to business use. In this case, you figure the percentage of business use for the year as follows.

Determine the percentage of business use for the period following the change. Do this by dividing business miles by total miles driven during that period.
Multiply the percentage in (1) by a fraction. The numerator (top number) is the number of months the car is used for business and the denominator (bottom number) is 12.

Example.

You use a car only for personal purposes during the first 6 months of the year. During the last 6 months of the year, you drive the car a total of 15,000 miles of which 12,000 miles are for business. This gives you a business use percentage of 80% (12,000 ÷ 15,000) for that period. Your business use for the year is 40% (80% × 6/12).

Limits. The amount you can claim for section 179 and depreciation deductions may be limited. The maximum amount you can claim depends on the year in which you placed your car in service. You have to reduce the maximum amount if you did not use the car exclusively for business. See Depreciation Limits, later.

Unadjusted basis. You use your unadjusted basis (often referred to as your basis or your basis for depreciation) to figure your depreciation using the MACRS depreciation chart, explained later under Modified Accelerated Cost Recovery System (MACRS). Your unadjusted basis for figuring depreciation is your original basis increased or decreased by certain amounts.

To figure your unadjusted basis, begin with your car's original basis, which generally is its cost. Cost includes sales taxes (see Sales taxes earlier), destination charges, and dealer preparation. Increase your basis by any substantial improvements you make to your car, such as adding air conditioning or a new engine. Decrease your basis by any deductible casualty loss, section 179 deduction, special depreciation allowance, diesel fuel tax credit, gas guzzler tax, clean fuel vehicle deduction, alternative motor vehicle credit, and qualified electric vehicle credit.

See Form 8910 for information on the alternative motor vehicle credit and Form 8834 for information on the qualified electric vehicle credit.

If your business use later falls to 50% or less, you may have to recapture (include in your income) any excess depreciation. See Car Used 50% or Less for Business, later, for more information.

If you acquired the car by gift or inheritance, see Publication 551, Basis of Assets, for information on your basis in the car.

Improvements. A major improvement to a car is treated as a new item of 5-year recovery property. It is treated as placed in service in the year the improvement is made. It does not matter how old the car is when the improvement is added. Follow the same steps for depreciating the improvement as you would for depreciating the original cost of the car. However, you must treat the improvement and the car as a whole when applying the limits on the depreciation deductions. Your car's depreciation deduction for the year (plus any section 179 deduction, special depreciation allowance, and depreciation on any improvements) cannot be more than the depreciation limit that applies for that year. See Depreciation Limits, later.

Car trade-in. If you traded one car (the “old car”) in on another car (the “new car”) in 2006, there are two ways you can treat the transaction.

You can elect to treat the transaction as a tax-free disposition of the old car and the purchase of the new car. If you make this election, you treat the old car as disposed of at the time of the trade-in. The depreciable basis of the new car is the adjusted basis of the old car (figured as if 100% of the car's use had been for business purposes) plus any additional amount you paid for the new car. You then figure your depreciation deduction for the new car beginning with the date you placed it in service. You make this election by completing Form 2106, Part II, Section D. This method is explained later, beginning at Effect of trade-in on basis.
If you do not make the election described in (1), you must figure depreciation separately for the remaining basis of the old car and for any additional amount you paid for the new car. You must apply two depreciation limits (see Depreciation Limits, later). The limit that applies to the remaining basis of the old car generally is the amount that would have been allowed had you not traded in the old car. The limit that applies to the additional amount you paid for the new car generally is the limit that applies for the tax year, reduced by the depreciation allowance for the remaining basis of the old car. You must use Form 4562, Depreciation and Amortization, to compute your depreciation deduction. You cannot use Form 2106, Part II, Section D. This method is explained in Publication 946.

If you elect to use the method described in (1), you must do so on a timely filed tax return (including extensions). Otherwise, you must use the method described in (2).

Effect of trade-in on basis. The discussion that follows applies to trade-ins of cars in 2006, where the election was made to treat the transaction as a tax-free disposition of the old car and the purchase of the new car. For information on how to figure depreciation for cars involved in a like-kind exchange (trade-in) in 2006, for which the election was not made, see Publication 946 and Temporary Regulations section 1.168(i)-6T(d)(3).

Traded car used only for business. If you trade in a car that you used only in your business for another car that will be used only in your business, your original basis in the new car is your adjusted basis in the old car, plus any additional amount you pay for the new car.

Example 1.

Paul trades in a car that has an adjusted basis of $5,000 for a new car. In addition, he pays cash of $20,000 for the new car. His original basis of the new car is $25,000 (his $5,000 adjusted basis in the old car plus the $20,000 cash paid). Paul's unadjusted basis is $25,000 unless he claims the section 179 deduction, or has other increases or decreases to his original basis, discussed under Unadjusted basis, earlier.

Example 2.

