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taxmap/pubs/p527-006.htm#TXMP47fb5c3f Depreciation(p7)

Depreciation

You recover the cost of income producing property through yearly tax deductions. You do this by depreciating the property; that is, by deducting some of the cost on the tax return each year.

Three basic factors determine how much depreciation you can deduct. They are: (1) your basis in the property, (2) the recovery period for the property, and (3) the depreciation method used. You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures and equipment, as an expense.

You can deduct depreciation only on the part of your property used for rental purposes. Depreciation reduces your basis for figuring gain or loss on a later sale or exchange.

You may have to use Form 4562 to figure and report your depreciation. See How To Report Rental Income and Expenses, later. Also see Publication 946.

taxmap/pubs/p527-006.htm#TXMP06700ebd Claiming the correct amount of depreciation.(p7)

You should claim the correct amount of depreciation each tax year. Even if you did not claim depreciation that you were entitled to deduct, you must still reduce your basis in the property by the full amount of depreciation that you could have deducted. See Decreases to basis, later, under Adjusted Basis for more information. If you did not deduct the correct amount of depreciation for property in any year, you may be able to make a correction for that year by filing Form 1040X, Amended U.S. Individual Income Tax Return. If you are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of depreciation. See Changing your accounting method, later.

taxmap/pubs/p527-006.htm#TXMP06442972 Filing an amended return.(p9)

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.
• You have not adopted a method of accounting for the property.

If an amended return is allowed, you must file it by the later of the following dates.

• 3 years from the date you filed your original return for the year in which you did not deduct the correct amount. (A return filed early is considered filed on the due date.)
• 2 years from the time you paid your tax for that year.

taxmap/pubs/p527-006.htm#TXMP2659e343 Changing your accounting method.(p9)

To change your accounting method, you must file Form 3115, Application for Change in Accounting Method, to get the consent of the IRS. In some instances, that consent is automatic. For more information, see Changing Your Accounting Method in chapter 1 of Publication 946.

taxmap/pubs/p527-006.htm#TXMP549daa20 (p9)

taxmap/pubs/p527-006.htm#TXMP1e637005 What Property Can be Depreciated(p9)

Depreciation, Property

You can depreciate your property if it meets all the following requirements.

• You own the property.
• You use the property in your business or income-producing activity (such as rental property).
• The property has a determinable useful life.
• The property is expected to last more than 1 year.
• The property is not excepted property (such as property placed in service and disposed of in the same year and section 197 intangibles).

taxmap/pubs/p527-006.htm#TXMP219fde7a Property having a determinable useful life.(p9)

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

taxmap/pubs/p527-006.htm#TXMP2e5df9e9 Land.(p9)

You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The costs of clearing, grading, planting, and landscaping are usually all part of the cost of land and cannot be depreciated.

taxmap/pubs/p527-006.htm#TXMP3bfdf553 Property you own.(p9)

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/p527-006.htm#TXMP2b0558e3 Rented property.(p9)

Generally, if you pay rent on property, you cannot depreciate that property. Usually, only the owner can depreciate it. If you make permanent improvements to the property, you may be able to depreciate the improvements. See Additions or improvements to property, later, under MACRS.

taxmap/pubs/p527-006.htm#TXMP28500490 Cooperative apartments.(p9)

If you are a tenant-stockholder in a cooperative housing corporation and rent your cooperative apartment to others, you can deduct depreciation for your stock in the corporation.

Figure your depreciation deduction as follows.

1. Figure the depreciation for all the depreciable real property owned by the corporation. (Depreciation methods are discussed later.) If you bought your cooperative stock after its first offering, figure the depreciable basis of this property as follows.
   1. Multiply your cost per share by the total number of outstanding shares.
   2. Add to the amount figured in (a) any mortgage debt on the property on the date you bought the stock.
   3. Subtract from the amount figured in (b) any mortgage debt that is not for the depreciable real property, such as the part for the land.
2. Subtract from the amount figured in (1) any depreciation for space owned by the corporation that can be rented but cannot be lived in by tenant-stockholders.
3. Divide the number of your shares of stock by the total number of shares outstanding, including any shares held by the corporation.
4. Multiply the result of (2) by the percentage you figured in (3). This is your depreciation on the stock.

