Depreciation is a tax method that allows taxpayers to recover the cost or other basis of certain business or income-producing property over its useful life, as required under IRS rules. It reflects the gradual recovery of cost due to wear and tear, deterioration, or obsolescence. Depreciation applies primarily to tangible property used in a trade or business or held for the production of income, and it does not apply to land. Depreciation begins when the property is placed in service (ready and available for its assigned use in a trade or business or income-producing activity) and ends when the property is fully depreciated, disposed of, or no longer used in a business or income-producing capacity.
What Property Can Be Depreciated?
- Tangible property used in a trade or business or held for income production (e.g., machinery, equipment, buildings, vehicles, furniture).
- Certain improvements to property that have a determinable useful life.
- Property used partially for business or investment purposes: depreciation is allowed only for the business or income-producing portion.
- Intangible property is generally not depreciated; instead, it is amortized under specific IRC provisions (e.g., IRC §197 for certain acquired intangibles).
When Does Depreciation Begin and End?
- Begins: When the property is placed in service (ready and available for its designated business or income-producing use).
- Ends: When the property is fully recovered (basis fully depreciated), disposed of, or retired from service, whichever occurs first.
Basis Adjustments for Depreciation
- The basis of depreciable property must be reduced by the greater of:
- Depreciation allowed (amount actually claimed), or
- Depreciation allowable (amount that could have been claimed under applicable rules)
- If depreciation is not claimed when allowable, the basis is still reduced as if it had been claimed. If excess depreciation is claimed, basis is reduced only to the extent of depreciation properly allowable under the law.
Depreciation Methods and Rules
- MACRS (Modified Accelerated Cost Recovery System): The required system for most tangible depreciable property placed in service after 1986. It uses prescribed recovery periods and methods under the General Depreciation System (GDS) or Alternative Depreciation System (ADS).
- Recovery periods: Determined by asset class (e.g., 3-year, 5-year, 7-year, 27.5-year residential rental, 39-year nonresidential real property).
- Conventions: Apply rules such as half-year, mid-quarter, or mid-month depending on property type and timing of placement in service.
Special Depreciation Allowance (Bonus Depreciation)
The special depreciation allowance (bonus depreciation) is an additional first-year depreciation deduction allowed for qualified property under IRC §168(k), when applicable under current law.
- It applies to qualifying property such as:
- Tangible property with a recovery period of 20 years or less under MACRS
- Certain qualified improvement property
- Certain computer software and other eligible property as defined by statute
- The allowable percentage depends on the tax year and applicable federal law in effect for that year.
- It is generally taken after any Section 179 deduction and before regular MACRS depreciation.
Recapture of Depreciation
If depreciable property is disposed of, any gain may be treated as ordinary income to the extent of depreciation previously allowed or allowable under IRC §§1245 or 1250. This includes all depreciation deductions claimed (or that should have been claimed), not only special depreciation allowance amounts.
Correcting Depreciation Deductions
If depreciation was incorrectly reported, it may be corrected by filing an amended return (Form 1040-X) or by filing Form 3115 (Application for Change in Accounting Method) if required under IRS procedures.
Source:
Form 4562 Instructions
Publication 946: How to Depreciate Property
Disclaimer: Always verify details with current Federal or State Department of Revenue Forms and Instructions. For complex situations, consult a CPA or tax attorney.