In October 2003, Marcia purchased a car for $26,000 and placed it in service for 100% use in her business. Marcia did not claim a section 179 deduction but she did claim the special depreciation allowance. Marcia's unadjusted basis for the car was $15,290 ($26,000 - $10,710 (50% special depreciation allowance, up to the maximum amount allowed)). For 2003 through 2005, Marcia figured her depreciation deduction using the MACRS depreciation chart for those years.

In September 2006, Marcia traded that car in and paid $14,200 cash for a new car to be used 100% in her business. Marcia is allowed one-half of the MACRS depreciation amount figured for 2006 for her old car. (See Disposition of a Car, later.)

Marcia figures her basis in the new car as follows.

Cost of old car		$26,000
Less total depreciation allowed: 2006—($15,290 × .1152) × ½ (Limit: $1,775)	$881
2005—($15,290 × .192) (Limit: $2,950)	2,936
2004—($15,290 × .32) (Limit: $4,900)	4,893
2003—($26,000 × .50) ¹ ($15,290 × .20) (Limit: $10,710)	10,710
Total depreciation allowed		-19,420

Adjusted basis of old car and basis of part of new car that can be treated as newly purchased MACRS property		$ 6,580

Additional basis (cash paid) for new car that is treated as newly purchased MACRS property		+14,200

Total basis of new car		$20,780

¹ 50% special depreciation allowance ($26,000 × 50% = $13,000). Unadjusted basis of the car: ($26,000 - $10,710 = $15,290). Regular depreciation: ($15,290 × .20 = $3,058). Total depreciation ($13,000 + $3,058 = $16,058) cannot exceed first year limit ($10,710).

Traded car used partly in business. If you trade in a car that you used partly in your business for a new car that you will use in your business, you must make a “trade-in” adjustment for the personal use of the old car. This adjustment has the effect of reducing your basis in your old car, but not below zero, for purposes of figuring your depreciation deduction for the new car. (This adjustment is not used, however, when you determine the gain or loss on the later disposition of the new car. See Publication 544, Sales and Other Dispositions of Assets, for information on how to report the disposition of your car.)

To figure the unadjusted basis of your new car for depreciation, first add to your adjusted basis in the old car any additional amount you pay for the new car. Then subtract from that total the excess, if any, of:

The total of the amounts that would have been allowable as depreciation during the tax years before the trade if 100% of the use of the car had been business and investment use, over
The total of the amounts actually allowable as depreciation during those years.

For information about figuring depreciation, see Modified Accelerated Cost Recovery System (MACRS), which follows Example 2, later.

Example 1.

In March, Mark traded his 2002 van (placed in service in June 2002) for a new 2006 model. He used the old van 75% for business and he used the new van 75% for business in 2006. Mark claimed actual expenses (including $12,756 depreciation expense) for the business use of the old van since 2002. He did not claim a section 179 deduction for the old or the new van.

Mark paid $19,500 for the 2002 van in June 2002. He paid an additional $12,500 when he acquired the 2006 van. Mark was allowed ½ of the depreciation deduction amount (which is included in the $12,756 depreciation expense total) for his old van for 2006, the year of disposition, as explained later under Disposition of a Car. Mark does not claim the special depreciation allowance.

Mark figures the unadjusted basis for depreciating his new van as shown next.

Cost of old van		$19,500
Less: Total depreciation allowed on the business cost of old van from 2002-2006		-12,756
Adjusted basis of old van before trade-in adjustment	$ 6,744

Trade-in adjustment:
Depreciation at 100% business use:
2006—($13,650 × .1152) × ½
(Limit: $1,775)	$ 786
2005—(13,650 × .1152)
(Limit: $1,775)	1,572
2004—(13,650 × .192)
(Limit: $2,950)	2,621
2003—(13,650 × .32)
(Limit: $4,900)	4,368
2002—(19,500 × .30) ¹ ($13,650 x .20)
(Limit: $7,660)	7,660
Total	$17,007
Less: Actual depreciation allowed	-12,756
Excess of 100% over actual	$ 4,251
Less: Lesser of excess amount
($4,251) or adjusted basis of old van ($6,744)		- 4,251

Unadjusted basis of part of new van that can be treated as newly purchased MACRS property		$ 2,493

Additional basis (cash paid) for new van that is treated as newly purchased MACRS property		$12,500

Example 2.

Rob paid $21,000 for a new car that he placed in service in 2003. He used it partly for business in 2003 (9,600 business miles of 15,000 total miles), 2004 (12,000 business miles of 16,000 total miles), and 2005 (14,400 miles of 18,000 total miles). He used the standard mileage rate in those years to claim the business use of his car. (See Depreciation adjustment when you used the standard mileage rate under Disposition of a Car, later.)

On January 3, 2006, Rob traded in this car and paid an additional $10,000 for his new car. Rob figures the unadjusted basis for his new car as shown next.

