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taxmap/pubs/p225-029.htm#TXMP68b5c81f Chapter 7 Depreciation, Depletion, and Amortization(p35)

Depreciation, Depletion, and Amortization

taxmap/pubs/p225-029.htm#TXMP702fbc36 What's New for 2007(p35)

taxmap/pubs/p225-029.htm#TXMP0fda3b85
Increased section 179 deduction dollar limits.(p35)

The maximum amount you can elect to deduct for most section 179 property you placed in service in 2007 is $125,000. This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $500,000. See Dollar Limits under Section 179 Deduction, later.

taxmap/pubs/p225-029.htm#TXMP503ee657 What's New for 2008(p35)

taxmap/pubs/p225-029.htm#TXMP3c962341
Extension of increased section 179 deduction.(p35)

If you own qualified section 179 GO Zone property acquired after August 27, 2005, and placed it in service before January 1, 2009, you may be eligible for an increased section 179 deduction.

taxmap/pubs/p225-029.htm#TXMP2c739211
Introduction

If you buy farm property such as machinery, equipment, livestock, or a structure with a useful life of more than a year, you generally cannot deduct its entire cost in one year. Instead, you must spread the cost over the time you use the property and deduct part of it each year. For most types of property, this is called depreciation.

This chapter gives information on depreciation methods that generally apply to property placed in service after 1986. For information on depreciating pre-1987 property, see Publication 534, Depreciating Property Placed in Service Before 1987.

To help you understand depreciation and how to complete Form 4562, Depreciation and Amortization, see the filled-in Form 4562 and related discussion in chapter 16.

Useful items

You may want to see:

See chapter 17 for information about getting publications and forms.

It is important to keep good records for property you depreciate. Do not file these records with your return. Instead, you should keep them as part of the permanent records of the depreciated property. They will help you verify the accuracy of the depreciation of assets placed in service in the current and previous tax years. For general information on recordkeeping, see Publication 583, Starting a Business and Keeping Records. For specific information on keeping records for section 179 property and listed property, see  Publication 946.

taxmap/pubs/p225-029.htm#TXMP1312ea34 Overview of Depreciation(p35)

Depreciation, Overview

This overview discusses basic information on the following.

• What property can be depreciated.
• What property cannot be depreciated.
• When depreciation begins and ends.
• Whether MACRS can be used to figure depreciation.
• What is the basis of your depreciable property.
• How to treat repairs and improvements.
• When you must file Form 4562.
• How you can correct depreciation claimed incorrectly.

taxmap/pubs/p225-029.htm#TXMP0cf83550 What Property Can  Be Depreciated?(p35)

What Property Can Be Depreciated?

You can depreciate most types of tangible property (except land), such as buildings, machinery, equipment, vehicles, certain livestock, and furniture. You can also depreciate certain intangible property, such as copyrights, patents, and computer software. To be depreciable, the property must meet all the following requirements.

• It must be property you own.
• It must be used in your business or income-producing activity.
• It must have a determinable useful life.
• It must have a useful life that extends substantially beyond the year you place it in service.

taxmap/pubs/p225-029.htm#TXMP6425e573 Property You Own(p35)

Property You Own

To claim depreciation, you usually must be the owner of the property. You are considered as owning property even if it is subject to a debt.

taxmap/pubs/p225-029.htm#TXMP7ee32e7f Leased property.(p35)

You can depreciate leased property only if you retain the incidents of ownership in the property. This means you bear the burden of exhaustion of the capital investment in the property. Therefore, if you lease property from someone to use in your trade or business or for the production of income, you generally cannot depreciate its cost because you do not retain the incidents of ownership. You can, however, depreciate any capital improvements you make to the leased property. See Additions and Improvements under Which Recovery Period Applies in chapter 4 of Publication 946.

If you lease property to someone, you generally can depreciate its cost even if the lessee (the person leasing from you) has agreed to preserve, replace, renew, and maintain the property. However, you cannot depreciate the cost of the property if the lease provides that the lessee is to maintain the property and return to you the same property or its equivalent in value at the expiration of the lease in as good condition and value as when leased.

taxmap/pubs/p225-029.htm#TXMP22086450 Life tenant.(p35)

Generally, if you hold business or investment property as a life tenant, you can depreciate it as if you were the absolute owner of the property. See Certain term interests in property, later for an exception.

taxmap/pubs/p225-029.htm#TXMP6baf78a6 Property Used in Your Business or Income-Producing Activity(p35)

Property Used in Your Business or Income-Producing Activity

To claim depreciation on property, you must use it in your business or income-producing activity. If you use property to produce income (investment use), the income must be taxable. You cannot depreciate property that you use solely for personal activities. However, if you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the percentage of business or investment use.

taxmap/pubs/p225-029.htm#TXMP3128e6f3 Example 1.(p36)

