Publication 946
How To Depreciate Property

Section 179 Deduction; Special Depreciation Allowance; MACRS Listed Property

For use in preparing 2002 Returns

4. Figuring Depreciation Under MACRS

Introduction

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? in chapter 1.

This chapter explains how to determine which MACRS depreciation system applies to your property. It also discusses other information you need to know before you can figure depreciation under MACRS. This information includes the property's recovery class, placed-in-service date, and basis, as well as the applicable recovery period, convention, and depreciation method. It explains how to use this information to figure your depreciation deduction and how to use a general asset account to depreciate a group of properties. Finally, it explains when and how to recapture MACRS depreciation.

Useful Items

You may want to see:

Publication

• 225   Farmer's Tax Guide
• 463   Travel, Entertainment, Gift, and Car
  Expenses
• 544   Sales and Other Dispositions of Assets
• 551   Basis of Assets
• 587   Business Use of Your Home (Including Use by Day-Care Providers)

Form (and Instructions)

• 2106   Employee Business Expenses
• 2106-EZ   Unreimbursed Employee Business Expenses
• 4562   Depreciation and Amortization

See chapter 7 for information about getting publications and forms.

Which Depreciation System (GDS or ADS) Applies?

• Listed property
• Nonresidential real property
• Placed in service
• Property class
• Recovery period
• Residential rental property
• Tangible property
• Tax exempt

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 it.

Required use of ADS.   You must use ADS for the following property.

• Listed property used 50% or less for business. (See chapter 5 for information on listed property.)
• Any tangible property used predominantly outside the United States during the year.
• Any tax-exempt use property.
• Any tax-exempt bond-financed 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.
• Any imported property covered by an executive order of the President of the United States.

If you are required to use ADS to depreciate your property, you cannot claim the special depreciation allowance or Liberty Zone depreciation allowance (discussed in chapter 3) for the property.

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 that 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?

• Class life
• Nonresidential real property
• Placed in service
• Property class
• Recovery period
• Residential rental property
• Section 1250 property
•  

The following is a list of the nine property classes under GDS and examples of the types of property included in each class.

1. 3-year property.
   1. Tractor units for over-the-road use.
   2. Any race horse over 2 years old when placed in service.
   3. Any other horse over 12 years old when placed in service.
   4. Qualified rent-to-own property (defined later).
2. 5-year property.
   1. Automobiles, taxis, buses, and trucks.
   2. Computers and peripheral equipment.
   3. Office machinery (such as typewriters, calculators, and copiers).
   4. Any property used in research and experimentation.
   5. Breeding cattle and dairy cattle.
   6. Appliances, carpets, furniture, etc., used in a residential rental real estate activity.
   7. Any qualified Liberty Zone leasehold improvement property (see Qualified New York Liberty Zone leasehold improvement property under Excepted Property in chapter 3).
3. 7-year property.
   1. Office furniture and fixtures (such as desks, files, and safes).
   2. Agricultural machinery and equipment.
   3. Any property that does not have a class life and has not been designated by law as being in any other class.
4. 10-year property.
   1. Vessels, barges, tugs, and similar water transportation equipment.
   2. Any single purpose agricultural or horticultural structure.
   3. Any tree or vine bearing fruits or nuts.
5. 15-year property.
   1. Certain improvements made directly to land or added to it (such as shrubbery, fences, roads, and bridges).
   2. Any retail motor fuels outlet (defined later), such as a convenience store.
   3. Any municipal wastewater treatment plant.
6. 20-year property. This class includes farm buildings (other than single purpose agricultural or horticultural structures).
7. 25-year property. This class is water utility property, which is either of the following.
   1. Property that is an integral part of the gathering, treatment, or commercial distribution of water, and that, without regard to this provision, would be 20-year property.
   2. Any municipal sewer.
8. Residential rental property. This is any building or structure, such as a rental home (including a mobile home), if 80% or more of its gross rental income for the tax year is from dwelling units. A dwelling unit is a house or apartment used to provide living accommodations in a building or structure. It does not include a unit in a hotel, motel, or other establishment where more than half the units are used on a transient basis. If you occupy any part of the building or structure for personal use, its gross rental income includes the fair rental value of the part you occupy.
9. Nonresidential real property. This is section 1250 property, such as an office building, store, or warehouse, that is neither residential rental property nor property with a class life of less than 27.5 years.

If your property is not listed above, you can determine its property class from the Table of Class Lives and Recovery Periods in Appendix B. The property class is generally the same as the GDS recovery period indicated in the table.

Qualified rent-to-own property.   Qualified rent-to-own property is property held by a rent-to-own dealer for purposes of being subject to a rent-to-own contract. It is tangible personal property generally used in the home for personal use. It includes computers and peripheral equipment, televisions, videocassette recorders, stereos, camcorders, appliances, furniture, washing machines and dryers, refrigerators, and other similar consumer durable property. Consumer durable property does not include real property, aircraft, boats, motor vehicles, or trailers.

If some of the property you rent to others under a rent-to-own agreement is of a type that may be used by the renters for either personal or business purposes, you still can treat this property as qualified property as long as it does not represent a significant portion of your leasing property. However, if this dual-use property does represent a significant portion of your leasing property, you must prove that this property is qualified rent-to-own property.

Rent-to-own dealer.   You are a rent-to-own dealer if you meet all the following requirements.

• You regularly enter into rent-to-own contracts in the ordinary course of your business.
• A substantial portion of these contracts end with the customer returning the property before making all the payments required to transfer ownership.
• The property is tangible personal property of a type generally used within the home for personal use.