Cost of old car		$21,000
Less: Total depreciation allowed:
2005—14,400 mi. × .17	$2,448
2004—12,000 mi. × .16	1,920
2003—9,600 mi. × .16	1,536	- 5,904
Adjusted basis of old car before trade-in adjustment		$15,096

Trade-in adjustment:
Depreciation at 100% business use:
2005—18,000 mi. × .17	$3,060
2004—16,000 mi. × .16	2,560
2003—15,000 mi. × .16	2,400
Total	$8,020
Less: Actual depreciation allowed	- 5,904
Excess of 100% over actual	$2,116
Less: Lesser of excess amount
($2,116) or adjusted basis of old car ($15,096)		- 2,116

Unadjusted basis of part of new car that can be treated as newly purchased MACRS property		$12,980

Additional basis (cash paid) for new car that is treated as newly purchased MACRS property		$10,000

Modified Accelerated Cost Recovery System (MACRS). The Modified Accelerated Cost Recovery System (MACRS) is the name given to the tax rules for getting back (recovering) through depreciation deductions the cost of property used in a trade or business or to produce income.

The maximum amount you can deduct is limited, depending on the year you placed your car in service. See Depreciation Limits, later.

Recovery period. Under MACRS, cars are classified as 5-year property. You actually depreciate the cost of a car, truck, or van over a period of 6 calendar years. This is because your car is generally treated as placed in service in the middle of the year and you claim depreciation for one-half of both the first year and the sixth year.

At the time this publication went to print, Congress was considering legislation that would extend the provision for faster recovery periods for certain Indian reservation property that expired at the end of 2005. To find out if this legislation was enacted, and for more details, go to www.irs.gov, click on More Forms and Publications , and then on What's Hot in forms and publications , or see Publication 553, Highlights of 2006 Tax Changes.

Depreciation methods. You can use one of the following methods to depreciate your car.

The 200% declining balance method (200% DB) over a 5-year recovery period that switches to the straight line method when that method provides an equal or greater deduction.
The 150% declining balance method (150% DB) over a 5-year recovery period that switches to the straight line method when that method provides an equal or greater deduction.
The straight line method (SL) over a 5-year recovery period.

If you use Table 4-1 (discussed later under MACRS depreciation chart ) to determine your depreciation rate for 2006, you do not need to determine in what year using the straight line method provides an equal or greater deduction. This is because the chart has the switch to the straight line method built into its rates.

Before choosing a method, you may wish to consider the following facts.

Using the straight line method provides equal yearly deductions throughout the recovery period.
Using the declining balance methods provides greater deductions during the earlier recovery years with the deductions generally getting smaller each year.

MACRS depreciation chart. A 2006 MACRS Depreciation Chart and instructions are included in this chapter as Table 4-1. Using this table will make it easy for you to figure the 2006 depreciation deduction for your car. A similar chart appears in the Instructions for Form 2106.

You may have to use the tables in Publication 946 instead of using this MACRS Depreciation Chart .

You must use the Depreciation Tables in Publication 946 rather than the 2006 MACRS Depreciation Chart in this publication if any one of the following three conditions applies to you.

You file your return on a fiscal year basis.
You file your return for a short tax year (less than 12 months).
During the year, all of the following conditions apply.
1. You placed some property in service from January through September.
2. You placed some property in service from October through December.
3. Your basis in the property you placed in service from October through December (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) was more than 40% of your total bases in all property you placed in service during the year.

Depreciation in future years. If you use the percentages from the chart, you generally must continue to use them for the entire recovery period of your car. However, you cannot continue to use the chart if your basis in your car is adjusted because of a casualty. In that case, for the year of the adjustment and the remaining recovery period, figure the depreciation without the chart using your adjusted basis in the car at the end of the year of the adjustment and over the remaining recovery period. See Figuring the Deduction Without Using the Tables in chapter 4 of Publication 946.

In future years, do not use the chart in this edition of the publication. Instead, use the chart in the publication or the form instructions for those future years.

Disposition of car during recovery period. If you dispose of the car before the end of the recovery period, you are generally allowed a half year of depreciation in the year of disposition unless you purchased the car during the last quarter of a year. See Depreciation deduction for the year of disposition under Disposition of a Car, later, for information on how to figure the depreciation allowed in the year of disposition.

How to use the 2006 chart. To figure your depreciation deduction for 2006, find the percentage in the column of the chart based on the date that you first placed the car in service and the depreciation method that you are using. Multiply the unadjusted basis of your car (defined earlier) by that percentage to determine the amount of your depreciation deduction. If you prefer to figure your depreciation deduction without the help of the chart, see Publication 946.

This image is too large to be displayed in the current screen. Please click the link to view the image.

Table 4-1. 2006 MACRS Depreciation Chart

Your deduction cannot be more than the maximum depreciation limit for cars. See Depreciation Limits, later.

