When Does Depreciation
Begin and End?
- Basis
- Exchange
- Placed in service
You begin to depreciate your property when you place it in service for use in your
trade or business or for the production of income. You stop depreciating property either
when you have fully recovered your cost or other basis or when you retire it from service,
whichever happens first.
Placed in Service
You place property in service when it is ready and available for a
specific use, whether in a business activity, an income-producing activity, a
tax-exempt activity, or a personal activity. Even if you are not using the property, it is
in service when it is ready and available for its specific use. If you place property in
service in a personal activity, you cannot claim depreciation. If you change the
property's use to use in a business or income-producing activity, you begin to depreciate
it at the time of the change.
Example 1. You bought a home and used it as your personal home
several years before you converted it to rental property. Although its specific use was
personal and no depreciation was allowable, you placed the home in service when you began
using it as your home. You can begin to claim depreciation in the year you converted it to
rental property because its use changed to an income-producing use at that time.
Example 2. You bought a planter for use in your farm business
late in the year after harvest was over. You begin to depreciate the planter that year
because it was ready and available for its specific use.
Example 3. Donald Steep bought a machine for his business. The
machine was delivered last year. However, it was not installed and operational until this
year. It is considered placed in service this year. If the machine had been ready and
available for use when it was delivered, it would be considered placed in service last
year even if it was not actually used until this year.
Example 4. On April 6, Sue Thorn bought a house to use as
residential rental property. She made several repairs and had it ready for rent on July 5.
At that time, she began to advertise it for rent in the local newspaper. The house is
considered placed in service in July when it was ready and available for rent. She can
begin to depreciate it in July.
Example 5. James Elm is a building contractor who specializes in
constructing office buildings. He bought a truck last year that had to be modified to lift
materials to second-story levels. The installation of the lifting equipment was completed
and James accepted delivery of the modified truck on January 10 of this year. The truck
was placed in service on January 10, the date it was ready and available to perform the
function for which it was bought.
Idle Property
Continue to claim a deduction for depreciation on property used in
your business or for the production of income even if it is temporarily idle. For
example, if you stop using a machine because there is a temporary lack of market for a
product made with that machine, continue to deduct depreciation on the machine.
Cost or Other Basis Fully Recovered
You stop depreciating property when you have fully recovered your cost or other basis.
You recover your basis when your section 179 and allowed or allowable depreciation
deductions equal your cost or investment in the property. See What Is the Basis of
Your Depreciable Property, later.
Retired From Service
You stop depreciating property when you retire it from service, even
if you have not fully recovered its cost or other basis. You retire property from
service when you permanently withdraw it from use in a trade or business or from use in
the production of income because of any of the following events.
- You sell or exchange the property.
- You convert the property to personal use.
- You abandon the property.
- You transfer the property to a supplies or scrap account.
- The property is destroyed.
Can You Use MACRS To Depreciate Your Property?
- Adjusted basis
- Basis
- Convention
- Exchange
- Fiduciary
- Grantor
- Intangible property
- Nonresidential real property
- Placed in service
- Related persons
- Residential rental property
- Salvage value
- Section 1245 property
- Section 1250 property
- Standard mileage rate
- Straight line method
- Unit-of-production method
- Useful life
You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most
property. MACRS is explained in chapter 4.
The following discussions describe the types of property that cannot be depreciated
using MACRS and explain what depreciation method should be used instead. You cannot
use MACRS to depreciate the following property.
- Property you placed in service before 1987.
- Certain property owned or used in 1986.
- Intangible property.
- Films, video tapes, and recordings.
- Certain corporate or partnership property acquired in a nontaxable transfer.
- Property you elected to exclude from MACRS.
If your property is not described in the above list, figure the depreciation using
MACRS. See chapter 4 for information.
Property You Placed in Service
Before 1987
You cannot use MACRS for property you placed in service before 1987
(except property you placed in service after July 31, 1986, if MACRS was elected).
Property placed in service before 1987 must be depreciated under the methods discussed in
Publication 534.
For a discussion of when property is placed in service, see When Does Depreciation
Begin and End, earlier.
Use of real property changed. You generally must use MACRS to
depreciate real property that you acquired for personal use before 1987 and changed to
business or income-producing use after 1986.
Improvements made after 1986. You must treat an improvement made
after 1986 to property you placed in service before 1987 as separate depreciable property.
Therefore, you can depreciate that improvement as separate property under MACRS if it is
the type of property that otherwise qualifies for MACRS depreciation. For more information
about improvements, see How Do You Treat Improvements, later in this chapter, and
Additions and Improvements under Which Recovery Period Applies? in
chapter 4.
Property Owned or Used in 1986
You may not be able to use MACRS for property you acquired and placed in service after
1986 if any of the situations described in the following discussions apply. If you cannot
use MACRS, the property must be depreciated under the methods discussed in Publication
534.