If you use your car for farm business, you can deduct depreciation based on its percentage of use in farming. If you also use it for investment purposes, you can depreciate it based on its percentage of investment use.

taxmap/pubs/p225-029.htm#TXMP450cdeb8 Example 2.(p36)

If you use part of your home for business, you may be able to deduct depreciation on that part based on its business use. For more information, see Business Use of Your Home in chapter 4.

taxmap/pubs/p225-029.htm#TXMP6b13b3d0 Inventory.(p36)

You can never depreciate inventory because it is not held for use in your business. Inventory is any property you hold primarily for sale to customers in the ordinary course of your business.

taxmap/pubs/p225-029.htm#TXMP6ea6cf22 Livestock.(p36)

Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account. Livestock you raise usually has no depreciable basis because the costs of raising them are deducted and not added to their basis. However, see Immature livestock under When Does Depreciation Begin and End, later for a special rule.

taxmap/pubs/p225-029.htm#TXMP644aec53 Property Having a Determinable Useful Life(p36)

Property Having a Determinable Useful Life

To be depreciable, your property must have a determinable useful life. This means it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes.

taxmap/pubs/p225-029.htm#TXMP1b2b2e2c Irrigation systems and water wells.(p36)

Irrigation systems and wells used in a trade or business can be depreciated if their useful life can be determined. You can depreciate irrigation systems and wells composed of masonry, concrete, tile, metal, or wood. In addition, you can depreciate costs for moving dirt to construct irrigation systems and water wells composed of these materials. However, land preparation costs for center pivot irrigation systems are not depreciable.

taxmap/pubs/p225-029.htm#TXMP5961e150 Dams, ponds, and terraces.(p36)

In general, you cannot depreciate earthen dams, ponds, and terraces unless the structures have a determinable useful life.

taxmap/pubs/p225-029.htm#TXMP05ad12e3 What Property Cannot Be Depreciated?(p36)

What Property Cannot Be Depreciated?

Certain property cannot be depreciated, even if the requirements explained earlier are met. This includes the following.

• Land. You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Although you cannot depreciate land, you can depreciate certain costs incurred in preparing land for business use. See chapter 1 of Publication 946.
• Property placed in service and disposed of in the same year. Determining when property is placed in service is explained later.
• Equipment used to build capital improvements. You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements.
• Intangible property such as section 197 intangibles. This property does not have a determinable useful life and generally cannot be depreciated. However, see Amortization, later. Special rules apply to computer software (discussed below).
• Certain term interests (discussed below).

taxmap/pubs/p225-029.htm#TXMP1a7dc505 Computer software.(p36)

Computer software is not a section 197 intangible even if acquired in connection with the acquisition of a business, if it meets all of the following tests.

• It is readily available for purchase by the general public.
• It is subject to a nonexclusive license.
• It has not been substantially modified.

If the software meets the tests above, it can be depreciated and may qualify for the section 179 deduction and the special depreciation allowance (if applicable), discussed later.

taxmap/pubs/p225-029.htm#TXMP310c2229 Certain term interests in property.(p36)

You cannot depreciate a term interest in property created or acquired after July 27, 1989, for any period during which the remainder interest is held, directly or indirectly, by a person related to you. This rule does not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. For more information, see chapter 1 of Publication 946.

taxmap/pubs/p225-029.htm#TXMP6cfc44a2 When Does Depreciation  Begin and End?(p36)

Depreciation

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.

taxmap/pubs/p225-029.htm#TXMP1be24aa4 Placed in Service(p36)

Placed in Service

Property is placed 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.

taxmap/pubs/p225-029.htm#TXMP00a56e8a
Example.(p36)

You bought a planter for use in your farm business. The planter was delivered in December 2007 after harvest was over. You begin to depreciate the planter for 2007 because it was ready and available for its specific use in 2007, even though it will not be used until the spring of 2008.

If your planter comes unassembled in December 2007 and is put together in February 2008, it is not placed in service until 2008. You begin to depreciate it in 2008.

If your planter was delivered and assembled in February 2008 but not used until April 2008, it is placed in service in February 2008, because this is when the planter was ready for its specified use. You begin to depreciate it in 2008.

taxmap/pubs/p225-029.htm#TXMP6eab4e2b Fruit or nut trees and vines.(p36)

If you acquire an orchard, grove, or vineyard before the trees or vines have reached the income-producing stage, and they have a preproductive period of more than 2 years, you must capitalize the preproductive-period costs under the uniform capitalization rules (unless you elect not to use these rules). See chapter 6 for information about the uniform capitalization rules. Your depreciation begins when the trees and vines reach the income-producing stage (that is, when they bear fruit, nuts, or grapes in quantities sufficient to commercially warrant harvesting).

taxmap/pubs/p225-029.htm#TXMP7ee3e26f Immature livestock.(p36)

Depreciation for livestock begins when the livestock reaches the age of maturity. If you acquire immature livestock for draft, dairy, or breeding purposes, your depreciation begins when the livestock reach the age when they can be worked, milked, or bred. When this occurs, your basis for depreciation is your initial cost for the immature livestock.

taxmap/pubs/p225-029.htm#TXMP2bfc78ea Idle Property(p36)

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 a market for a product made with that machine, continue to deduct depreciation on the machine.

taxmap/pubs/p225-029.htm#TXMP6e16207a Cost or Other Basis Fully Recovered(p36)

Cost or Other Basis Fully Recovered

You stop depreciating property when you have fully recovered your cost or other basis. This happens when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property.

taxmap/pubs/p225-029.htm#TXMP6d1dffb2 Retired From Service(p36)

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.

