Depreciation
You recover your cost in income producing property through yearly tax deductions. You do this by depreciating the property; that is, by
deducting some of your cost on your 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.
Claiming the correct amount of depreciation.
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. 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. 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 Claiming the correct
amount of depreciation in Publication 527 for more information.
Changing your accounting method to deduct unclaimed depreciation.
If you claimed less depreciation than allowable in an earlier year, you can change your accounting method to take a deduction in the current year
for the unclaimed depreciation. To change your accounting method, you must have the consent of the IRS. In some instances, you can receive automatic
consent. For more information, see chapter 1 of Publication 946.
Land.
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 are not depreciable.
Depreciation Methods
There are three ways to figure depreciation. The depreciation method you use depends on the type of property and when the property 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, if placed in service
before 1981.
This chapter discusses MACRS only. If you need more information about depreciating property placed in service before 1987, see Publication 534.
If you placed property in service before 2002, continue to use the same method of figuring depreciation that you used in the past.
Section 179 election.
You cannot claim the section 179 deduction for property held to produce rental income. See chapter 2 of Publication 946.
No deduction greater than basis.
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.
Cooperative apartments.
If you are a tenant-stockholder in a cooperative housing corporation and rent your cooperative apartment to others, you can deduct depreciation for
the apartment even though it is owned by the corporation. Your depreciation deduction is your share of the corporation's depreciation. See
Cooperative apartments in Publication 527 for information on how to figure your depreciation deduction.
Special Depreciation Allowance
You can claim a special depreciation allowance for qualified property you placed in service after September 10, 2001. The allowance is a
depreciation deduction equal to 30% of the property's depreciable basis. The special depreciation allowance is figured before you calculate your regular MACRS deduction.
You must claim the special depreciation allowance for all qualified property. However, you can elect not to claim the allowance. If you make this
election for any property, it applies to all property in the same property class placed in service during the year. See Election Not To Claim the
Allowance in Publication 946 for more information.
Qualified property.
To qualify for the special depreciation allowance, your property must meet the following requirements.
- It must be new property that is depreciated under MACRS with a recovery period of 20 years or less.
- It must meet the following tests.
- Acquisition date test.
- Placed in service date test.
- Original use test.
Acquisition date test.
Generally, you must have acquired the property after September 10, 2001.
Placed in service date test.
Generally, the property must be placed in service for use in your trade or business or for the production of income after September 10, 2001, and
before January 1, 2005.
Original use test.
The original use of the property must have begun with you after September 10, 2001. Original use means the first use to which the property
is put, whether or not by you.
Example.
Dave bought and placed in service a new refrigerator ($700) for one of his residential rental properties in June of 2002. Dave notes that the
refrigerator has a 5-year recovery period (see Table 10-2.). Dave's refrigerator is qualifying property and he claims the special
depreciation allowance.
Dave determines the total depreciable basis of the property to be $700. Next, he multiplies this amount by 30% to figure his special depreciation
allowance deduction of $210 ($700 × 30%). This leaves an adjusted basis of $490 ($700 - $210), which he will use to figure his MACRS
deduction.
For more information, see Special Depreciation Allowance in Publication 946.
MACRS
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 main system is called the General Depreciation System
(GDS). The second system is called 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.
Personal home changed to rental use.
You must use MACRS to figure the depreciation on property you used as your home and changed to rental property in 2002.
Excluded property.
You cannot use MACRS for certain personal property placed in service in your rental property in 2002 if it had been previously placed in service
before MACRS became effective in 1987 (before August 1, 1986, if election made).
In addition, you may elect to exclude certain property from the application of MACRS. See Publication 946 for more information.
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.
Recovery periods for property used in rental activities are shown in Table 10-2.
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.
Additions or improvements to property.
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 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.
Example.
You own a residential rental house that you have been renting since 1986 and are depreciating under ACRS. You put an addition onto the house and
you placed it in service in 2002. You must use MACRS for the addition. Under MACRS, the addition would be depreciated as residential rental property
over 27.5 years.
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.