 For the
following discussions, do not treat property as owned before you placed it in service. If
you owned property in 1986 but did not place it in service until 1987, you do not treat it
as owned in 1986.
Personal property. You cannot
use MACRS for personal property (section 1245 property) in any of the following
situations.
- You or someone related to you owned or used the property in 1986.
- You acquired the property from a person who owned it in 1986 and as part of the
transaction the user of the property did not change.
- You lease the property to a person (or someone related to this person) who owned or used
the property in 1986.
- You acquired the property in a transaction in which:
- The user of the property did not change, and
- The property was not MACRS property in the hands of the person from whom you acquired it
because of (2) or (3).
Real property. You generally
cannot use MACRS for real property (section 1250 property) in any of the following
situations.
- You or someone related to you owned the property in 1986.
- You lease the property to a person who owned the property in 1986 (or someone related to
that person).
- You acquired the property in a like-kind exchange, involuntary conversion, or
repossession of property you or someone related to you owned in 1986. MACRS applies only
to that part of your basis in the acquired property that represents cash paid or unlike
property given up. It does not apply to the carried-over part of the basis.
Exceptions. These rules do not apply to the following.
- Residential rental property or nonresidential real property.
- Any property if, in the first tax year it is placed in service, the deduction under the
Accelerated Cost Recovery System (ACRS) is more than the deduction under MACRS using the
half-year convention. (For information on how to figure depreciation under ACRS, see
Publication 534.)
- Property that was MACRS property in the hands of the person from whom you acquired it
because of (2).
Example. On March 3, 2002, you bought a machine from your
father, who had bought and placed it in service on November 1, 1986. You used it only for
business in 2002. Your father owned and used the machinery in 1986, so it does not qualify
for MACRS unless the deduction under ACRS is more than the deduction under MACRS. Your
deduction under ACRS would be $150. Your deduction under MACRS would be $142.90. The
deduction for the machinery under ACRS is more than that under MACRS, so you must use
MACRS.
Related persons. For this
purpose, the following are related persons.
- An individual and a member of his or her family, including only a spouse, child, parent,
brother, sister, half-brother, half-sister, ancestor, and lineal descendant.
- A corporation and an individual who directly or indirectly owns more than 10% of the
value of the outstanding stock of that corporation.
- Two corporations that are members of the same controlled group.
- A trust fiduciary and a corporation if more than 10% of the value of the outstanding
stock is directly or indirectly owned by or for the trust or grantor of the trust.
- The grantor and fiduciary, and the fiduciary and beneficiary, of any trust.
- The fiduciaries of two different trusts, and the fiduciaries and beneficiaries of two
different trusts, if the same person is the grantor of both trusts.
- Certain educational and charitable organizations and any person (or, if that person is
an individual, a member of that person's family) who directly or indirectly controls the
organization.
- Two S corporations, and an S corporation and a regular corporation, if the same persons
own more than 10% of the value of the outstanding stock of each corporation.
- A corporation and a partnership if the same persons own both of the following.
- More than 10% of the value of the outstanding stock of the corporation.
- More than 10% of the capital or profits interest in the partnership.
- The executor and beneficiary of any estate.
- A partnership and a person who directly or indirectly owns more than 10% of the capital
or profits interest in the partnership.
- Two partnerships, if the same persons directly or indirectly own more than 10% of the
capital or profits interest in each.
- The related person and a person who is engaged in trades or businesses under common
control. (See section 52(a) and 52(b) of the Internal Revenue Code.)
When to determine relationship. You must determine whether
you are related to another person at the time you acquire the property.
A partnership acquiring property from a terminating partnership must determine whether
it is related to the terminating partnership immediately before the event causing the
termination. For this rule, a terminating partnership is one that sells or exchanges,
within 12 months, 50% or more of its total interest in partnership capital or profits.
Ownership of stock or partnership interest.
To determine whether a person directly or indirectly owns any of the
outstanding stock of a corporation or an interest in a partnership, apply the
following rules.
- Stock or a partnership interest directly or indirectly owned by or for a corporation,
partnership, estate, or trust is considered owned proportionately by or for its
shareholders, partners, or beneficiaries. However, for a partnership interest owned by or
for a C corporation, this applies only to shareholders who directly or indirectly own 5%
or more of the value of the stock of the corporation.
- An individual is considered to own the stock or partnership interest directly or
indirectly owned by or for the individual's family.
- An individual who owns, except by applying rule (2), any stock in a corporation is
considered to own the stock directly or indirectly owned by or for the individual's
partner.
- For purposes of rules (1), (2), or (3), stock or a partnership interest considered to be
owned by a person under rule (1) is treated as actually owned by that person. However,
stock or a partnership interest considered to be owned by an individual under rule (2) or
(3) is not treated as owned by that individual for reapplying either rule (2) or (3) to
make another person considered to be the owner of the same stock or partnership interest.
