Publication 225
Farmer's Tax Guide

For use in preparing 2002 Returns

Acknowledgment:

The valuable advice and assistance given us each year by the National Farm Income Tax Extension Committee is gratefully acknowledged.

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 $200,000, 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 2002, Partnership P placed in service section 179 property with a total cost of $204,000. P must reduce its dollar limit by $4,000 ($204,000 - $200,000). Its maximum section 179 deduction is $20,000 ($24,000 - $4,000), 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 $20,000. P allocates $10,000 of its section 179 deduction and $15,000 of its taxable income to John, one of its partners.

John also conducts a business as a sole proprietor and in 2002, 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 2003.

How Do You Elect the Deduction?

You elect the section 179 deduction by completing Part I of Form 4562.

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

File Form 4562 with either of the following.

• Your original tax return filed for the year the property was placed in service (whether or not you filed it timely).
• An amended return filed by the due date (including extensions) for your return for the year the property was placed in service. (You cannot make an election for the section 179 deduction on an amended return filed after the due date (including extensions) of the original return.)

If you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). For more information, see the instructions for Part I of Form 4562.

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 11 under Section 1245 Property.
 

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

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

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

Example.   In 2000, 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. He used the property only for business in 2000 and 2001. During 2002, he used the property 40% for business and 60% for personal use. He figures his recapture amount as follows.

Paul must include $1,375 in income for 2002.

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

Claiming the Special Depreciation Allowance

You can take the special depreciation allowance to recover part of the cost of qualified property placed in service during the tax year. The allowance applies for the year you place the property in service. It is an additional 30% deduction you can take before you figure regular depreciation under MACRS for the year you place the property in service. This part of the chapter explains what is qualified property, how to figure the allowance, and how to elect not to claim it.

What Is Qualified Property?

You can take the special depreciation allowance for qualified property. Your property is qualified property if it meets the following requirements.

1. It is new property of one of the following types.
   1. Property depreciated under the modified accelerated cost recovery system (MACRS) with a recovery period of 20 years or less. See Can You Use MACRS To Depreciate Your Property, earlier, and Which Recovery Period Applies, later.
   2. Water utility property. See chapter 4 in Publication 946.
   3. Computer software that is not a section 197 intangible as described in Computer software under Section 197 intangibles, earlier. (The cost of some computer software is treated as part of the cost of hardware and is depreciated under MACRS.)
   4. Qualified leasehold improvement property (defined next).
2. It is property that meets the following tests (explained later under Tests To Be Met).
   1. Acquisition date test.
   2. Placed in service date test.
   3. Original use test.
3. It is not excepted property (explained later under Excepted Property).

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

• The improvement is made under or pursuant to a lease by the lessee (or any sublessee) or the lessor of that part of the building.
• That part of the building is to be occupied exclusively by the lessee (or any sublessee) of that part.
• The improvement is placed in service more than 3 years after the date the building was first placed in service.

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

• The enlargement of the building.
• Any elevator or escalator.
• Any structural component benefiting a common area.
• The internal structural framework of the building.

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

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

Tests To Be Met

To be qualified property, the property must meet all of the following tests.

Acquisition date test.   Generally, you must have acquired the property either:

• After September 10, 2001, and before September 11, 2004, but only if no written binding contract for the acquisition was in effect before September 11, 2001, or
• Pursuant to a written binding contract entered into after September 10, 2001, and before September 11, 2004.

Property you manufacture, construct, or produce for your own use meets this test if you began the manufacture, construction, or production of the property after September 10, 2001, and before September 11, 2004.

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

If you sold property you placed in service after September 10, 2001, and you leased it back within 3 months after the property was originally placed in service, the property is treated as placed in service no earlier than the date it is used under the leaseback.

Original use test.   The original use of the property must have begun with you after September 10, 2001. Original use means the first use to which the property is put, whether or not by you. Additional capital expenditures you incurred after September 10, 2001, to recondition or rebuild your property meet the original use test.

Excepted Property

Qualified property does not include any of the following.

• Property used by any person before September 11, 2001.
• Property required to be depreciated using ADS. This includes property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect.
• Qualified New York Liberty Zone leasehold improvement property (defined in chapter 3 of Publication 946).

How Much Can You Deduct?

The special depreciation allowance for qualified property is an additional deduction of 30% of the property's depreciable basis.

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

• Any section 179 deduction taken with respect to the property.
• Any deduction for removal of barriers to the disabled and the elderly with respect to the property.
• Any investment credit, disabled access credit, or enhanced oil recovery credit with respect to the property.

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

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

Example   On November 1, 2002, Tom Brown bought and placed in service in his business qualified property costing $100,000. He chooses to deduct $24,000 of the property's cost as a section 179 deduction. He uses the remaining $76,000 of cost to figure his special depreciation allowance of $22,800 ($76,000 × 30%). He uses the remaining $53,200 ($76,000 - $22,800) of cost to figure his regular MACRS depreciation deduction for 2002 and later years.

How Can You Elect Not To Claim the Allowance?

You can elect not to claim the special depreciation allowance for qualified property. If you make this election for any property, it applies to all property in the same property class placed in service during the year. To make this election, attach a statement to your return indicating you elect not to claim the allowance and the class of property for which you are making the election.

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

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

Figuring Depreciation Under MACRS

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

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

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

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

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

Which Depreciation System (GDS or ADS) Applies?

Your use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period you use. You generally must 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 for business. For information on listed property, see Additional Rules for Listed Property, later.
• Any tax-exempt use property.
• Any tax-exempt bond-financed property.
• Any imported property covered by an executive order of the President of the United States.
• Any tangible property used predominantly outside the United States during the year.

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

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

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

Which Property Class Applies Under GDS?

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

1. 3-year property.
2. 5-year property.
3. 7-year property.
4. 10-year property.
5. 15-year property.
6. 20-year property.
7. 25-year property.
8. Residential rental property.
9. Nonresidential real property.

See 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 investment credit, disabled access credit, or enhanced oil recovery credit.
• Any special depreciation allowance.

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

Which Recovery Period Applies?

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

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

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

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

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

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

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

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

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

- Continue -