Your depreciation deduction for the year cannot be more than the part of your adjusted basis (defined later under MACRS) in the stock of the corporation that is allocable to your rental property.

See Cooperative apartments under What Property Can Be Depreciated? in chapter 1 of Publication 946 for more information.

taxmap/pubs/p527-006.htm#TXMP1d8b8f4f No deduction greater than basis.(p9)

The total of all your yearly depreciation deductions cannot be more than the cost or other basis of the property. For this purpose, your yearly depreciation deductions include any depreciation that you were allowed to claim, even if you did not claim it.

taxmap/pubs/p527-006.htm#w15052W03

Table 2. MACRS Recovery Periods for Property Used in Rental Activities   MACRS Recovery Period   Type of Property General Depreciation System Alternative Depreciation System   Computers and their peripheral equipment 5 years 5 years   Office machinery, such as: 0000Typewriters 0000Calculators 0000Copiers 5 years 6 years   Automobiles 5 years 5 years   Light trucks 5 years 5 years   Appliances, such as: 0000Stoves 0000Refrigerators 5 years 9 years   Carpets 5 years 9 years   Furniture used in rental property 5 years 9 years   Office furniture and equipment, such as: 0000Desks 0000Files 7 years 10 years   Any property that does not have a class life and that has not 0000been designated by law as being in any other class 7 years 12 years   Roads 15 years 20 years   Shrubbery 15 years 20 years   Fences 15 years 20 years   Residential rental property (buildings or structures) 0000and structural components such as furnaces, 0000waterpipes, venting, etc. 27.5 years 40 years   Additions and improvements, such as a new roof The same recovery period as that of the property to which the addition or improvement is made, determined as if the property were placed in service at the same time as the addition or improvement.

taxmap/pubs/p527-006.htm#TXMP4a86fcdb Depreciation Methods(p9)

Depreciation, Method

There are three ways to figure depreciation. The depreciation method you use depends on the type of property and when it was placed in service. For property used in rental activities you use one of the following.

• MACRS (Modified Accelerated Cost Recovery System) for property placed in service after 1986.
• ACRS (Accelerated Cost Recovery System) for property placed in service after 1980 but before 1987.
• Useful lives and either straight line or an accelerated method of depreciation, such as the declining balance method, for property placed in service before 1981.

This publication discusses MACRS only. If you need information about depreciating property placed in service before 1987, see Publication 534.

If you placed property in service before 2007, continue to use the same method of figuring depreciation that you used in the past.

taxmap/pubs/p527-006.htm#TXMP31048af1 Section 179 deduction.(p9)

You cannot claim the section 179 deduction for property held to produce rental income. See chapter 2 of Publication 946.

taxmap/pubs/p527-006.htm#TXMP2ce39a6a Alternative minimum tax.(p9)

If you use accelerated depreciation, you may have to file Form 6251, Alternative Minimum Tax—Individuals. Accelerated depreciation can be determined under MACRS, ACRS, and any other method that allows you to deduct more depreciation than you could deduct using a straight line method.

taxmap/pubs/p527-006.htm#TXMP5d73a69e Special Depreciation Allowance(p9)

Special Depreciation Allowance

You can take a special depreciation allowance (in addition to your regular MACRS depreciation deduction) for qualified Gulf Opportunity Zone (GO Zone) property you placed in service in 2007. The allowance is 50% of the property's depreciable basis. You figure the special depreciation allowance before you figure your regular MACRS deduction.

taxmap/pubs/p527-006.htm#TXMP2000e4ce Choosing not to use the special allowance.(p9)

If you want to take only the regular MACRS depreciation deduction, you must elect out of the special allowance. The election must be made separately for each class of property that has qualifying property. To make the election, attach a statement to your return indicating that you are electing out of the special depreciation allowance under IRC 1400N(d)(2)(B)(iv) and the class(es) of property for which you are making the election.

taxmap/pubs/p527-006.htm#TXMP78c7e5b7 Qualified Gulf Opportunity Zone Property(p9)

Qualified Gulf Opportunity Zone Property

Your property is qualified GO Zone property if it meets the following requirements.