For information on abandonment of property, see chapter 8. For information on destroyed property, see chapter 11 and Publication 547, Casualties, Disasters, and Thefts.

taxmap/pubs/p225-029.htm#TXMP6b1f10e7 Can You Use MACRS To Depreciate Your Property?(p37)

Modified Accelerated Cost Recovery System

You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most business and investment property placed in service after 1986. MACRS is explained later under Figuring Depreciation Under MACRS.

You cannot use MACRS to depreciate the following property.

• Property you placed in service before 1987. Use the methods discussed in Publication 534
• Certain property owned or used in 1986. See Chapter 1 of Publication 946.
• Intangible property.
• Films, video tapes, and recordings.
• Certain corporate or partnership property acquired in a nontaxable transfer.
• Property you elected to exclude from MACRS.

For more information, see Chapter 1 of Publication 946.

taxmap/pubs/p225-029.htm#TXMP0348e21d What Is the Basis of Your Depreciable Property?(p37)

Depreciation, Basis

To figure your depreciation deduction, you must determine the basis of your property. To determine basis, you need to know the cost or other basis of your property.

taxmap/pubs/p225-029.htm#TXMP60ec574e Cost or other basis.(p37)

The basis of property you buy is usually its cost plus amounts you paid for items such as sales tax, freight charges, and installation and testing fees. The cost includes the amount you pay in cash, debt obligations, other property, or services.

There are times when you cannot use cost as basis. In these situations, the fair market value (FMV) or the adjusted basis of the property may be used.

taxmap/pubs/p225-029.htm#TXMP1efb0a2d Adjusted basis.(p37)

To find your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service.

taxmap/pubs/p225-029.htm#TXMP0dc49536 Basis adjustment for depreciation allowed or allowable.(p37)

After you place your property in service, you must reduce the basis of the property by the depreciation allowed or allowable, whichever is greater. Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). Depreciation allowable is depreciation you are entitled to deduct.

If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable.

If you deduct more depreciation than you should, you must reduce your basis by any amount deducted from which you received a tax benefit (the depreciation allowed).

For more information, see chapter 6.

taxmap/pubs/p225-029.htm#TXMP3853f8be How Do You Treat Repairs and Improvements?(p37)

How Do You Treat Repairs and Improvements?

You generally deduct the cost of repairing business property in the same way as any other business expense. However, if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it. Treat improvements as separate depreciable property. See chapter 1 of Publication 946 for more information.

taxmap/pubs/p225-029.htm#TXMP4755d3c1 Improvements to rented property.(p37)

You can depreciate permanent improvements you make to business property you rent from someone else.

taxmap/pubs/p225-029.htm#TXMP116a999d
Example.(p37)

You repair a small section on a corner of the roof of a barn that you rent to others. You deduct the cost of the repair as a business expense. However, if you replace the entire roof, the new roof is considered to be an improvement because it increases the value and lengthens the life for the property. You depreciate the cost of the new roof.

taxmap/pubs/p225-029.htm#TXMP0d5dd73f Do You Have To File  Form 4562?(p37)

Depreciation and Amortization

Use Form 4562 to claim your deduction for depreciation and amortization. You must complete and attach Form 4562 to your tax return if you are claiming any of the following.

• A section 179 deduction for the current year or a section 179 carryover from a prior year.
• Depreciation for property placed in service during the current year.
• Depreciation on any vehicle or other listed property, regardless of when it was placed in service.
• Amortization of costs that began in the current year.

For more information, see the Instructions for Form 4562.

taxmap/pubs/p225-029.htm#TXMP24dd44cf How Do You Correct Depreciation Deductions?(p37)

Depreciation, Correcting Deduction

If you deducted an incorrect amount of depreciation in any year, you may be able to make a correction by filing an amended return for that year. You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations.

• You claimed the incorrect amount because of a mathematical error made in any year.
• You claimed the incorrect amount because of a posting error made in any year, for example, omitting an asset from the depreciation schedule.
• You have not adopted a method of accounting for the property.

If you are not allowed to make the correction on an amended return, you may be able to change your accounting method to claim the correct amount of depreciation. See the Instructions for Form 3115.

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