Publication 946
How To Depreciate Property

Section 179 Deduction; Special Depreciation Allowance; MACRS Listed Property

For use in preparing 2002 Returns

Recovery Periods Under ADS

The recovery periods for most property generally are longer under ADS than they are under GDS. The following table shows some of the ADS recovery periods.

The ADS recovery periods for property not listed above can be found in the tables in Appendix B. Rent-to-own property, residential rental property, and nonresidential real property are defined earlier under Which Property Class Applies Under GDS.

Additions and Improvements

An addition or improvement you make to depreciable property is treated as separate depreciable property. (See How Do You Treat Improvements? in chapter 1.) Its property class and recovery period are the same as those that would apply to the original property if you had placed it in service at the same time you placed the addition or improvement in service. The recovery period begins on the later of the following dates.

• The date you place the addition or improvement in service.
• The date you place in service the property to which you made the addition or improvement.

Example.   You own a rental home that you have been renting out since 1981. If you put an addition on the home and place the addition in service this year, you would use MACRS to figure your depreciation deduction for the addition. Under GDS, the property class for the addition is residential rental property and its recovery period is 27.5 years because the home to which the addition is made would be residential rental property if you had placed it in service this year.

Which Convention Applies?

• Basis
• Convention
• Disposition
• Nonresidential real property
• Placed in service
• Recovery period
• Residential rental property

Under MACRS, averaging conventions establish when the recovery period begins and ends. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property.

The mid-month convention.   Use this convention for all nonresidential real property and residential rental property.

Under this convention, you treat all property placed in service or disposed of during a month as placed in service or disposed of at the midpoint of the month. This means that a one-half month of depreciation is allowed for the month the property is placed in service or disposed of.

The mid-quarter convention.   Use this convention if the mid-month convention does not apply and the total depreciable bases of MACRS property you placed in service during the last three months of the tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) are more than 40% of the total depreciable bases of all MACRS property you placed in service during the entire year.

Under this convention, you treat all property placed in service or disposed of during any quarter of the tax year as placed in service or disposed of at the midpoint of that quarter. This means that 1½ months of depreciation is allowed for the quarter the property is placed in service or disposed of.

The half-year convention.   Use this convention if neither the mid-quarter convention nor the mid-month convention applies.

Under this convention, you treat all property placed in service or disposed of during a tax year as placed in service or disposed of at the midpoint of the year. This means that a one-half year of depreciation is allowed for the year the property is placed in service or disposed of.

Which Depreciation Method Applies?

• Declining balance method
• Listed property
• Nonresidential real property
• Placed in service
• Property class
• Recovery period
• Residential rental property
• Straight line method
• Tax exempt

MACRS provides three depreciation methods under GDS and one depreciation method under ADS.

• The 200% declining balance method over a GDS recovery period.
• The 150% declining balance method over a GDS recovery period.
• The straight line method over a GDS recovery period.
• The straight line method over an ADS recovery period.

For property placed in service before 1999, you could have elected the 150% declining balance method using the ADS recovery periods for certain property classes. If you made this election, continue to use the same method and recovery period for that property.

Table 4-1 lists the types of property you can depreciate under each method. It also give a brief explanation of the method.

Depreciation Methods for Farm Property

If you place personal property in service in a farming business after 1988, you can depreciate it under GDS using any method other than the 200% declining balance method. You can depreciate real property using the straight line method under either GDS or ADS.

Farming business.   A farming business is any trade or business involving cultivating land or raising or harvesting any agricultural or horticultural commodity. A farming business includes the following.

• Operating a nursery or sod farm.
• Raising or harvesting crops.
• Raising or harvesting trees bearing fruit, nuts, or other crops.
• Raising ornamental trees. An evergreen tree is not an ornamental tree if it is more than 6 years old when it is severed from its roots.
• Raising, shearing, feeding, caring for, training, and managing animals.

Processing activities.   In general, a farming business includes processing activities that are normally part of the growing, raising, or harvesting of agricultural products. However, a farming business generally does not include the processing of commodities or products beyond those activities that are normally part of the growing, raising, or harvesting of such products.

Fruit or nut trees and vines.   Depreciate trees and vines bearing fruit or nuts under GDS using the straight line method over a recovery period of 10 years.

ADS required for some farmers.   If you elect not to apply the uniform capitalization rules to any plant produced in your farming business, you must use ADS. You must use ADS for all property you place in service in any year the election is in effect. See the regulations under section 263A of the Internal Revenue Code for information on the uniform capitalization rules that apply to farm property.

Electing a Different Method

As shown in Table 4-1, you can elect a different method for depreciation for certain types of property. You must make the election by the due date of the return (including extensions) for the year you placed 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 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. Once you make the election, you cannot change it.

If you elect to use a different method for one item in a property class, you must apply the same method to all property in that class placed in service in the year of the election. However, you can make the election on a property-by-property basis for nonresidential real and residential rental property.

150% election.   Instead of using the 200% declining balance method over the GDS recovery period for nonfarm property in the 3-, 5-, 7-, and 10-year property classes, you can elect to use the 150% declining balance method. Make the election by entering 150 DB under column (f) in Part III of Form 4562.

Straight line election.   Instead of using either the 200% or 150% declining balance methods over the GDS recovery period, you can elect to use the straight line method over the GDS recovery period. Make the election by entering S/L under column (f) in Part III of Form 4562.

Election of ADS.   As explained earlier under Which Depreciation System (GDS or ADS) Applies, you can elect to use ADS even though your property may come under GDS. ADS uses the straight line method of depreciation over fixed ADS recovery periods. Most ADS recovery periods are listed in Appendix B, or see the table under Recovery Periods Under ADS, earlier.