1. It is one of the following types of property.
   1. Property depreciated under MACRS with a recovery period of 20 years or less.
   2. Water utility property.
   3. Certain computer software.
   4. Qualified leasehold improvement property.
   5. Certain nonresidential real property and residential rental property.
2. It meets the tests explained next under Other tests to be met.
3. It is not excepted property explained later under Excepted property.

taxmap/pubs/p527-006.htm#TXMP125d6a3e Other tests to be met.(p10)

To be qualified GO Zone property, the property must meet all of the following tests.

• Acquisition date test.
• Placed-in-service date test.
• Substantial use test.
• Original use test.

taxmap/pubs/p527-006.htm#TXMP16643f99 Acquisition date test.(p10)

You must have acquired the property by purchase after August 27, 2005, with no binding written contract for the acquisition in effect before August 28, 2005.

taxmap/pubs/p527-006.htm#TXMP6e9957d2 Placed-in-service date test.(p10)

The property must be placed in service for use in your trade or business or for the production of income before January 1, 2008 (January 1, 2009, in the case of qualifying nonresidential real property and residential rental property).

taxmap/pubs/p527-006.htm#TXMP2eed86c1 Substantial use test.(p10)

Substantially all (80 percent or more) of the use of the property must be in the GO Zone and in the active conduct of your trade or business in the GO Zone.

taxmap/pubs/p527-006.htm#TXMP51804a8f Original use test.(p10)

The original use of the property in the GO Zone must have begun with you after August 27, 2005.

Used property can be qualified GO Zone property if it has not previously been used within the GO Zone. Also, additional capital expenditures you incurred after August 27, 2005, to recondition or rebuild your property meet the original use test if the original use of the property in the GO Zone began with you.

If you sold property you placed in service after August 27, 2005, and you leased it back within 3 months after you originally placed the property in service, the lessor is considered to be the original user of the property.

taxmap/pubs/p527-006.htm#TXMP23f6d644 Excepted property.(p10)

Qualified GO Zone property does not include any of the following.

• Property required to be depreciated using the Alternative Depreciation System (ADS).
• Property any portion of which is financed with the proceeds of a tax-exempt obligation under section 103 of the Internal Revenue Code.
• Any qualified revitalization building for which you have elected to claim a commercial revitalization deduction for qualified revitalization expenditures.
• Any property used in connection with any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, or any store, the principal business of which is the sale of alcoholic beverages for consumption off premises.
• Any gambling or animal racing property.
• Property for which you elected not to claim any special depreciation allowance.

taxmap/pubs/p527-006.htm#TXMP658264e4 More information.(p10)

For more information about the special depreciation allowance, see Publication 946.

taxmap/pubs/p527-006.htm#TXMP24323620 MACRS(p10)

Modified Accelerated Cost Recovery System

Most business and investment property placed in service after 1986 is depreciated using MACRS.

MACRS consists of two systems that determine how you depreciate your property—the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). GDS is used to figure your depreciation deduction for property used in most rental activities, unless you elect ADS.

To figure your MACRS deduction, you need to know the following information about your property:

• Its recovery period,
• Its placed-in-service date, and
• Its depreciable basis.

taxmap/pubs/p527-006.htm#TXMP26a7a128 Personal home changed to rental use.(p10)

You must use MACRS to figure the depreciation on property used as your home and changed to rental property in 2007.

taxmap/pubs/p527-006.htm#TXMP6520099c Excluded property.(p10)

You cannot use MACRS for certain personal property placed in service in your rental property in 2007 if it had been previously placed in service before MACRS became effective. Generally, personal property is excluded from MACRS if you (or a person related to you) owned or used it in 1986 or if your tenant is a person (or someone related to the person) who owned or used it in 1986. However, the property is not excluded if your 2007 deduction under MACRS (using a half-year convention) is less than the deduction you would have under ACRS. See What Method Can You Use To Depreciate Your Property? in chapter 1 of Publication 946 for more information.

taxmap/pubs/p527-006.htm#TXMP239c615d Recovery Periods Under GDS(p10)

Recovery Periods Under GDS

Each item of property that can be depreciated is assigned to a property class. The recovery period of the property depends on the class the property is in. Under GDS, the recovery period of an asset is generally the same as its property class. The property classes under GDS are:

• 3-year property,
• 5-year property,
• 7-year property,
• 10-year property,
• 15-year property,
• 20-year property,
• Nonresidential real property, and
• Residential rental property.

