Publication 946
How To Depreciate Property

Section 179 Deduction; Special Depreciation Allowance; MACRS Listed Property

For use in preparing 2002 Returns

How Do You Use General Asset Accounts?

• Adjusted basis
• Amortization
• Amount realized
• Basis
• Clean-fuel vehicle
• Clean-fuel vehicle refueling property
• Convention
• Disposition
• Exchange
• Placed in service
• Recovery period
• Section 1245 property
• Unadjusted basis

To make it easier to figure MACRS depreciation, you can group separate properties into one or more general asset accounts (GAAs). You then can depreciate all the properties in each account as a single item of property.

Property you cannot include.   You cannot include property in a GAA if you use it in both a personal activity and a trade or business (or for the production of income) in the year in which you first place it in service. If property you included in a GAA is later used in a personal activity, see Terminating GAA Treatment, later.

Property generating foreign source income.   For information on the GAA treatment of property that generates foreign source income, see section 1.168(i)-1(f) of the regulations.

Grouping Property

Each GAA must include only property you placed in service in the same year and that has the following in common.

• Asset class, if any.
• Recovery period.
• Depreciation method.
• Convention.

The following rules also apply when you establish a GAA.

• No asset class. Properties without an asset class, but with the same depreciation method, recovery period, and convention, can be grouped into the same GAA.
• Mid-quarter convention. Property subject to the mid-quarter convention can only be grouped into a GAA with property placed in service in the same quarter.
• Mid-month convention. Property subject to the mid-month convention can only be grouped into a GAA with property placed in service in the same month.
• Passenger automobiles. Passenger automobiles subject to the limits on passenger automobile depreciation must be grouped into a separate GAA.

Figuring Depreciation for a GAA

After you have set up a GAA, you generally figure the MACRS depreciation for it by using the applicable depreciation method, recovery period, and convention for the property in the GAA. For each GAA, record the depreciation allowance in a separate depreciation reserve account.

Example.   Make & Sell, a calendar-year corporation, set up a GAA for ten machines. The machines cost a total of $10,000 and were placed in service in June 2002. One of the machines cost $8,200 and the rest cost a total of $1,800. This GAA is depreciated under the 200% declining balance method with a 5-year recovery period and a half-year convention. Make & Sell did not claim the section 179 deduction on the machines and elected not to claim a special depreciation allowance. The depreciation allowance for 2002 is $2,000 [($10,000 × 40%) ÷ 2]. As of January 1, 2003, the depreciation reserve account is $2,000.

Passenger automobiles.   To figure depreciation on passenger automobiles in a GAA, apply the deduction limits discussed in chapter 5 under Do the Passenger Automobile Limits Apply. Multiply the amount determined using these limits by the number of automobiles originally included in the account, reduced by the total number of automobiles removed from the GAA as discussed in Terminating GAA Treatment, later.

Disposing of GAA Property

When you dispose of property included in a GAA, the following rules generally apply.

• Neither the depreciable basis nor the depreciation reserve account of the GAA is affected. You continue to depreciate the account as if the disposition had not occurred.
• The property is treated as having an adjusted basis of zero, so you cannot realize a loss on the disposition. If the property is transferred to a supplies, scrap, or similar account, its basis in that account is zero.
• Any amount realized on the disposition is treated as ordinary income. (See Treatment of amount realized, later in this discussion.)

However, these rules do not apply to any disposition described later under Terminating GAA Treatment.

Disposition.   Property in a GAA is considered disposed of when you do any of the following.

• Permanently withdraw it from use in your trade or business or from the production of income.
• Transfer it to a supplies, scrap, or similar account.
• Sell, exchange, retire, physically abandon, or destroy it.

The retirement of a structural component of real property is not a disposition.

Treatment of amount realized.   When you dispose of property in a GAA, you must recognize any amount realized from the disposition as ordinary income, up to a limit. The limit is:

1. The unadjusted depreciable basis of the GAA plus
2. Any expensed costs for property in the GAA that are subject to recapture as depreciation (not including any expensed costs for property that you removed from the GAA under the rules discussed later under Terminating GAA Treatment), minus
3. Any amount previously recognized as ordinary income upon the disposition of other property from the GAA.

Unadjusted depreciable basis.   The unadjusted depreciable basis of a GAA is the total of the unadjusted depreciable bases of all the property in the GAA. The unadjusted depreciable basis of an item of property in a GAA is the amount you would use to figure gain or loss on its sale, but figured without reducing your original basis by any depreciation allowed or allowable in earlier years. However, you do reduce your original basis by any amortization deduction, section 179 deduction, deduction for a clean-fuel vehicle or clean-fuel vehicle refueling property, or electric vehicle credit.

Expensed costs.   Expensed costs that are subject to recapture as depreciation include the following.

1. The section 179 deduction.
2. The deduction for clean-fuel vehicles or clean-fuel vehicle refueling property.
3. Amortization deductions for the following.
   1. Pollution control facilities.
   2. Removal of barriers for the elderly and disabled.
   3. Tertiary injectants.
   4. Reforestation expenses.