Rent-to-own contract.   This is any lease for the use of consumer property between a rent-to-own dealer and a customer who is an individual. The lease contract must meet all the following requirements.

• Be titled Rent-to-Own Agreement, Lease Agreement with Ownership Option, or other similar language.
• Provide a beginning date and a maximum period of time, not to exceed 156 weeks or 36 months from the beginning date, for which the contract can be in effect (including renewals or options to extend).
• Provide for regular periodic (weekly or monthly) payments that can be either level or decreasing. If the payments are decreasing, no payment can be less than 40 percent of the largest payment.
• Provide for total payments that generally exceed the normal retail price of the property plus interest.
• Provide for total payments that do not exceed $10,000 for each item of property.
• Provide that the customer has no legal obligation to make all payments outlined in the contract and that, at the end of each weekly or monthly payment period, the customer can either continue to use the property by making the next payment or return the property in good working order with no further obligations and no entitlement to a return of any prior payments.
• Provide that legal title to the property remains with the rent-to-own dealer until the customer makes either all the required payments or the early purchase payments required under the contract to acquire legal title.
• Provide that the customer has no right to sell, sublease, mortgage, pawn, pledge, or otherwise dispose of the property until all contract payments have been made.

Retail motor fuels outlet.   Real property is a retail motor fuels outlet if it is used to a substantial extent in the retail marketing of petroleum or petroleum products (whether or not it is also used to sell food or other convenience items) and meets any one of the following three tests.

• It is not larger than 1,400 square feet.
• 50% or more of the gross revenues generated from the property are derived from petroleum sales.
• 50% or more of the floor space in the property is devoted to petroleum marketing sales.

A retail motor fuels outlet does not include any facility related to petroleum and natural gas trunk pipelines.

What Is the Placed-in-Service Date?

• Placed in service
•  

You begin to claim depreciation when your property is placed in service for either use in a trade or business or 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? in chapter 1 for examples illustrating when property is placed in service.

What Is the Basis for Depreciation?

• Basis
•  

The basis for depreciation of MACRS property is the property's cost or other basis multiplied by the percentage of business/investment use. (For a discussion of business/investment use, see Partial business or investment use under Property Used in Your Business or Income-Producing Activity in chapter 1.) 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 or Liberty Zone depreciation allowance.

For information about how to determine the cost or other basis of property, see What Is the Basis of Your Depreciable Property? in chapter 1.

Which Recovery Period Applies?

• Active conduct of a trade or business
• Basis
• Improvement
• Listed property
• Nonresidential real property
• Placed in service
• Property class
• Recovery period
• Residential rental property
• Section 1245 property
•  

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 Under GDS

Under GDS, property that is not qualified Indian reservation property is depreciated over one of the following recovery periods.

The GDS recovery periods for property not listed above can be found in Appendix B, Table of Class Lives and Recovery Periods. Residential rental property and nonresidential real property are defined earlier under Which Property Class Applies Under GDS.

Office in the home.   If you begin to use part of your home as an office, depreciate that part of your home as nonresidential real property over 39 years (31.5 years if you began using it for business before May 13, 1993). See Publication 587 for a discussion of the tests you must meet to claim expenses, including depreciation, for the business use of your home.

Home changed to rental use.   If you begin to rent a home that was your personal home before 1987, you depreciate it as residential rental property over 27.5 years.

Indian Reservation Property

The recovery periods for qualified property you placed in service on an Indian reservation after 1993 and before 2005 are shorter than those listed earlier. The following table shows these shorter recovery periods.

Nonresidential real property is defined earlier under Which Property Class Applies Under GDS.

Qualified property.   Property eligible for the shorter recovery periods are 3-, 5-, 7-, 10-, 15-, and 20-year property and nonresidential real property. You must use this property predominantly in the active conduct of a trade or business within an Indian reservation. Real property you rent to others that is located on an Indian reservation is also eligible for the shorter recovery periods.

The following property is not qualified property.

1. Property used or located outside an Indian reservation on a regular basis, other than qualified infrastructure property.
2. Property acquired directly or indirectly from a related person.
3. Property placed in service for purposes of conducting or housing class I, II, or III gaming activities. (These activities are defined in section 4 of the Indian Regulatory Act (25 U.S.C. 2703).)
4. Any property you must depreciate under ADS. Determine whether property is qualified without regard to the election to use ADS and after applying the special rules for listed property not used predominantly for qualified business use (discussed in chapter 5).

Qualified infrastructure property.   Item (1) above does not apply to qualified infrastructure property located outside the reservation that is used to connect with qualified infrastructure property within the reservation. Qualified infrastructure property is property that meets all the following rules.

• It is qualified property, as defined earlier, except that it is outside the reservation.
• It benefits the tribal infrastructure.
• It is available to the general public.
• It is placed in service in connection with the active conduct of a trade or business within a reservation.

Infrastructure property includes, but is not limited to, roads, power lines, water systems, railroad spurs, and communications facilities.

Related person.   For purposes of item (2) above, see Related persons in the discussion on property owned or used in 1986 under Can You Use MACRS To Depreciate Your Property? in chapter 1 for a description of related persons.

Indian reservation.   The term Indian reservation means a reservation as defined in section 3(d) of the Indian Financing Act of 1974 (25 U.S.C. 1452(d)) or section 4(10) of the Indian Child Welfare Act of 1978 (25 U.S.C. 1903(10)). For a definition of the term former Indian reservations in Oklahoma as used in section 3(d) of the Indian Financing Act of 1974, see Notice 98-45 in Cumulative Bulletin 1998-2.

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