Intangible Property
Generally, if you can depreciate intangible property, you usually use
the straight line method of depreciation. However, you can choose to depreciate
certain intangible property under the income forecast method.
You cannot
depreciate intangible property that is a section 197 intangible or that otherwise does not
meet all the requirements discussed earlier under What Property Can Be Depreciated.
Straight Line Method
This method lets you deduct the same amount of depreciation each year over the useful
life of the property. To figure your deduction, first determine the adjusted basis,
salvage value, and estimated useful life of your property. Subtract the salvage value, if
any, from the adjusted basis. The balance is the total depreciation you can take over the
useful life of the property.
Divide the balance by the number of years in the useful life. This gives you your
yearly depreciation deduction. Unless there is a big change in adjusted basis or useful
life, this amount will stay the same throughout the time you depreciate the property. If,
in the first year, you use the property for less than a full year, you must prorate your
depreciation deduction for the number of months in use.
Example. In April, Frank bought a patent for $5,100. It was not
acquired in connection with the acquisition of any part of a trade or business. He
depreciates the patent under the straight line method, using a 17-year useful life and no
salvage value. He divides the $5,100 basis by 17 years to get his $300 yearly depreciation
deduction. He only used the patent for 9 months during the year, so he multiplies $300 by 9/12 to get his deduction of $225. Next year, Frank can deduct $300 for
the full year.
Patents and copyrights. If you
can depreciate the cost of a patent or copyright, you can use the straight line method
over the useful life. The useful life of a patent or copyright is the lesser of the
life granted to it by the government or the remaining life when you acquire it. However,
if the patent or copyright becomes valueless before the end of its useful life, you can
deduct in that year any of its remaining cost or other basis.
Computer software. If you can
depreciate the cost of computer software, you can use the straight line method over a
useful life of 36 months.
Income Forecast Method
You can choose to use the income forecast method instead of the
straight line method to depreciate the following depreciable intangibles.
- Motion picture films or video tapes.
- Sound recordings.
- Copyrights.
- Books.
- Patents.
Under the income forecast method, each year's depreciation deduction is equal to the
cost, less salvage value, of the property, multiplied by a fraction. The numerator of the
fraction is the current year's net income from the property, and the denominator is the
total income anticipated from the property through the end of the 10th taxable year
following the taxable year the property is placed in service. For more information, see
section 167(g) of the Internal Revenue Code.
Films, Video Tapes, and Recordings
You cannot use MACRS for motion picture films, video tapes, and sound
recordings. For this purpose, sound recordings are discs, tapes, or other
phonorecordings resulting from the fixation of a series of sounds. You can depreciate this
property under the straight line method or the income forecast method (both discussed
earlier under Intangible Property).
Videocassettes. If you are in the business of renting
videocassettes, you can depreciate only those videocassettes bought for rental. If the
videocassette has a useful life of one year or less, you can deduct the cost as a business
expense.
Corporate or Partnership Property Acquired in a Nontaxable Transfer
MACRS does not apply to property used before 1987 and transferred after 1986 to a
corporation or partnership (except property the transferor placed in service after July
31, 1986, if MACRS was elected) to the extent its basis is carried over from the
property's adjusted basis in the transferor's hands. You must continue to use the same
depreciation method as the transferor and figure depreciation as if the transfer had not
occurred. However, if MACRS would otherwise apply, you can use it to depreciate the part
of the property's basis that exceeds the carried-over basis.
The nontaxable transfers covered by this rule include the following.
- A distribution in complete liquidation of a subsidiary.
- A transfer to a corporation controlled by the transferor.
- An exchange of property solely for corporate stock or securities in a reorganization.
- A contribution of property to a partnership in exchange for a partnership interest.
- A partnership distribution of property to a partner.
Election To Exclude Property
From MACRS
If you can properly depreciate any property under a method not based
on a term of years, such as the unit-of-production method, you can elect to exclude
that property from MACRS. You make the election by reporting your depreciation for the
property on line 15 in Part II of Form 4562 and attaching a statement as described in the
instructions for Form 4562. You must make this election by the return due date (including
extensions) for the tax year you place your property in service. However, if you timely
filed your return for the year without making the election, you can still make the
election by filing an amended return within six months of the due date of the return
(excluding extensions). Attach the election to the amended return and write Filed
pursuant to section 301.9100-2 on the election statement. File the amended return at
the same address you filed the original return.
Use of standard mileage rate. If you use the standard mileage rate
to figure your tax deduction for your business automobile, you are treated as having made
an election to exclude the automobile from MACRS. See Publication 463 for a discussion of
the standard mileage rate.
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