Example 1.   The facts are the same as in the example under Figuring Depreciation for a GAA, earlier. In February 2003, Make & Sell sells the machine that cost $8,200 to an unrelated person for $9,000. The machine is treated as having an adjusted basis of zero.

The unadjusted depreciable basis and depreciation reserve of the GAA are not affected by the sale of the machine. The depreciation allowance for the GAA in 2003 is $3,200 [($10,000 - $2,000) × 40%].

Example 2.   Assume the same facts as in Example 1. In June 2004, Make & Sell sells seven machines to an unrelated person for a total of $1,100. These machines are treated as having an adjusted basis of zero.

On its 2004 tax return, Make & Sell recognizes $1,000 as ordinary income. This is the GAA's unadjusted depreciable basis ($10,000) plus the expensed costs ($0), minus the amount previously recognized as ordinary income ($9,000). The remaining amount realized of $100 ($1,100 - $1,000) is section 1231 gain (discussed in chapter 3 of Publication 544).

The unadjusted depreciable basis and depreciation reserve of the GAA are not affected by the disposition of the machines. The depreciation allowance for the GAA in 2004 is $1,920 [($10,000 - $5,200) × 40%].

Terminating GAA Treatment

You must remove the following property from a GAA.

• Property you dispose of in a nonrecognition transaction or an abusive transaction.
• Property you dispose of in a qualifying disposition or in a disposition of all the property in the GAA, if you choose to terminate GAA treatment.
• Property you change to personal use.
• Property for which you must recapture the investment credit, the credit for qualified electric vehicles, the section 179 deduction, or the deduction for clean-fuel vehicles and clean-fuel vehicle refueling property.

If you remove property from a GAA, you must make the following adjustments.

1. Reduce the unadjusted depreciable basis of the GAA by the unadjusted depreciable basis of the property as of the first day of the tax year in which the disposition, change in use, or recapture event occurs. (You can use any reasonable method that is consistently applied to determine the unadjusted depreciable basis of the property you remove from a GAA.)
2. Reduce the depreciation reserve account by the depreciation allowed or allowable for the property (computed in the same way as computed for the GAA) as of the end of the tax year immediately preceding the year in which the disposition, change in use, or recapture event occurs.

These adjustments have no effect on the recognition and character of prior dispositions subject to the rules discussed earlier under Disposing of GAA Property.

Nonrecognition transactions.   If you dispose of GAA property in a nonrecognition transaction, you must remove it from the GAA. The following are nonrecognition transactions.

• The distribution to one corporation of property in complete liquidation of another corporation.
• The transfer of property to a corporation solely in exchange for stock in that corporation if the transferor is in control of the corporation immediately after the exchange.
• The transfer of property by a corporation that is a party to a reorganization in exchange solely for stock and securities in another corporation that is also a party to the reorganization.
• The contribution of property to a partnership in exchange for an interest in the partnership.
• The distribution of property (including money) from a partnership to a partner.
• Any transaction between members of the same affiliated group during any year for which the group makes a consolidated return.

Rules for recipient (transferee).   The recipient of the property (the person to whom it is transferred) must include your (the transferor's) adjusted basis in the property in a GAA. If you transferred either all of the property or the last item of property in a GAA, the recipient's basis in the property is the result of the following.

• The adjusted depreciable basis of the GAA as of the beginning of your tax year in which the transaction takes place, minus
• The depreciation allowable to you for the year of the transfer.

For this purpose, the adjusted depreciable basis of a GAA is the unadjusted depreciable basis of the GAA minus any depreciation allowed or allowable for the GAA.

Abusive transactions.   If you dispose of GAA property in an abusive transaction, you must remove it from the GAA. A disposition is an abusive transaction if it is not a nonrecognition transaction (described earlier) and a main purpose for the disposition is to get a tax benefit or a result that would not be available without the use of a GAA. Examples of abusive transactions include the following.

1. A transaction with a main purpose of shifting income or deductions among taxpayers in a way that would not be possible without choosing to use a GAA to take advantage of differing effective tax rates.
2. A choice to use a GAA with a main purpose of disposing of property from the GAA so that you can use an expiring net operating loss or credit. For example, if you have a net operating loss carryover or a credit carryover, the following transactions will be considered abusive transactions unless there is strong evidence to the contrary.
   1. A transfer of GAA property to a related person.
   2. A transfer of GAA property under an agreement where the property continues to be used, or is available for use, by you.

Figuring gain or loss.   You must determine the gain, loss, or other deduction due to an abusive transaction by taking into account the property's adjusted basis. The adjusted basis of the property at the time of the disposition is the result of the following:

• The unadjusted depreciable basis of the property, minus
• The depreciation allowed or allowable for the property figured by using the depreciation method, recovery period, and convention that applied to the GAA in which the property was included.

If there is a gain, the amount subject to recapture as ordinary income is the smaller of the following.