Example.

Phil bought a used truck in February 2005 to use exclusively in his landscape business. He paid $9,200 for the truck with no trade-in. Phil did not claim any section 179 deduction, the truck did not qualify for any special depreciation allowance, and he chose to use the 200% DB method to get the largest depreciation deduction in the early years.

Phil used the MACRS depreciation chart in 2005 to find his percentage. The unadjusted basis of his truck equals its cost because Phil used it exclusively for business. He multiplied the unadjusted basis of his truck, $9,200, by the percentage that applied, 20%, to figure his 2005 depreciation deduction of $1,840.

In 2006, Phil used the truck for personal purposes when he repaired his father's cabin. His records show that the business use of his truck was 90% in 2006. Phil used Table 4-1 to find his percentage. Reading down the first column for the date placed in service and across to the 200% DB column, he locates his percentage, 32%. He multiplies the unadjusted basis of his truck, $8,280 ($9,200 cost × 90% business use), by 32% to figure his 2006 depreciation deduction of $2,650.

Depreciation Limits

There are limits on the amount you can deduct for depreciation of your car, truck or van, or electric car. The section 179 deduction is treated as depreciation for purposes of the limits. The maximum amount you can deduct each year depends on the year you place the car in service. These limits are shown in the following tables.

Maximum Depreciation Deduction for Cars

Date				4th &
Placed	1st	2nd	3rd	Later
In Service	Year	Year	Year	Years
2006	$2,960	$4,800	$2,850	$1,775
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 ³	4,900	2,950	1,775
2001-2002	7,660 ³	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
¹$2,960 if the car is not qualified property or if you elect not to claim the special depreciation allowance.
²$7,660 if you acquired the car before 5/6/2003. $3,060 if the car is not qualified property or if you elect not to claim any special depreciation allowance.
³$3,060 if you acquired the car before 9/11/2001, the car is not qualified property, or you elect not to claim the special depreciation allowance.

Trucks and vans. For 2006, the maximum depreciation deductions for trucks and vans and passenger vehicles such as minivans and sport utility vehicles that are built on a truck chassis are generally higher than those for cars. For trucks and vans placed in service before 2003, use the Maximum Depreciation Deduction for Cars table.

Maximum Depreciation Deduction for Trucks and Vans

Date				4th &
Placed	1st	2nd	3rd	Later
In Service	Year	Year	Year	Years
2005-2006	$3,260	$5,200	$3,150	$1,875
2004	10,910 ¹	5,300	3,150	1,875
2003	11,010 ^2,3	5,400	3,250	1,975
¹If the special depreciation allowance does not apply or you make the election not to claim the special depreciation allowance, the first year limit is $3,260.
²If the special depreciation allowance does not apply or you make the election not to claim the special depreciation allowance, the first year limit is $3,360.
³If the truck or van was acquired before 5/06/03, the truck or van is qualified property, and you claim the special depreciation allowance for the truck or van, the maximum deduction is $7,960.

Exceptions for clean-fuel cars. There are two exceptions to the depreciation limits for cars. They are effective after August 5, 1997, for cars that run on clean fuel. The exceptions follow.

Amounts you pay for retrofit parts and components to modify a car to run on clean fuel are not subject to the depreciation limit on cars. Only the cost of the car before modification is subject to the limit.
If you place a car in service after August 5, 1997, that was produced to run on electricity, your depreciation limit is increased. The amounts are shown in the following table.

<emphasis role="bold">Maximum Depreciation Deduction for Electric Cars Placed in Service After August 5, 1997</emphasis>

Date				4th &
Placed	1st	2nd	3rd	Later
In Service	Year	Year	Year	Years
2006	$8,980	$14,400	$8,650	$5,225
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 ³	14,700	8,750	5,325
2001	23,080 ⁴	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
¹$8,880 if the car is not qualified property or if you elect not to claim the special depreciation allowance.
²$22,880 if you acquired the car before 5/6/2003. $9,080 if the car is not qualified property or if you elect not to claim any special depreciation allowance.
³$9,180 if the car is not qualified property or if you elect not to claim the special depreciation allowance.
⁴$9,280 if you acquired the car before 9/11/2001, the car is not qualified property, or you elect not to claim the special depreciation allowance.

The examples throughout this chapter illustrate gas-fueled cars.

Car used less than full year. The depreciation limits are not reduced if you use a car for less than a full year. This means that you do not reduce the limit when you either place a car in service or dispose of a car during the year. However, the depreciation limits are reduced if you do not use the car exclusively for business and investment purposes. See Reduction for personal use, later.

Example.

Marie purchased a car in June 2006 for $20,000 to use exclusively in her business. She does not claim the section 179 deduction and she chooses the 200% DB method of depreciation.

Marie's MACRS depreciation (using the rate from Table 4-1) is $4,000 ($20,000 × 20%). However, the maximum amount she can deduct for depreciation is $2,960. (See the Maximum Depreciation Deduction for Cars table earlier.)