The class to which property is assigned is determined by its class life. Class lives and recovery periods for most assets are listed in Appendix B in Publication 946.

Under GDS, property that you placed in service during 2007 in your rental activities generally falls into one of the following classes. Also see Table 2.

• 5-year property. This class includes computers and peripheral equipment, office machinery (typewriters, calculators, copiers, etc.), automobiles, and light trucks. This class also includes appliances, carpeting, furniture, etc., used in a residential rental real estate activity.
  Depreciation on automobiles, certain computers, and cellular telephones is limited. See chapter 5 of Publication 946.
  
• 7-year property. This class includes office furniture and equipment (desks, files, etc.). This class also includes any property that does not have a class life and that has not been designated by law as being in any other class.
• 15-year property. This class includes roads and shrubbery (if depreciable).
• Residential rental property. This class includes any real property that is a rental building or structure (including a mobile home) for which 80% or more of the gross rental income for the tax year is from dwelling units. It does not include a unit in a hotel, motel, inn, or other establishment where more than half of the units are used on a transient basis. If you live in any part of the building or structure, the gross rental income includes the fair rental value of the part you live in. The recovery period for residential rental property is 27.5 years.

The other property classes do not generally apply to property used in rental activities. These classes are not discussed in this publication. See Publication 946 for more information.

taxmap/pubs/p527-006.htm#TXMP4b2c5835 Qualified Indian reservation property.(p10)

Shorter recovery periods are provided under MACRS for qualified Indian reservation property placed in service on Indian reservations before 2008. For more information, see chapter 4 of Publication 946.

taxmap/pubs/p527-006.htm#TXMP58360387 Additions or improvements to property.(p10)

Treat depreciable additions or improvements you make to any property as separate property items for depreciation purposes. The recovery period for an addition or improvement to property begins on the later of:

• The date the addition or improvement is placed in service, or
• The date the property to which the addition or improvement was made is placed in service.

The property class and recovery period of the addition or improvement is the one that would apply to the original property if it were placed in service at the same time as the addition or improvement.

taxmap/pubs/p527-006.htm#TXMP01c5582a
Example.(p10)

You own a residential rental house that you have been renting since 1986 and that you are depreciating under ACRS. You put an addition onto the house and placed it in service in 2007. You must use MACRS for the addition. Under GDS, the addition is depreciated as residential rental property over 27.5 years.

taxmap/pubs/p527-006.htm#TXMP6431d831 Placed-in-Service Date(p11)

Placed-in-Service Date

You can begin to depreciate property when you place it in service in your trade or business or for the production of income. Property is considered placed in service in a rental activity when it is ready and available for a specific use in that activity.

taxmap/pubs/p527-006.htm#TXMP5b8ef2f1
Example 1.(p11)

On November 22 of last year, you purchased a dishwasher for your rental property. The appliance was delivered on December 7, but was not installed and ready for use until January 3 of this year. Because the dishwasher was not ready for use last year, it is not considered placed in service until this year.

If the appliance had been ready for use when it was delivered in December of last year, it would have been considered placed in service in December, even if it was not actually used until this year.

taxmap/pubs/p527-006.htm#TXMP28400e36
Example 2.(p11)

On April 6, you purchased a house to use as residential rental property. You made extensive repairs to the house and had it ready for rent on July 5. You began to advertise the house for rent in July and actually rented it beginning September 1. The house is considered placed in service in July when it was ready and available for rent. You can begin to depreciate the house in July.

taxmap/pubs/p527-006.htm#TXMP571adc99
Example 3.(p11)

You moved from your home in July. During August and September you made several repairs to the house. On October 1, you listed the property for rent with a real estate company, which rented it on December 1. The property is considered placed in service on October 1, the date when it was available for rent.

taxmap/pubs/p527-006.htm#TXMP11eb6ec0 Depreciable Basis(p11)

Depreciable Basis

The depreciable basis of property used in a rental activity is generally its adjusted basis when you place it in service in that activity. This is its cost or other basis when you acquired it, adjusted for certain items occurring before you place it in service in the rental activity.

