Depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property. It is an allowance for the wear and tear, deterioration, or obsolescence of the property.
This chapter discusses the general rules for depreciating property and answers the following questions.
- What property can be depreciated?
- What property cannot be depreciated?
- When does depreciation begin and end?
- What method can you use to depreciate your property?
- What is the basis of your depreciable property?
- How do you treat repairs and improvements?
- Do you have to file Form 4562?
- How do you correct depreciation deductions?
You may want to see:
Publication 534 Depreciating Property Placed in Service Before 1987 535 Business Expenses 538 Accounting Periods and Methods 551 Basis of Assets Form (and Instructions) Sch C (Form 1040): Profit or Loss From Business Sch C-EZ (Form 1040): Net Profit From Business 2106 : Employee Business Expenses 2106-EZ : Unreimbursed Employee Business Expenses 3115 : Application for Change in Accounting Method 4562 : Depreciation and Amortization
See chapter 6 for information about getting publications and forms. taxmap/pubs/p946-001.htm#en_us_publink1000107298
Words you may need to know (see Glossary)
- Adjusted basis
- Fair market value
- Intangible property
- Listed property
- Placed in service
- Tangible property
- Term interest
- Useful life
You can depreciate most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. You also can depreciate certain intangible property, such as patents, copyrights, 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 be expected to last more than one year.
The following discussions provide information about these requirements.
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/p946-001.htm#en_us_publink1000107300
You made a down payment to purchase rental property and assumed the previous owner's mortgage. You own the property and you can depreciate it.taxmap/pubs/p946-001.htm#en_us_publink1000107301
You bought a new van that you will use only for your courier business. You will be making payments on the van over the next 5 years. You own the van and you can depreciate it.taxmap/pubs/p946-001.htm#en_us_publink1000107302
You can depreciate leased property only if you retain the incidents of ownership in the property (explained below). 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 property. See How Do You Treat Repairs and Improvements later in this chapter and Additions and Improvements under Which Recovery Period Applies in chapter 4.
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, 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, you cannot depreciate the cost of the property.taxmap/pubs/p946-001.htm#en_us_publink1000107303
Incidents of ownership in property include the following.
- The legal title to the property.
- The legal obligation to pay for the property.
- The responsibility to pay maintenance and operating expenses.
- The duty to pay any taxes on the property.
- The risk of loss if the property is destroyed, condemned, or diminished in value through obsolescence or exhaustion.
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. However, see Certain term interests in property under Excepted Property, later. taxmap/pubs/p946-001.htm#en_us_publink1000107305
If you are a tenant-stockholder in a cooperative housing corporation and use your cooperative apartment in your business or for the production of income, you can depreciate your stock in the corporation, even though the corporation owns the apartment.
Figure your depreciation deduction as follows.
- Figure the depreciation for all the depreciable real property owned by the corporation in which you have a proprietary lease or right of tenancy. If you bought your cooperative stock after its first offering, figure the depreciable basis of this property as follows.
- Multiply your cost per share by the total number of outstanding shares, including any shares held by the corporation.
- Add to the amount figured in (a) any mortgage debt on the property on the date you bought the stock.
- 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.
- 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.
- Divide the number of your shares of stock by the total number of outstanding shares, including any shares held by the corporation.
- 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 in the stock of the corporation that is allocable to your business or income-producing property. You must also reduce your depreciation deduction if only a portion of the property is used in a business or for the production of income.taxmap/pubs/p946-001.htm#en_us_publink1000107306
You figure your share of the cooperative housing corporation's depreciation to be $30,000. Your adjusted basis in the stock of the corporation is $50,000. You use one half of your apartment solely for business purposes. Your depreciation deduction for the stock for the year cannot be more than $25,000 (1/2 of $50,000).taxmap/pubs/p946-001.htm#en_us_publink1000107307
If you change your cooperative apartment to business use, figure your allowable depreciation as explained earlier. The basis of all the depreciable real property owned by the cooperative housing corporation is the smaller of the following amounts.
- The fair market value of the property on the date you change your apartment to business use. This is considered to be the same as the corporation's adjusted basis minus straight line depreciation, unless this value is unrealistic.
- The corporation's adjusted basis in the property on that date. Do not subtract depreciation when figuring the corporation's adjusted basis.
If you bought the stock after its first offering, the corporation's adjusted basis in the property is the amount figured in (1), above. The fair market value of the property is considered to be the same as the corporation's adjusted basis figured in this way minus straight line depreciation, unless the value is unrealistic.
For a discussion of fair market value and adjusted basis, see Publication 551.taxmap/pubs/p946-001.htm#en_us_publink1000107308
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.taxmap/pubs/p946-001.htm#en_us_publink1000107309
If you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the business or investment use. For example, you cannot deduct depreciation on a car used only for commuting, personal shopping trips, family vacations, driving children to and from school, or similar activities.
You must keep records showing the business, investment, and personal use of your property. For more information on the records you must keep for listed property, such as a car, see What Records Must Be Kept in chapter 5.
Although you can combine business and investment use of property when figuring depreciation deductions, do not treat investment use as qualified business use when determining whether the business-use requirement for listed property is met. For information about qualified business use of listed property, see What Is the Business-Use Requirement in chapter 5.
If you use part of your home as an office, you may be able to deduct depreciation on that part based on its business use. For information about depreciating your home office, see Publication 587.taxmap/pubs/p946-001.htm#en_us_publink1000107313
You cannot 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.
If you are a rent-to-own dealer, you may be able to treat certain property held in your business as depreciable property rather than as inventory. See Rent-to-own dealer under Which Property Class Applies Under GDS in
In some cases, it is not clear whether property is held for sale (inventory) or for use in your business. If it is unclear, examine carefully all the facts in the operation of the particular business. The following example shows how a careful examination of the facts in two similar situations results in different conclusions. taxmap/pubs/p946-001.htm#en_us_publink1000107314
Maple Corporation is in the business of leasing cars. At the end of their useful lives, when the cars are no longer profitable to lease, Maple sells them. Maple does not have a showroom, used car lot, or individuals to sell the cars. Instead, it sells them through wholesalers or by similar arrangements in which a dealer's profit is not intended or considered. Maple can depreciate the leased cars because the cars are not held primarily for sale to customers in the ordinary course of business, but are leased.
If Maple buys cars at wholesale prices, leases them for a short time, and then sells them at retail prices or in sales in which a dealer's profit is intended, the cars are treated as inventory and are not depreciable property. In this situation, the cars are held primarily for sale to customers in the ordinary course of business.taxmap/pubs/p946-001.htm#en_us_publink1000107315
Generally, containers for the products you sell are part of inventory and you cannot depreciate them. However, you can depreciate containers used to ship your products if they have a life longer than one year and meet the following requirements.
- They qualify as property used in your business.
- Title to the containers does not pass to the buyer.
To determine if these requirements are met, consider the following questions.
- Does your sales contract, sales invoice, or other type of order acknowledgment indicate whether you have retained title?
- Does your invoice treat the containers as separate items?
- Do any of your records state your basis in the containers?
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/p946-001.htm#en_us_publink1000107317
To be depreciable, property must have a useful life that extends substantially beyond the year you place it in service.taxmap/pubs/p946-001.htm#en_us_publink1000107318
You maintain a library for use in your profession. You can depreciate it. However, if you buy technical books, journals, or information services for use in your business that have a useful life of one year or less, you cannot depreciate them. Instead, you deduct their cost as a business expense.