Reduction for personal use. The depreciation limits are reduced based on your percentage of personal use. If you use a car less than 100% in your business or work, you must determine the depreciation deduction limit by multiplying the limit amount by the percentage of business and investment use during the tax year.

Example.

In April 2006, Karl, an outside dental supply salesman, purchased a new car for $25,400 to make sales calls in a territory that extends 200 miles around his home base. He uses his car 85% for his business. Karl does not claim the section 179 deduction and he chooses the 200% DB method to figure his depreciation deduction.

In 2006, Karl figures his MACRS depreciation deduction to be $4,318 (($25,400 x 85%) x 20%). However, Karl's deduction is limited to $2,516. This is the depreciation limit ($2,960) multiplied by the business use percentage (85%).

Karl continues to use his car 85% for business. Depreciation in the next four years continues to be subject to deduction limits. Karl figures his depreciation limits for those years as follows.

Year	Limit x Business Use	Depreciation
2007	$4,800 × 85%	$4,080
2008	2,850 × 85%	2,423
2009, 2010	1,775 × 85%	1,509

In 2011, using the rate from Table 4-1, Karl's MACRS deduction is $1,244 (($25,400 × 85%) × 5.76%). Since that amount is less than the depreciation limit of $1,509 ($1,775 × 85%), Karl's depreciation deduction for 2011 is $1,244.

If Karl continues to use his car for business after 2011, he can continue to claim a depreciation deduction for his unrecovered basis. However, he cannot deduct more than $1,775 multiplied by his business use percentage. See Deductions in years after the recovery period, later.

Section 179 deduction. The section 179 deduction is treated as a depreciation deduction. If you place a car that is not a truck, van, or electric vehicle in service in 2006, use it only for business, and choose the section 179 deduction, the combined section 179 and depreciation deduction for that car for 2006 is limited to $2,960.

Example.

On September 4, 2006, Jack bought a used car for $10,000 and placed it in service. He used it 80% for his business and he chooses to take a section 179 deduction for the car.

Before applying the limit, Jack figures his maximum section 179 deduction to be $8,000. This is the cost of his qualifying property (up to the maximum $108,000 amount) multiplied by his business use ($10,000 × 80%).

Jack then figures that his section 179 deduction for 2006 is limited to $2,368 (80% of $2,960). He then has an unadjusted basis of $5,632 (($10,000 × 80%) - $2,368) for determining his depreciation deduction. Since he has already reached the maximum limit for 2006, Jack will use the unadjusted basis to figure his depreciation deduction for 2007.

Deductions in years after the recovery period. If the depreciation limits apply to your car, you may have unrecovered basis in your car at the end of the recovery period. If you continue to use your car for business, you can deduct that unrecovered basis (subject to depreciation limits) after the recovery period ends.

Unrecovered basis. This is your cost or other basis in the car reduced by any clean-fuel vehicle deduction, alternative motor vehicle credit, electric vehicle credit, and depreciation and section 179 deductions that would have been allowable if you had used the car 100% for business and investment use.

The recovery period. For 5-year property, your recovery period is 6 calendar years. A part year's depreciation is allowed in the first calendar year, a full year's depreciation is allowed in each of the next 4 calendar years, and a part year's depreciation is allowed in the 6th calendar year.

Under MACRS, your recovery period is the same whether you use declining balance or straight line depreciation. You determine your unrecovered basis in the 7th year after you placed the car in service.

How to treat unrecovered basis. If you continue to use your car for business after the recovery period, you can claim a depreciation deduction in each succeeding tax year until you recover your full basis in the car. The maximum amount you can deduct each year is determined by the date you placed the car in service and your business-use percentage. For example, no deduction is allowed for a year you use your car 100% for personal purposes.

Example.

In May 2000, Bob bought and placed in service a car that he used exclusively in his business. The car cost $31,500. Bob did not claim a section 179 deduction for the car. He continued to use the car 100% in his business throughout the recovery period (2000 through 2005). For those years, Bob used Table 4-1 and the Maximum Depreciation Deduction for Cars table (as explained earlier) to compute his depreciation deductions as shown in the following table.

	MACRS	MACRS	Maximum	Deprec.
Year	%	Amount	Deduction	Allowed
2000	20.00	$ 6,300	$ 3,060	$ 3,060
2001	32.00	10,080	4,900	4,900
2002	19.20	6,048	2,950	2,950
2003	11.52	3,629	1,775	1,775
2004	11.52	3,629	1,775	1,775
2005	5.76	1,814	1,775	1,775
Total		$31,500	$16,235	$16,235

At the end of 2005, Bob had an unrecovered basis in the car of $15,265. This was the $31,500 original basis of his car less the $16,235 depreciation deductions allowed during the recovery period.