If you depreciate your property under MACRS, you may also have to reduce your basis by certain deductions and credits with respect to the property.

Basis and adjusted basis are explained in the following discussions.

If you used the property for personal purposes before changing it to rental use, its depreciable basis is the lesser of its adjusted basis or its fair market value when you change it to rental use. See Basis of Property Changed to Rental Use, later.

taxmap/pubs/p527-006.htm#TXMP7e655b24 Cost Basis(p11)

Cost Basis

The basis of property you buy is usually its cost. The cost is the amount you pay for it in cash, in debt obligation, in other property, or in services. Your cost also includes amounts you pay for:

• Sales tax charged on the purchase (but see Exception below),
• Freight charges to obtain the property, and
• Installation and testing charges.

taxmap/pubs/p527-006.htm#TXMP0562aae7 Exception.(p11)

You can elect to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction on Schedule A (Form 1040). If you make that choice, you cannot include those sales taxes as part of your cost basis.

taxmap/pubs/p527-006.htm#TXMP3c7a18bb Loans with low or no interest.(p11)

If you buy property on any time-payment plan that charges little or no interest, the basis of your property is your stated purchase price, less the amount considered to be unstated interest. See Unstated Interest and Original Issue Discount (OID) in Publication 537, Installment Sales.

taxmap/pubs/p527-006.htm#TXMP22d08970 Real property.(p11)

If you buy real property, such as a building and land, certain fees and other expenses you pay are part of your cost basis in the property.

taxmap/pubs/p527-006.htm#TXMP15019501 Real estate taxes.(p11)

If you buy real property and agree to pay real estate taxes on it that were owed by the seller and the seller did not reimburse you, the taxes you pay are treated as part of your basis in the property. You cannot deduct them as taxes paid.

If you reimburse the seller for real estate taxes the seller paid for you, you can usually deduct that amount. Do not include that amount in your basis in the property.

taxmap/pubs/p527-006.htm#TXMP6d038634 Settlement fees and other costs.(p11)

Settlement fees and closing costs that are for buying the property are part of your basis in the property. These include:

• Abstract fees,
• Charges for installing utility services,
• Legal fees,
• Recording fees,
• Surveys,
• Transfer taxes,
• Title insurance, and
• Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.

Some settlement fees and closing costs you cannot include in your basis in the property are:

1. Fire insurance premiums,
2. Rent or other charges relating to occupancy of the property before closing, and
3. Charges connected with getting or refinancing a loan, such as:
   1. Points (discount points, loan origination fees),
   2. Mortgage insurance premiums,
   3. Loan assumption fees,
   4. Cost of a credit report, and
   5. Fees for an appraisal required by a lender.

Also, do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

taxmap/pubs/p527-006.htm#TXMP41e019f4 Assumption of a mortgage.(p12)

If you buy property and become liable for an existing mortgage on the property, your basis is the amount you pay for the property plus the amount that still must be paid on the mortgage.

taxmap/pubs/p527-006.htm#TXMP417c03d5
Example.(p12)

You buy a building for $60,000 cash and assume a mortgage of $240,000 on it. Your basis is $300,000.

taxmap/pubs/p527-006.htm#TXMP64832057 Land and buildings.(p12)

If you buy buildings and your cost includes the cost of the land on which they stand, you must divide the cost between the land and the buildings to figure the basis for depreciation of the buildings. The part of the cost that you allocate to each asset is the ratio of the fair market value of that asset to the fair market value of the whole property at the time you buy it.

If you are not certain of the fair market values of the land and the buildings, you can divide the cost between them based on their assessed values for real estate tax purposes.

taxmap/pubs/p527-006.htm#TXMP017a77b5
Example.(p12)

You buy a house and land for $100,000. The purchase contract does not specify how much of the purchase price is for the house and how much is for the land.