Cost Basis
To deduct the proper amount of depreciation each year, you must first determine your basis in the property you intend to depreciate. The basis used
for figuring depreciation is your original basis in the property increased by any additions or improvements made to the property. Your original basis
is usually your cost. However, if you acquire the property in some other way, such as by inheriting it, getting it as a gift, or building it yourself,
you may have to figure your original basis in another way. Other adjustments could also affect your basis. See chapter 14.
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.
Mid-month convention.
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.
Half-year convention.
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.
Mid-quarter convention.
A mid-quarter convention must be used if the mid-month convention does not apply and the total depreciable basis of MACRS property you 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 tax year.
Table 10-2. 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: Typewrites, Calculators, Copiers |
5 years |
6 years |
|
| Automobiles |
5 years |
5 years |
|
| Light trucks |
5 years |
5 years |
|
| Appliances, such as: Stoves Refrigerators |
5 years |
9 years |
|
| Carpets |
5 years |
9 years |
|
| Furniture used in rental property |
5 years |
9 years |
|
| Office furniture and equipment, such as: Desks, Files |
7 years |
10 years |
|
| Any property that does not have a class life and that has not been 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) and structural components such as furnaces, water pipes, venting, etc., |
27.5 years |
40 years |
|
| Additions and improvements, such as a new roof |
The recovery period 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. |
|
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.
Example.
During the tax year, Jordan Gregory purchased the following items to use in his rental property.
- 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.
Jordan uses the calendar year as his tax year. He elects not to claim the special depreciation allowance, discussed earlier. The total basis of all
property placed in service in 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). Jordan must use the mid-quarter convention instead of the half-year convention for all three items.
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:
- Use the percentage from the optional MACRS tables, see Table 10-3, or
- Actually figure the deduction using the depreciation method and convention that apply over the recovery period of the property.
Publication 946 discusses computing depreciation using the proper method and convention.
Table 10-3. Optional MACRS Tables
Table 10-3-A. MACRS 5-Year property
| |
Half-year
convention |
Mid-quarter convention |
| Year |
|
First quarter |
Second quarter |
Third quarter |
Fourth quarter |
1
2
3
4
5
6 |
20.00%
32.00
19.20
11.52
11.52
5.76 |
35.00%
26.00
15.60
11.01
11.01
1.38 |
25.00%
30.00
18.00
11.37
11.37
4.26 |
15.00%
34.00
20.40
12.24
11.30
7.06 |
5.00%
38.00
22.80
13.68
10.94
9.58 |
Table 10-3-B. MACRS 7-Year property
| |
Half-year
convention |
Mid-quarter convention |
| Year |
|
First quarter |
Second quarter |
Third quarter |
Fourth quarter |
1
2
3
4
5
6 |
14.29%
24.49
17.49
12.49
8.93
8.92 |
25.00%
21.43
15.31
10.93
8.75
8.74 |
17.85%
23.47
16.76
11.97
8.87
8.87 |
10.71%
25.51
18.22
13.02
9.30
8.85 |
3.57%
27.55
19.68
14.06
10.04
8.73 |
Table 10-3-C. MACRS 15-Year property
| |
Half-year
convention |
Mid-quarter convention |
| Year |
|
Second quarter |
First quarter |
Third quarter |
Forth quarter |
1
2
3
4
5
6 |
5.00%
9.50
8.55
7.70
6.93
6.23 |
8.75%
9.13
8.21
7.39
6.65
5.99 |
6.25%
9.38
8.44
7.59
6.83
6.15 |
3.75%
9.63
8.66
7.80
7.02
6.31 |
1.25%
9.88
8.89
8.00
7.20
6.48 |
Table 10-3-D. Residential Rental Property (27.5-year)
| |
|
Use the row for the month of the taxable year placed in service. |
| Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Year 6 |
| |
Jan.
Feb.
March
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec. |
|
3.485%
3.182
2.879
2.576
2.273
1.970
1.667
1.364
1.061
0.758
0.4555
0.152
|
|
3.636%
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636 |
|
3.636%
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636 |
|
3.636%
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636 |
|
3.636%
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636 |
|
3.636%
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636
3.636 |
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