Bob continued to use the car 100% for business in 2006. He can claim a depreciation deduction of $1,775 (the maximum allowed for each subsequent year) for the year. If he continues to use the car 100% for business in 2007 and later years, Bob can deduct the lesser of $1,775 or his remaining unrecovered basis in each of those years until his deductions total the $13,490 unrecovered basis ($15,265 - $1,775 claimed in 2006).

If Bob's business use of the car was less than 100% during any year, his depreciation deduction would be less than the maximum amount allowable for that year. However, in determining his unrecovered basis in the car, he would still reduce his original basis by the maximum amount allowable. Bob's unrecovered basis at the beginning of 2006 would be $15,265 ($31,500 - $16,235) in this example. This is true even if his actual depreciation deduction for any year was less than the maximum amount shown.

Car Used 50% or Less for Business

If you use your car 50% or less for qualified business use (defined earlier under Depreciation Deduction) either in the year the car is placed in service or in a later year, special rules apply. The rules that apply in these two situations are explained in the following paragraphs. (For this purpose, “car” was defined earlier under Actual Car Expenses and includes certain trucks and vans and electric cars.)

Qualified business use 50% or less in year placed in service. If you use your car 50% or less for qualified business use (defined earlier under Depreciation Deduction) in the year the car is placed in service, the following rules apply.

You cannot take the section 179 deduction.
You must figure depreciation using the straight line method over a 5-year recovery period. You must continue to use the straight line method even if your percentage of business use increases to more than 50% in a later year.

Instead of making the computation yourself, you can use column (c) of Table 4-1 to find the percentage to use.

Example.

On May 22, 2006, Dan bought a car for $17,500. He used it 40% for his consulting business. Because he did not use the car more than 50% for business, Dan cannot take any section 179 deduction and he must use the straight line method over a 5-year recovery period to recover the cost of his car.

Dan deducts $700 in 2006. This is the lesser of:

$700 (($17,500 cost × 40% business use) × 10% recovery percentage (from column (c), Table 4-1)), or
$1,184 ($2,960 maximum limit × 40% business use).

Qualified business use 50% or less in a later year. If you use your car more than 50% in qualified business use in the tax year it is placed in service but the business use drops to 50% or less in a later year, you can no longer use an accelerated depreciation method for that car.

For the year the business use drops to 50% or less and all later years in the recovery period, you must use the straight line depreciation method over a 5-year recovery period. In addition, for the year your business use drops to 50% or less, you must recapture (include in your gross income) any excess depreciation (discussed later). You also increase the adjusted basis of your car by the same amount.

Example.

In June 2003, you purchased a car for exclusive use in your business. You met the more-than-50%-use test for the first 3 years of the recovery period (2003 through 2005) but failed to meet it in the fourth year (2006). You determine your depreciation for 2006 using 20% (from column (c) of Table 4-1). You also will have to determine and include in your gross income any excess depreciation, discussed next.

Excess depreciation. You must include any excess depreciation in your gross income and add it to your car's adjusted basis for the first tax year in which you do not use the car more than 50% in qualified business use. Use Form 4797, Sales of Business Property, to figure and report the excess depreciation in your gross income.

Excess depreciation is:

The amount of the depreciation deductions allowable for the car (including any section 179 deduction claimed and any special depreciation allowance claimed) for tax years in which you used the car more than 50% in qualified business use, minus
The amount of the depreciation deductions that would have been allowable for those years if you had not used the car more than 50% in qualified business use for the year you placed it in service. This means the amount of depreciation figured using the straight line method.

Example.

On September 25, 2003, you bought a car for $20,500 and placed it in service. You did not claim the section 179 deduction but you did claim the 50% special depreciation allowance. You used the car exclusively in qualified business use for 2003, 2004, and 2005. For those years, you figured the special depreciation allowance and you used the appropriate MACRS Depreciation Chart to figure depreciation deductions totaling $15,958 ($10,710 for 2003, $3,280 for 2004, and $1,968 for 2005) under the 200% DB method.

During 2006, you used the car 30% for business and 70% for personal purposes. Since you did not meet the more-than-50%-use test, you must switch from the 200% DB depreciation method to the straight line depreciation method for 2006, and include in gross income for 2006 your excess depreciation determined as follows.

Total depreciation claimed: (MACRS 200% DB method)		$15,958
Minus total depreciation allowable: (Straight line method)
2003—50% of $20,500, plus
10% of $10,250	$10,710
(Limit: $10,710)
2004—20% of $10,250	2,050
(Limit: $4,900)
2005—20% of $10,250	2,050	14,810
(Limit: $2,950)
Excess depreciation		$1,148

In 2006, using Form 4797, you figure and report the $1,148 excess depreciation you must include in your gross income. Your adjusted basis in the car is also increased by $1,148. Your 2006 depreciation deduction is $533 ($20,500 (unadjusted basis) × 30% (business use percentage) × 20% (from column (c) of Table 4-1 on the line for Jan. 1— Sept. 30, 2003) limited to $533 ($1,775 x 30% business use)).