1. The depreciation allowed or allowable for the property, including any expensed cost (such as section 179 deductions or the additional depreciation allowed or allowable for the property).
2. The result of the following:
   1. The original unadjusted depreciable basis of the GAA (plus, for section 1245 property originally included in the GAA, any expensed cost), minus
   2. The total gain previously recognized as ordinary income on the disposition of property from the GAA.

Qualifying dispositions.   If you dispose of GAA property in a qualifying disposition, you can choose to remove the property from the GAA. A qualifying disposition is one that does not involve all the property, or the last item of property, remaining in a GAA and that is described below.

1. A disposition that is a direct result of fire, storm, shipwreck, other casualty, or theft.
2. A charitable contribution for which a deduction is allowed.
3. A disposition that is a direct result of a cessation, termination, or disposition of a business, manufacturing or other income producing process, operation, facility, plant, or other unit (other than by transfer to a supplies, scrap, or similar account).
4. A nontaxable transaction, such as a like-kind exchange or an involuntary conversion, other than a nonrecognition transaction (described earlier) or a transaction that is nontaxable only because it is a disposition from a GAA.

If you choose to remove the property from the GAA, figure your gain, loss, or other deduction resulting from the disposition in the manner described earlier under Abusive transactions.

Example.   Sankofa, a calendar-year corporation, maintains one GAA for 12 machines. Each machine costs $15,000 and was placed in service in 2002. Of the 12 machines, nine cost a total of $135,000 and are used in Sankofa's New York plant and three machines cost $45,000 and are used in Sankofa's New Jersey plant. Assume this GAA uses the 200% declining balance depreciation method, a 5-year recovery period, and a half-year convention. Sankofa does not claim the section 179 deduction and elects not to claim a special depreciation allowance for any of the machines. As of January 1, 2004, the depreciation reserve account for the GAA is $93,600.

For Sankofa's 2004 return, gain or loss for each of the three machines at the New Jersey plant is determined as follows. The depreciation allowed or allowable in 2004 for each machine is $1,440 [($15,000 - $7,800) × 40% ÷ 2]. The adjusted basis of each machine is $5,760 (the adjusted depreciable basis of $7,200 removed from the account less the $1,440 depreciation allowed or allowable in 2004). As a result, the loss recognized in 2004 for each machine is $760 ($5,000 - $5,760). This loss is subject to section 1231 treatment. See chapter 3 of Publication 544 for information on section 1231 losses.

Disposition of all property in a GAA.   If you dispose of all the property, or the last item of property, in a GAA, you can choose to end the GAA. If you make this choice, you figure the gain or loss by comparing the adjusted depreciable basis of the GAA with the amount realized.

If there is a gain, the amount subject to recapture as ordinary income is limited to the result of the following.

• The depreciation allowed or allowable for the GAA, including any expensed cost (such as section 179 deductions or the additional depreciation allowed or allowable for the GAA), minus
• The total gain previously recognized as ordinary income on the disposition of property from the GAA.

Example.   Duforcelf, a calendar-year corporation, maintains a GAA for 1,000 calculators that cost a total of $60,000 and were placed in service in 2002. Assume this GAA is depreciated under the 200% declining balance method, has a recovery period of 5 years, and uses a half-year convention. Duforcelf does not claim the section 179 deduction and elects not to claim a special depreciation allowance for the calculators. In 2003, Duforcelf sells 200 of the calculators to an unrelated person for $10,000. The $10,000 is recognized as ordinary income.

In March 2004, Duforcelf sells the remaining calculators in the GAA to an unrelated person for $35,000. Duforcelf decides to end the GAA.

On the date of the disposition, the adjusted depreciable basis of the account is $23,040 (unadjusted depreciable basis of $60,000 minus the depreciation allowed or allowable of $36,960). In 2004, Duforcelf recognizes a gain of $11,960. This is the amount realized of $35,000 minus the adjusted depreciable basis of $23,040. The gain subject to recapture as ordinary income is limited to the depreciation allowed or allowable minus the amounts previously recognized as ordinary income ($36,960 - $10,000 = $26,960). Therefore, the entire gain of $11,960 is recaptured as ordinary income.

Electing To Use a GAA

An election to include property in a GAA is made separately by each owner of the property. This means that an election to include property in a GAA must be made at the partnership or S corporation level and not by each partner or shareholder separately.

How to make the election.   Make the election by completing line 18 of Form 4562.

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

You must maintain records that identify the property included in each GAA, that establish the unadjusted depreciable basis and depreciation reserve of the GAA, and that reflect the amount realized during the year upon dispositions from each GAA. However, see chapter 2 for the recordkeeping requirements for section 179 property.

Revoking an election.   You can revoke an election to use a GAA only in the following situations.

• You include in the GAA property that generates foreign source income, both United States and foreign source income, or combined gross income of an FSC, a DISC, or a possessions corporation and its related supplier, and that inclusion results in a substantial distortion of income.
• You remove property from the GAA as described under Terminating GAA Treatment, earlier.

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