Words you may need to know (see Glossary)
- Adjusted basis
- Intangible property
- Nonresidential real property
- Placed in service
- Related persons
- Residential rental property
- Salvage value
- Section 1245 property
- Section 1250 property
- Standard mileage rate
- Straight line method
- Unit-of-production method
- Useful life
You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most property. MACRS is discussed in chapter 4.
You cannot use MACRS to depreciate the following property.
- Property you placed in service before 1987.
- Certain property owned or used in 1986.
- Intangible property.
- Films, video tapes, and recordings.
- Certain corporate or partnership property acquired in a nontaxable transfer.
- Property you elected to exclude from MACRS.
The following discussions describe the property listed above and explain what depreciation method should be used.
You cannot use MACRS for property you placed in service before 1987 (except property you placed in service after July 31, 1986, if MACRS was elected). Property placed in service before 1987 must be depreciated under the methods discussed in Publication 534.
For a discussion of when property is placed in service, see When Does Depreciation Begin and End, earlier.taxmap/pubs/p946-004.htm#en_us_publink1000107339
You generally must use MACRS to depreciate real property that you acquired for personal use before 1987 and changed to business or income-producing use after 1986. taxmap/pubs/p946-004.htm#en_us_publink1000107340
You must treat an improvement made after 1986 to property you placed in service before 1987 as separate depreciable property. Therefore, you can depreciate that improvement as separate property under MACRS if it is the type of property that otherwise qualifies for MACRS depreciation. For more information about improvements, see How Do You Treat Repairs and Improvements, later and Additions and Improvements under Which Recovery Period Applies in chapter 4.taxmap/pubs/p946-004.htm#en_us_publink1000107341
You may not be able to use MACRS for property you acquired and placed in service after 1986 if any of the situations described below apply. If you cannot use MACRS, the property must be depreciated under the methods discussed in Publication 534.
For the following discussions, do not treat property as owned before you placed it in service. If you owned property in 1986 but did not place it in service until 1987, you do not treat it as owned in 1986.
You cannot use MACRS for personal property (section 1245 property) in any of the following situations.
- You or someone related to you owned or used the property in 1986.
- You acquired the property from a person who owned it in 1986 and as part of the transaction the user of the property did not change.
- You lease the property to a person (or someone related to this person) who owned or used the property in 1986.
- You acquired the property in a transaction in which:
- The user of the property did not change, and
- The property was not MACRS property in the hands of the person from whom you acquired it because of (2) or (3) above.
You generally cannot use MACRS for real property (section 1250 property) in any of the following situations.
- You or someone related to you owned the property in 1986.
- You lease the property to a person who owned the property in 1986 (or someone related to that person).
- You acquired the property in a like-kind exchange, involuntary conversion, or repossession of property you or someone related to you owned in 1986. MACRS applies only to that part of your basis in the acquired property that represents cash paid or unlike property given up. It does not apply to the carried-over part of the basis.
The rules above do not apply to the following.
- Residential rental property or nonresidential real property.
- Any property if, in the first tax year it is placed in service, the deduction under the Accelerated Cost Recovery System (ACRS) is more than the deduction under MACRS using the half-year convention. For information on how to figure depreciation under ACRS, see Publication 534.
- Property that was MACRS property in the hands of the person from whom you acquired it because of (2) above.
For this purpose, the following are related persons.
- An individual and a member of his or her family, including only a spouse, child, parent, brother, sister, half-brother, half-sister, ancestor, and lineal descendant.
- A corporation and an individual who directly or indirectly owns more than 10% of the value of the outstanding stock of that corporation.
- Two corporations that are members of the same controlled group.
- A trust fiduciary and a corporation if more than 10% of the value of the outstanding stock is directly or indirectly owned by or for the trust or grantor of the trust.
- The grantor and fiduciary, and the fiduciary and beneficiary, of any trust.
- The fiduciaries of two different trusts, and the fiduciaries and beneficiaries of two different trusts, if the same person is the grantor of both trusts.
- A tax-exempt educational or charitable organization and any person (or, if that person is an individual, a member of that person's family) who directly or indirectly controls the organization.
- Two S corporations, and an S corporation and a regular corporation, if the same persons own more than 10% of the value of the outstanding stock of each corporation.
- A corporation and a partnership if the same persons own both of the following.
- More than 10% of the value of the outstanding stock of the corporation.
- More than 10% of the capital or profits interest in the partnership.