Leasing a Car

If you lease a car, truck, or van that you use in your business, you can use the standard mileage rate or actual expenses to figure your deductible expense. This section explains how to figure actual expenses for a leased car, truck, or van.

Deductible payments. You can deduct the part of each lease payment that is for the use of the car in your business. You cannot deduct any part of a lease payment that is for personal use of the car, such as commuting.

You must spread any advance payments over the entire lease period. You cannot deduct any payments you make to buy a car, even if the payments are called lease payments.

If you lease a car for 30 days or more, you may have to reduce your lease payment deduction by an “inclusion amount.”

Inclusion Amounts

If you lease a car that you use in your business for a lease term of 30 days or more, you may have to include an inclusion amount in your income for each tax year you lease the car. To do this, you do not add an amount to income. Instead, you reduce your deduction for your lease payment. (This reduction has an effect similar to the limit on the depreciation deduction you would have on the car if you owned it.)

The inclusion amount is a percentage of part of the fair market value of the leased car multiplied by the percentage of business and investment use of the car for the tax year. It is prorated for the number of days of the lease term in the tax year.

The inclusion amount applies to each tax year that you lease the car if the fair market value (defined next) of the car when the lease began was more than the amounts shown in the following table.

	Year Lease Began	Fair Market Value*
	2005-2006	$15,200
	2004	17,500
	2003	18,000
	1999-2002	15,500
	1997-1998	15,800
	1995-1996	15,500
	1994	14,600
	1993	14,300
	1992	13,700
	1991	13,400
	1987-1990	12,800

	*For 2006, the fair market value for trucks and vans is $16,700 and for electric cars it is $45,000.

Fair market value. Fair market value is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all the necessary facts. Sales of similar property around the same date may be helpful in figuring the fair market value of the property.

Figure the fair market value on the first day of the lease term. If the capitalized cost of a car is specified in the lease agreement, use that amount as the fair market value.

Figuring the inclusion amount. Inclusion amounts are listed in Appendix A for cars, in Appendix B for trucks and vans, and in Appendix C for electric cars leased after August 5, 1997. If the fair market value of the car is $100,000 or less, use the appropriate appendix (depending on the year you first placed the car in service) to determine the inclusion amount. If the fair market value is more than $100,000, see the Revenue Procedure(s) identified in the footnote of the appendices for the inclusion amount. Revenue Procedures are available at most IRS offices and many local libraries. You can also find them on the Internet at www.irs.gov.

For each tax year during which you lease the car for business, determine your inclusion amount by following these three steps.

Locate the appendix that applies to you. To find the inclusion amount, do the following.
1. Find the line that includes the fair market value of the car on the first day of the lease term.
2. Go across the line to the column for the tax year in which the car is used under the lease to find the dollar amount. For the last tax year of the lease, use the dollar amount for the preceding year.
Prorate the dollar amount from (1)(b) for the number of days of the lease term included in the tax year.
Multiply the prorated amount from (2) by the percentage of business and investment use for the tax year. This is your inclusion amount.

Example.

On January 17, 2005, you leased a car for 3 years and placed it in service for use in your business. The car had a fair market value of $32,250 on the first day of the lease term. You use the car 75% for business and 25% for personal purposes during each year of the lease. Assuming you continue to use the car 75% for business, you use Appendix A-5 to arrive at the following inclusion amounts for each year of the lease:

Tax year	Dollar amount	Proration	Business use	Inclusion amount
2005	$81	349/365	75%	$58
2006	179	365/365	75%	134
2007	265	365/365	75%	199
2008	265	16/366	75%	9

For each year of the lease that you deduct lease payments, you must reduce your deduction by the inclusion amount computed for that year.

Leased car changed from business to personal use. If you lease a car for business use and, in a later year, change it to personal use, follow the rules explained earlier under Figuring the inclusion amount. For the tax year in which you stop using the car for business, use the dollar amount for the previous tax year. Prorate the dollar amount for the number of days in the lease term that fall within the tax year.

Example.

On August 16, 2005, Will leased an electric car with a fair market value of $58,600 for 3 years. He used the car exclusively in his own data processing business. On November 5, 2006, Will closed his business and went to work for a company where he is not required to use a car for business. Using Appendix C-5, Will computed his inclusion amount for 2005 and 2006 as shown in the following table and reduced his deductions for lease payments by those amounts.

Tax year	Dollar amount	Proration	Business use	Inclusion amount
2005	$60	138/365	100%	$23
2006	142	309/365	100%	120

Leased car changed from personal to business use. If you lease a car for personal use and, in a later year, change it to business use, you must determine the car's fair market value on the date of conversion. Then figure the inclusion amount using the rules explained earlier under Figuring the inclusion amount. Use the fair market value on the date of conversion.