The latest real estate tax assessment on the property was based on an assessed value of $80,000, of which $68,000 is for the house and $12,000 is for the land.

You can allocate 85% ($68,000 ÷ $80,000) of the purchase price to the house and 15% ($12,000 ÷ $80,000) of the purchase price to the land.

Your basis in the house is $85,000 (85% of $100,000) and your basis in the land is $15,000 (15% of $100,000).

taxmap/pubs/p527-006.htm#TXMP0c6460d7 Basis Other Than Cost(p12)

Basis Other Than Cost

There are many times when you cannot use cost as a basis. You cannot use cost as a basis for property that you received:

• In return for services you performed,
• In an exchange for other property,
• As a gift,
• From your spouse, or from your former spouse as the result of a divorce, or
• As an inheritance.

If you received property in one of these ways, see Publication 551 for information on how to figure your basis.

taxmap/pubs/p527-006.htm#TXMP5d9e3d9e Adjusted Basis(p12)

Adjusted Basis

Before you can figure allowable depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property. The result of these adjustments to the basis is the adjusted basis.

taxmap/pubs/p527-006.htm#TXMP021b29cb Increases to basis.(p12)

You must increase the basis of any property by the cost of all items properly added to a capital account. This includes:

• The cost of any additions or improvements having a useful life of more than one year,
• Amounts spent after a casualty to restore the damaged property,
• The cost of extending utility service lines to the property, and
• Legal fees, such as the cost of defending and perfecting title.

taxmap/pubs/p527-006.htm#TXMP638ff87d Additions or improvements.(p12)

Add to the basis of your property the amount an addition or improvement actually cost you, including any amount you borrowed to make the addition or improvement. This includes all direct costs, such as material and labor, but not your own labor. It also includes all expenses related to the addition or improvement.

For example, if you had an architect draw up plans for remodeling your property, the architect's fee is a part of the cost of the remodeling. Or, if you had your lot surveyed to put up a fence, the cost of the survey is a part of the cost of the fence.

Keep separate accounts for depreciable additions or improvements made after you place the property in service in your rental activity. For information on depreciating additions or improvements, see Additions or improvements to property, earlier, under Recovery Periods Under GDS.

The cost of landscaping improvements is usually treated as an addition to the basis of the land, which is not depreciable. See What Property Can Be Depreciated, earlier.

taxmap/pubs/p527-006.htm#TXMP0bb37328 Assessments for local improvements.(p12)

Assessments for items which tend to increase the value of property, such as streets and sidewalks, must be added to the basis of the property. For example, if your city installs curbing on the street in front of your house, and assesses you and your neighbors for the cost of curbing, you must add the assessment to the basis of your property. Also add the cost of legal fees paid to obtain a decrease in an assessment levied against property to pay for local improvements. You cannot deduct these items as taxes or depreciate them.

Assessments for maintenance or repair or meeting interest charges are deductible as taxes. Do not add them to your basis in the property.

taxmap/pubs/p527-006.htm#TXMP0ba45ead Deducting vs. capitalizing costs.(p12)

You cannot add to your basis costs that are deductible as current expenses. However, there are certain costs you can choose either to deduct or to capitalize. If you capitalize these costs, include them in your basis. If you deduct them, do not include them in your basis.

The costs you may be able to choose to deduct or to capitalize include carrying charges, such as interest and taxes, that you must pay to own property.

For more information about deducting or capitalizing costs, see chapter 7 in Publication 535.

taxmap/pubs/p527-006.htm#TXMP37183566 Decreases to basis.(p12)

You must decrease the basis of your property by any items that represent a return of your cost. These include:

• The amount of any insurance or other payment you receive as the result of a casualty or theft loss,
• Any deductible casualty loss not covered by insurance,
• Any amount you receive for granting an easement,
• Any residential energy credit you were allowed before 1986, or after 2005, if you added the cost of the energy items to the basis of your home, and
• The amount of depreciation you could have deducted on your tax returns under the method of depreciation you selected. If you took less depreciation than you could have under the method you selected, you must decrease the basis by the amount you could have taken under that method.