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

Farm property.   Instead of using the 150% declining balance rate over a GDS recovery period for property you use in a farming business, you can elect to depreciate it using either of the following methods.

• The straight line method over a GDS recovery period.
• The straight line method over an ADS recovery period.

How Is the Depreciation Deduction Figured?

• Adjusted basis
• Amortization
• Basis
• Business/investment use
• Clean-fuel vehicle
• Clean-fuel vehicle refueling property
• Convention
• Declining balance method
• Disposition
• Exchange
• Nonresidential real property
• Placed in service
• Property class
• Recovery period
• Straight line method

To figure your depreciation deduction under MACRS, you first determine the depreciation system, property class, placed-in-service date, basis amount, recovery period, convention, and depreciation method that applies to your property. Then, you are ready to figure your depreciation deduction. You can figure it using a percentage table provided by the IRS, or you can figure it yourself without using the table.

Using the MACRS Percentage Tables

To help you figure your deduction under MACRS, the IRS has established percentage tables that incorporate the applicable convention and depreciation method. These percentage tables are in Appendix A near the end of this publication.

Which table to use.   Appendix A contains the MACRS Percentage Table Guide, which is designed to help you locate the correct percentage table to use for depreciating your property. The percentage tables immediately follow the guide.

Rules Covering the Use of the Tables

The following rules cover the use of the percentage tables.

1. You must apply the rates in the percentage tables to your property's unadjusted basis.
2. You cannot use the percentage tables for a short tax year. See Figuring the Deduction for a Short Tax Year, later, for information on figuring the deduction.
3. Once you start using the percentage tables for any item of property, you generally must continue to use them for the entire recovery period of the property.
4. You must stop using the tables if you adjust the basis of the property for any reason other than -
   1. Depreciation allowed or allowable, or
   2. An addition or improvement to that property that is depreciated as a separate item of property.

Basis adjustment due to recapture of clean-fuel vehicle deduction or credit.   If you increase the basis of your property because of the recapture of part or all of a deduction for clean-fuel vehicles or the credit for clean-fuel vehicle refueling property, you cannot continue to use the percentage tables. For the year of the adjustment and the remaining recovery period, you must figure the depreciation deduction yourself using the property's adjusted basis at the end of the year. See Figuring the Deduction Without Using the Tables, later.

Basis adjustment due to casualty loss.   If you reduce the basis of your property because of a casualty, you cannot continue to use the percentage tables. For the year of the adjustment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year. See Figuring the Deduction Without Using the Tables, later.

Example.   On October 26, 2001, Sandra Elm, a calendar year taxpayer, bought and placed in service in her business a new item of 7-year property. It cost $39,000 and she elected a section 179 deduction of $24,000. She also took a special depreciation allowance of $4,500 [30% of $15,000 ($39,000 - $24,000)]. Her unadjusted basis after the section 179 deduction and special depreciation allowance was $10,500 ($15,000 - $4,500). She figured her MACRS depreciation deduction using the percentage tables. For 2001, her MACRS depreciation deduction was $375.

In July 2002, the property was vandalized and Sandra had a deductible casualty loss of $3,000. She must adjust the property's basis for the casualty loss, so she can no longer use the percentage tables. Her adjusted basis at the end of 2002, before figuring her 2002 depreciation, is $7,125. She figures that amount by subtracting the 2001 MACRS depreciation of $375 and the casualty loss of $3,000 from the unadjusted basis of $10,500. She must now figure her depreciation for 2002 without using the percentage tables.

Figuring the Unadjusted Basis of
Your Property

You must apply the table rates to your property's unadjusted basis each year of the recovery period. Unadjusted basis is the same basis amount you would use to figure gain on a sale, but you figure it without reducing your original basis by any MACRS depreciation taken in earlier years. However, you do reduce your original basis by the following amounts.

• Any amortization taken on the property.
• Any section 179 deduction claimed.
• Any special depreciation allowance (or Liberty Zone depreciation allowance) taken on the property.
• Any deduction claimed for a clean-fuel vehicle or clean-fuel vehicle refueling property.
• Any electric vehicle credit. (This is the lesser of $4,000 or 10% of the cost of the vehicle, even if the credit is less than that amount.)

The clean-fuel vehicle and clean-fuel vehicle refueling property deductions and the electric vehicle credit are discussed in chapter 12 of Publication 535.

For business property you purchase during the year, the unadjusted basis is its cost minus these adjustments. If you trade property, your unadjusted basis in the property received is the cash paid plus the adjusted basis of the property traded minus these adjustments.

MACRS Worksheet

You can use this worksheet to help you figure your depreciation deduction using the percentage tables. (Use a separate worksheet for each item of property.) Then, use the information from this worksheet to prepare Form 4562.

Do not use this worksheet for automobiles. Use the Depreciation Worksheet for Passenger Automobiles in chapter 5.

The following example shows how to figure your MACRS depreciation deduction using the percentage tables and the MACRS worksheet.

Example.   You bought office furniture (7-year property) for $10,000 and placed it in service on August 11, 2002. You use the furniture only for business. This is the only property you placed in service this year. You did not elect a section 179 deduction and elected not to claim a special depreciation allowance. You use GDS and the half-year convention to figure your depreciation. You refer to the MACRS Percentage Table Guide in Appendix A and find that you should use Table A-1. You did not elect a section 179 deduction and elected not to claim a special depreciation allowance, so your property's unadjusted basis is its cost, $10,000. Multiply your property's unadjusted basis each year by the percentage for 7-year property given in Table A-1. You figure your depreciation deduction using the MACRS worksheet as follows.