Example.

In March 2004, Janice leased a car for 4 years for personal use. On June 1, 2006, she started working as a self-employed advertising consultant and started using the leased car for business purposes. Her records show that her business use for June 1 through December 31 was 60%. To figure her inclusion amount for 2006, Janice obtained an appraisal from an independent car leasing company that showed the fair market value of her 2004 car on June 1, 2006, was $21,650. Using Appendix A-6, Janice computed her inclusion amount for 2006 as shown in the following table.

Tax year	Dollar amount	Proration	Business use	Inclusion amount
2006	$45	214/365	60%	$16

Reporting inclusion amounts. For information on reporting inclusion amounts, employees should see Car rentals under Completing Forms 2106 and 2106-EZ in chapter 6. Sole proprietors should see the instructions for Schedule C (Form 1040) and farmers should see the instructions for Schedule F (Form 1040).

Disposition of a Car

If you dispose of your car, you may have a taxable gain or a deductible loss. The portion of any gain that is due to depreciation (including any section 179 or clean-fuel vehicle deduction) that you claimed on the car will be treated as ordinary income. However, you may not have to recognize a gain or loss if you dispose of the car because of a casualty, theft, or trade-in.

This section gives some general information about dispositions of cars. For information on how to report the disposition of your car, see Publication 544.

Casualty or theft. For a casualty or theft, a gain results when you receive insurance or other reimbursement that is more than your adjusted basis in your car. If you then spend all of the proceeds to acquire replacement property (a new car or repairs to the old car) within a specified period of time, you do not recognize any gain. Your basis in the replacement property is its cost minus any gain that is not recognized. See Publication 547 for more information.

Trade-in. When you trade in an old car for a new one, the transaction is considered a like-kind exchange. Generally, no gain or loss is recognized. (For exceptions, see chapter 1 of Publication 544.) In a trade-in situation, your basis in the new property is generally your adjusted basis in the old property plus any additional amount you pay. (See Unadjusted basis, earlier.)

Depreciation adjustment when you used the standard mileage rate. If you used the standard mileage rate for the business use of your car, depreciation was included in that rate. The rate of depreciation that was allowed in the standard mileage rate is shown in the chart that follows. You must reduce your basis in your car (but not below zero) by the amount of this depreciation.

These rates do not apply for any year in which the actual expenses method was used.

		Depreciation
	Year(s)	Rate per Mile
	2005-2006	$.17
	2003-2004	.16
	2001-2002	.15
	2000	.14
	1994-1999	.12
	1992-1993	.11½
	1989-1991	.11
	1988	.10½
	1987	.10
	1986	.09
	1983-1985	.08
	1982	.07½
	1980-1981	.07

For tax years after 1989, the depreciation rates apply to all business miles. For tax years before 1990, the depreciation rates apply to the first 15,000 miles.

Example.

In 2001, you bought a car for exclusive use in your business. The car cost $22,500. From 2001 through 2006, you used the standard mileage rate to figure your car expense deduction. You drove your car 14,100 miles in 2001, 16,300 miles in 2002, 15,600 miles in 2003, 16,700 miles in 2004, 15,100 miles in 2005, and 14,900 miles in 2006. Your depreciation is figured as follows.

Year	Miles x Rate	Depreciation
2001	14,100 × .15	$2,115
2002	16,300 × .15	2,445
2003	15,600 × .16	2,496
2004	16,700 × .16	2,672
2005	15,100 × .17	2,567
2006	14,900 × .17	2,533
Total depreciation		$14,828

At the end of 2006, your adjusted basis in the car is $7,672 ($22,500 - $14,828).

Depreciation deduction for the year of disposition. If you deduct actual car expenses and you dispose of your car before the end of its recovery period, you are allowed a reduced depreciation deduction for the year of disposition.

To figure the reduced depreciation deduction for a car disposed of in 2006, first determine the depreciation deduction for the full year using Table 4-1.

If you used a Date Placed in Service line for Jan. 1—Sept. 30, you can deduct one-half of the depreciation amount figured for the full year. Figure your depreciation deduction for the full year using the rules explained in this chapter and deduct 50% of that amount with your other actual car expenses.

If you used a Date Placed in Service line for Oct. 1—Dec. 31, you can deduct a percentage of the depreciation amount figured for the full year. The percentage you use is determined by the month you disposed of the car. Figure your depreciation deduction for the full year using the rules explained in this chapter and multiply the result by the percentage from the following table for the month that you disposed of the car.

Month	Percentage
Jan., Feb., March	12.5%
April, May, June	37.5%
July, Aug., Sept.	62.5%
Oct., Nov., Dec.	87.5%

Do not use this table if you are a fiscal year filer. See Sale or Other Disposition Before the Recovery Period Ends in chapter 4 of Publication 946.

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