If you deducted more depreciation than you should have, you must decrease your basis by the amount you should have deducted, plus the part of the excess you deducted that actually lowered your tax liability for any year.

taxmap/pubs/p527-006.htm#TXMP3752bafe Basis of Property  Changed to Rental Use(p12)

Basis of Property Changed to Rental Use

When you change property you held for personal use to rental use (for example, you rent your former home), you figure the basis for depreciation using the lesser of fair market value or adjusted basis.

taxmap/pubs/p527-006.htm#TXMP4510cbc2 Fair market value.(p12)

This is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property.

taxmap/pubs/p527-006.htm#TXMP57e68c39 Figuring the basis.(p12)

The basis for depreciation is the lesser of:

• The fair market value of the property on the date you changed it to rental use, or
• Your adjusted basis on the date of the change—that is, your original cost or other basis of the property, plus the cost of permanent additions or improvements since you acquired it, minus deductions for any casualty or theft losses claimed on earlier years' income tax returns and other decreases to basis.

taxmap/pubs/p527-006.htm#TXMP7f426788
Example.(p12)

Several years ago you built your home for $140,000 on a lot that cost you $14,000. Before changing the property to rental use last year, you added $28,000 of permanent improvements to the house and claimed a $3,500 deduction for a casualty loss to the house. Because land is not depreciable, you can only include the cost of the house when figuring the basis for depreciation.

The adjusted basis of the house at the time of the change in use was $164,500 ($140,000 + $28,000 − $3,500).

On the date of the change in use, your property had a fair market value of $168,000, of which $21,000 was for the land and $147,000 was for the house.

The basis for depreciation on the house is the fair market value at the date of the change ($147,000), because it is less than your adjusted basis ($164,500).

taxmap/pubs/p527-006.htm#TXMP399218ea MACRS Depreciation  Under GDS(p13)

MACRS Depreciation Under GDS

You can figure your MACRS depreciation deduction under GDS in one of two ways. The deduction is substantially the same both ways. (The difference, if any, is slight.) You can either:

• Actually compute the deduction using the depreciation method and convention that apply over the recovery period of the property, or
• Use the percentage from the optional MACRS tables, shown later.

If you actually compute the deduction, the depreciation method you use depends on the class of the property.

taxmap/pubs/p527-006.htm#TXMP507bb179 5-, 7-, or 15-year property.(p13)

For property in the 5- or 7-year class, use the 200% declining balance method and a half-year convention. However, in limited cases you must use the mid-quarter convention, if it applies. These conventions are explained later. For property in the 15-year class, use the 150% declining balance method and a half-year convention.

You can also choose to use the 150% declining balance method for property in the 5- or 7-year class. The choice to use the 150% method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. You make this election on Form 4562. In Part III, column (f), enter "150 DB."

If you use either the 200% or 150% declining balance method, you figure your deduction using the straight line method in the first tax year that the straight line method gives you an equal or larger deduction.

You can also choose to use the straight line method with a half-year or mid-quarter convention for 5-, 7-, or 15-year property. The choice to use the straight line method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. You elect the straight line method on Form 4562. In Part III, column (f), enter "S/L." Once you make this election, you cannot change to another method.

taxmap/pubs/p527-006.htm#TXMP0a721234 Residential rental property.(p13)

You must use the straight line method and a mid-month convention for residential rental property.

taxmap/pubs/p527-006.htm#TXMP6f9c7258 Declining Balance Method(p13)

Declining Balance Method

To figure your MACRS deduction, first determine your declining balance rate from the table on the next page. However, if you elect to use the 150% declining balance method for 5- or 7-year property, figure the declining balance rate by dividing 1.5 (150%) by the recovery period for the property.

In the first tax year, multiply the adjusted basis of the property by the declining balance rate and apply the appropriate convention to figure your depreciation. In later years (before the year you switch to the straight line method), use the following steps to figure your depreciation.

1. Reduce your adjusted basis by the depreciation allowable for the earlier years.
2. Multiply the new adjusted basis in (1) by the same rate used in earlier years.