- The executor and beneficiary of any estate.
- A partnership and a person who directly or indirectly owns more than 10% of the capital or profits interest in the partnership.
- Two partnerships, if the same persons directly or indirectly own more than 10% of the capital or profits interest in each.
- The related person and a person who is engaged in trades or businesses under common control. See section 52(a) and 52(b) of the Internal Revenue Code.
You must determine whether you are related to another person at the time you acquire the property.
A partnership acquiring property from a terminating partnership must determine whether it is related to the terminating partnership immediately before the event causing the termination. For this rule, a terminating partnership is one that sells or exchanges, within 12 months, 50% or more of its total interest in partnership capital or profits. taxmap/pubs/p946-004.htm#en_us_publink1000107348
To determine whether a person directly or indirectly owns any of the outstanding stock of a corporation or an interest in a partnership, apply the following rules.
- Stock or a partnership interest directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its shareholders, partners, or beneficiaries. However, for a partnership interest owned by or for a C corporation, this applies only to shareholders who directly or indirectly own 5% or more of the value of the stock of the corporation.
- An individual is considered to own the stock or partnership interest directly or indirectly owned by or for the individual's family.
- An individual who owns, except by applying rule (2), any stock in a corporation is considered to own the stock directly or indirectly owned by or for the individual's partner.
- For purposes of rules (1), (2), or (3), stock or a partnership interest considered to be owned by a person under rule (1) is treated as actually owned by that person. However, stock or a partnership interest considered to be owned by an individual under rule (2) or (3) is not treated as owned by that individual for reapplying either rule (2) or (3) to make another person considered to be the owner of the same stock or partnership interest.
Generally, if you can depreciate intangible property, you usually use the straight line method of depreciation. However, you can choose to depreciate certain intangible property under the income forecast method (discussed later).
You cannot depreciate intangible property that is a section 197 intangible or that otherwise does not meet all the requirements discussed earlier under What Property Can Be Depreciated.
This method lets you deduct the same amount of depreciation each year over the useful life of the property. To figure your deduction, first determine the adjusted basis, salvage value, and estimated useful life of your property. Subtract the salvage value, if any, from the adjusted basis. The balance is the total depreciation you can take over the useful life of the property.
Divide the balance by the number of years in the useful life. This gives you your yearly depreciation deduction. Unless there is a big change in adjusted basis or useful life, this amount will stay the same throughout the time you depreciate the property. If, in the first year, you use the property for less than a full year, you must prorate your depreciation deduction for the number of months in use. taxmap/pubs/p946-004.htm#en_us_publink1000107352
In April, Frank bought a patent for $5,100 that is not a section 197 intangible. He depreciates the patent under the straight line method, using a 17-year useful life and no salvage value. He divides the $5,100 basis by 17 years to get his $300 yearly depreciation deduction. He only used the patent for 9 months during the first year, so he multiplies $300 by 9/12 to get his deduction of $225 for the first year. Next year, Frank can deduct $300 for the full year.taxmap/pubs/p946-004.htm#en_us_publink1000107353
If you can depreciate the cost of a patent or copyright, use the straight line method over the useful life. The useful life of a patent or copyright is the lesser of the life granted to it by the government or the remaining life when you acquire it. However, if the patent or copyright becomes valueless before the end of its useful life, you can deduct in that year any of its remaining cost or other basis. taxmap/pubs/p946-004.htm#en_us_publink1000107354
Computer software is a section 197 intangible and cannot be depreciated if you acquired it in connection with the acquisition of assets constituting a business or a substantial part of a business.
However, computer software is not a section 197 intangible and can be depreciated, 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 may also qualify for the section 179 deduction and the special depreciation allowance, discussed later. If you can depreciate the cost of computer software, use the straight line method over a useful life of 36 months. taxmap/pubs/p946-004.htm#en_us_publink1000107355
The useful life of computer software leased under a lease agreement entered into after March 12, 2004, to a tax-exempt organization, governmental unit, or foreign person or entity (other than a partnership), cannot be less than 125% of the lease term.taxmap/pubs/p946-004.htm#en_us_publink1000107356
You can amortize certain intangibles created on or after December 30, 2003, over a 15-year period using the straight line method and no salvage value, even though they have a useful life that cannot be estimated with reasonable accuracy. For example, amounts paid to acquire memberships or privileges of indefinite duration, such as a trade association membership, are eligible costs.
