Cost Recovery

You can usually "recover" (subtract from income) your cost for capital expenses over a number of years. Each year a part of your basis is recovered through depreciation or amortization. Use depreciation to recover capital expenses for most tangible business assets. Use amortization to recover the cost of intangible assets, such as start-up costs. Amortization is discussed in chapter 9 of Publication 535.

Under certain circumstances, you may be able to recover a limited amount of the cost of qualifying property as a current expense by electing the "section 179 deduction" rather than recover the cost as a capital expense. The "section 179 deduction," is discussed next.

Form 4562. Generally, use Form 4562 to report depreciation, amortization, and the section 179 deduction. A filled-in Form 4562 is illustrated in an example in Publication 946.

Section 179 Deduction

You can elect to deduct all or part of the cost of certain qualifying property in the year you place it in service. Property is placed in service when it is first made ready and available for a specific use.

Qualifying property. Qualifying property includes tangible personal property for which depreciation is allowable. See chapter 2 in Publication 946 for more information.

Dollar limit. The total section 179 cost you can choose to deduct has increased for 2001. See Publication 553, Highlights of 2001 Tax Changes.

Taxable income limit. The total cost you can deduct each year after you apply the dollar limit is further limited to the taxable income from the active conduct of any trade or business during the year.

Any cost not deductible in one year because of this limit can be carried to the next tax year.

More information. For more information, see chapter 2 in Publication 946.

Depreciation

If you do not choose a section 179 deduction or you choose a section 179 deduction and do not recover all your cost, you can take a depreciation deduction for part or all of the cost you did not claim as a section 179 deduction.

Property whose cost can be recovered through depreciation is depreciable property. Depreciable property includes most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. Depreciable property also includes certain intangible property.

You can depreciate property if it meets the following requirements.

• It must be property you own.
• It is used in business or held for the production of income.
• It must have a determinable useful life. This means that it is something that wears out, decays, gets used up, becomes obsolete, or loses value from natural causes.
• It has a useful life that extends substantially beyond the year it is placed in service.

You must use the modified accelerated cost recovery system (MACRS) to depreciate most property placed in service after 1986.

For more information about the depreciation of property placed in service after 1986, see Publication 946. It contains a detailed discussion of MACRS.

For more information about property placed in service before 1987, see Publication 534, Depreciating Property Placed in Service Before 1987.

Listed Property

Listed property includes property which lends itself to personal use, such as property used for transportation, entertainment equipment, certain computers, and cellular phones. In addition, there are recordkeeping requirements and rules you must follow when depreciating listed property. If listed property is not used more than 50% for a qualified business purpose during any tax year, you cannot claim the section 179 deduction and special rules apply to the depreciation deduction. See chapter 4 in Publication 946.

Passenger automobiles. For most passenger automobiles, the total depreciation deduction (including the section 179 deduction) you can claim is limited.

For automobiles placed in service during 2001, your depreciation, including the section 179 deduction, cannot be more than $3,060. For 2002 and 2003, the maximum depreciation deduction for automobiles placed in service in 2001 is $4,900 and $2,950, respectively. The maximum depreciation deduction for each year after 2003 is $1,775.

If your business/investment use of the automobile is less than 100%, you must reduce the maximum deduction amount proportionately.

Example. Peter purchases a car this year for $4,500 and he uses it 60% for business. He chooses to take a section 179 deduction for the car. The cost of Peter's car that qualifies for the section 179 deduction is $2,700 ($4,500 × 60%). However, Peter's section 179 deduction is limited to $1,836 ($3,060 × 60%).