See Conventions, later, for information on depreciation in the year you dispose of property.

taxmap/pubs/p527-006.htm#TXMP250d8048 Declining balance rates.(p13)

The following table shows the declining balance rate that applies for each class of property and the first year for which the straight line method will give an equal or greater deduction. (The rates for 5- and 7-year property are based on the 200% declining balance method. The rate for 15-year property is based on the 150% declining balance method.)

Class	Declining Balance Rate	Year
5	40%	4th
7	28.57%	5th
15	10%	7th

taxmap/pubs/p527-006.htm#TXMP50aee99b Straight Line Method(p13)

Straight Line Method

To figure your MACRS deduction under the straight line method, you must apply a different depreciation rate to the adjusted basis of your property for each tax year in the recovery period.

In the first year, multiply the adjusted basis of the property by the straight line rate. You must figure the depreciation for the first year using the convention that applies. (See Conventions, later.)

taxmap/pubs/p527-006.htm#TXMP035ced70 Straight line rate.(p13)

For any tax year, figure the straight line rate by dividing the number 1 by the years remaining in the recovery period at the beginning of the tax year. When figuring the number of years remaining, you must take into account the convention used in the first year. If the remaining recovery period at the beginning of the tax year is less than 1 year, the straight line rate for that tax year is 100%.

taxmap/pubs/p527-006.htm#TXMP4bc3331a
Example.(p13)

You place in service property with a basis of $1,000 and a 5-year recovery period. The straight line rate is 20% (1 divided by 5) for the first tax year. After you apply the half-year convention, the first year rate is 10% (20% divided by 2). Depreciation for the first year is $100.

At the beginning of the second year, the remaining recovery period is 41/2 years because of the half-year convention. The straight line rate for the second year is 22.22% (1 divided by 4.5).

To figure your depreciation deduction for the second year:

1. Subtract the depreciation taken in the first year ($100) from the basis of the property ($1,000), and
2. Multiply the remaining basis ($900) by 22.22%. The depreciation for the second year is $200.

taxmap/pubs/p527-006.htm#TXMP77525ce8 Residential rental property.(p13)

In the first year that you claim depreciation for residential rental property, you can only claim depreciation for the number of months the property is in use, and you must use the mid-month convention (explained under Conventions, next).

taxmap/pubs/p527-006.htm#TXMP32c1ccee Conventions(p13)

Conventions

Under MACRS, 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.

taxmap/pubs/p527-006.htm#TXMP0a8a0318 Mid-month convention.(p13)

A mid-month convention is used for all residential rental property and nonresidential real property. Under this convention, you treat all property placed in service, or disposed of, during any month as placed in service, or disposed of, at the midpoint of that month.

taxmap/pubs/p527-006.htm#TXMP1440091c Mid-quarter convention.(p13)

A mid-quarter convention must be used if the mid-month convention does not apply and the total depreciable basis of MACRS property placed in service in the last 3 months of a tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) is more than 40% of the total basis of all such property you place in service during the year.

Under this convention, you treat all property placed in service, or disposed of, during any quarter of a tax year as placed in service, or disposed of, at the midpoint of the quarter.

taxmap/pubs/p527-006.htm#TXMP6d2df605
Example.(p13)

During the tax year, Tom Martin purchased the following items to use in his rental property. He elects not to claim the special depreciation allowance, discussed earlier.

• A dishwasher for $400 that he placed in service in January.
• Used furniture for $100 that he placed in service in September.
• A refrigerator for $500 that he placed in service in October.

Tom uses the calendar year as his tax year. The total basis of all property placed in service that year is $1,000. The $500 basis of the refrigerator placed in service during the last 3 months of his tax year exceeds $400 (40% × $1,000). Tom must use the mid-quarter convention instead of the half-year convention for all three items.

taxmap/pubs/p527-006.htm#TXMP0ec44a87 Half-year convention.(p13)

The half-year convention is used 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 that tax year.

If this convention applies, you deduct a half-year of depreciation for the first year and the last year that you depreciate the property. You deduct a full year of depreciation for any other year during the recovery period.