The following are not eligible.
- Any intangible asset acquired from another person.
- Created financial interests.
- Any intangible asset that has a useful life that can be estimated with reasonable accuracy.
- Any intangible asset that has an amortization period or limited useful life that is specifically prescribed or prohibited by the Code, regulations, or other published IRS guidance.
- Any amount paid to facilitate an acquisition of a trade or business, a change in the capital structure of a business entity, and certain other transactions.
You must also increase the 15-year safe harbor amortization period to a 25-year period for certain intangibles related to benefits arising from the provision, production, or improvement of real property. For this purpose, real property includes property that will remain attached to the real property for an indefinite period of time, such as roads, bridges, tunnels, pavements, and pollution control facilities. taxmap/pubs/p946-004.htm#en_us_publink1000107357
You can choose to use the income forecast method instead of the straight line method to depreciate the following depreciable intangibles.
- Motion picture films or video tapes.
- Sound recordings.
Under the income forecast method, each year's depreciation deduction is equal to the cost, less salvage value, of the property, multiplied by a fraction. The numerator of the fraction is the current year's net income from the property, and the denominator is the total income anticipated from the property through the end of the 10th taxable year following the taxable year the property is placed in service. For more information, see section 167(g) of the Internal Revenue Code.taxmap/pubs/p946-004.htm#en_us_publink1000107358
You can elect to amortize all applicable expenses paid or incurred in the current year in creating or acquiring musical compositions or copyrights to musical compositions placed in service during the tax year instead of using the income forecast method. If you make the election, amortize the expenses ratably over a 5-year period beginning with the month the property is placed in service. This election does not apply to the following.
- Expenses that are qualified creative expenses under section 263A(h),
- Property to which a simplified procedure established under section 263A(i)(2) applies,
- Property that is an amortizable section 197 intangible, or
- Expenses that would not be allowable as a deduction.
For more information, see section 167(g)(8) of the Internal Revenue Code.
You cannot use MACRS for motion picture films, video tapes, and sound recordings. For this purpose, sound recordings are discs, tapes, or other phonorecordings resulting from the fixation of a series of sounds. You can depreciate this property using either the straight line method or the income forecast method. taxmap/pubs/p946-004.htm#en_us_publink1000107360
You can include participations and residuals in the adjusted basis of the property for purposes of computing your depreciation deduction under the income forecast method. The participations and residuals must relate to income to be derived from the property before the end of the 10th taxable year after the property is placed in service. For this purpose, participations and residuals are defined as costs which by contract vary with the amount of income earned in connection with the property.
Instead of including these amounts in the adjusted basis of the property, you can deduct the costs in the taxable year that they are paid. taxmap/pubs/p946-004.htm#en_us_publink1000107361
If you are in the business of renting videocassettes, you can depreciate only those videocassettes bought for rental. If the videocassette has a useful life of one year or less, you can currently deduct the cost as a business expense. taxmap/pubs/p946-004.htm#en_us_publink1000107362
MACRS does not apply to property used before 1987 and transferred after 1986 to a corporation or partnership (except property the transferor placed in service after July 31, 1986, if MACRS was elected) to the extent its basis is carried over from the property's adjusted basis in the transferor's hands. You must continue to use the same depreciation method as the transferor and figure depreciation as if the transfer had not occurred. However, if MACRS would otherwise apply, you can use it to depreciate the part of the property's basis that exceeds the carried-over basis.
The nontaxable transfers covered by this rule include the following.
- A distribution in complete liquidation of a subsidiary.
- A transfer to a corporation controlled by the transferor.
- An exchange of property solely for corporate stock or securities in a reorganization.
- A contribution of property to a partnership in exchange for a partnership interest.
- A partnership distribution of property to a partner.
If you can properly depreciate any property under a method not based on a term of years, such as the unit-of-production method, you can elect to exclude that property from MACRS. You make the election by reporting your depreciation for the property on line 15 in Part II of Form 4562 and attaching a statement as described in the instructions for Form 4562. You must make this election by the return due date (including extensions) for the tax year you place your property in service. However, if you timely filed your return for the year without making the election, you can still 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. File the amended return at the same address you filed the original return. taxmap/pubs/p946-004.htm#en_us_publink1000107364
If you use the standard mileage rate to figure your tax deduction for your business automobile, you are treated as having made an election to exclude the automobile from MACRS. See Publication 463 for a discussion of the standard mileage rate.