IRS Publication 946 How to Depreciate Property for Business Owners

IRS Publication 946 is a valuable resource for business owners looking to depreciate property. It provides a comprehensive guide on how to calculate depreciation and claim it on tax returns.

The publication explains that depreciation is the decrease in value of property over time due to wear and tear, obsolescence, or other factors. This decrease in value is spread over the property's useful life.

Business owners can use the Modified Accelerated Cost Recovery System (MACRS) to depreciate property, which allows for faster depreciation in the early years of ownership.

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Depreciation ends when you dispose of an asset or reach the end of its recovery period.

You must stop claiming depreciation when the cumulative depreciation you've claimed over the years equals your original cost or other basis in the property, or when you stop using the asset in your business.

The recovery period for most assets is determined by the Modified Accelerated Cost Recovery System (MACRS), which is discussed in chapter 4 of IRS Publication 946.

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Here are the class lives for different types of assets:

You can use percentage tables to calculate depreciation, such as Table A-1 and Table A-2 in Appendix A of IRS Publication 946.

You stop depreciating property when you have fully recovered your cost or other basis, which includes your section 179 deduction, allowed or allowable depreciation deductions, and salvage value, if applicable.

You can use MACRS to depreciate most property, but there are some exceptions, such as property placed in service before 1987, certain property owned or used in 1986, and intangible property.

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You must choose a depreciation method that's permissible by the IRS. This method is fixed at the time you place the asset into service and must be followed as long as you own the property.

You can't create your own system, and you must choose one of the methods offered by the IRS. For example, you can't choose to depreciate your computer over three years if the IRS mandates a five-year period.

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You can't use MACRS to depreciate certain property, including property placed in service before 1987, certain corporate or partnership property acquired in a nontaxable transfer, and property you elected to exclude from MACRS.

Here are some examples of property that can't be depreciated using MACRS:

Depreciation ends when you dispose of an asset or reach the end of its recovery period, whichever happens first.

You must stop claiming depreciation when the cumulative depreciation you've claimed over the years is equal to your original cost or other basis in the property.

The recovery period is the time it takes for an asset to be fully depreciated, and it varies depending on the type of asset, but some common recovery periods include 3, 5, or 7 years.

You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income.

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The asset depreciation period is a crucial aspect of depreciation, and it's essential to understand how it works. You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income. This is when depreciation starts, as per Example 3.

The depreciation period can vary depending on the type of property and its class life. For instance, a tractor has a 5-year class life, as mentioned in Example 2. This means you can depreciate it over a period of 5 years.

You can use Percentage Tables to calculate depreciation, which are available in Appendix A of IRS Publication 946, How to Depreciate Property. These tables provide percentages to calculate the annual depreciation over a property's class life to recover the cost of 3-, 5-, 7-, 10-, 15-, and 20-year property using 200 percent declining balance, as shown in Table A-1 in Example 2.

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The depreciation period also depends on the convention used. For example, if you purchased a property in May, you would use the half-year convention, as mentioned in Example 2. This means you would treat the property as if you owned it for half of the final year.

You stop depreciating property when you have fully recovered your cost or other basis, or when you retire it from service, whichever happens first. This is when depreciation ends, as per Example 3.

Here are the class lives for different types of property:

This table is based on the information provided in the article section examples and is a helpful reference for determining the class life of different types of property.

You can continue to claim a deduction for depreciation on property used in your business even if it's temporarily idle.

Depreciation can be claimed on property used in a business or for the production of income, even if it's not being used at the moment.

For instance, if you stop using a machine because there's a temporary lack of a market for a product made with that machine, you can still deduct depreciation on the machine.

The key is to have a clear understanding of your business's needs and how to apply depreciation rules accordingly.

You should keep track of your property's basis and depreciation period to ensure you're taking the correct deductions.

If you're unsure about how to apply depreciation rules to your business, it's always a good idea to consult with a tax professional.

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To qualify, the assets must be in the same class, have the same recovery period, and use the same depreciation method. For example, if you purchase five computers to use in your business, you can create a general asset account for them.

You can't include a desk in the same asset group as computers, even if you purchase them together, because the recovery periods are different. If you place assets into a general asset account, you'll treat all the assets in the group as a single asset for depreciation purposes.

Here's a quick rundown of the requirements for creating a general asset account:

MACRS is required for most property, but there are some exceptions. If you placed property in service before 1987, you can't use MACRS to depreciate it.

You'll also need to find a different method for certain property owned or used in 1986, such as intangible property, films, video tapes, and recordings.

If you acquired property in a nontaxable transfer or elected to exclude it from MACRS, you'll need to choose a different depreciation method.

You can use MACRS for most other types of property, but it's essential to review the specific rules and exceptions to ensure you're using the correct method.

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You can combine similar assets into groups to simplify depreciation recordkeeping and reporting.

The IRS allows you to create a "general asset account" if you place more than one asset of the same type into service during the year, and the assets meet certain conditions.

To qualify for a general asset account, the assets must be in the same class, with the same recovery period, and use the same depreciation method.

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If you purchase multiple assets of the same type, you can create a general asset account for them, such as five computers.

However, you cannot include different types of assets in the same group, like a desk with computers.

If you place assets into a general asset group, you will treat all the assets in the group as a single asset for depreciation purposes.

This can cause problems if you sell one, but not all, of the assets in the group before the end of the recovery period.

You might have to recognize the full amount of the sales price as ordinary income, rather than the sales price minus the tax basis of the item.

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Depreciation calculation can be a complex process, but it's essential to understand how to do it correctly to avoid any issues with the IRS. You can use percentage tables to calculate depreciation, which are available in Appendix A of IRS Publication 946, How to Depreciate Property.

Tax preparation software often incorporates these tables or formulas to calculate allowable depreciation amounts. Stand-alone depreciation schedules created by capital management software also use these tables or formulas.

Armand purchased a tractor in May 2018 for $200,000, and he used Table A-1 to calculate his allowable depreciation because of the half-year convention. He found that he's allowed 19.20 percent of the original cost or $38,400 for the third year.

To calculate depreciation, you need to know the class life of the property and the year it was placed in service. The class life is the number of years it takes to recover the cost of the property, and it's determined by the type of property.

For example, a 5-year property has a class life of 5 years, while a 20-year property has a class life of 20 years. You can find the class life of your property in the IRS tables or by consulting with a tax professional.

Here's a table showing the class life of different types of property:

You must use a permissible method to depreciate your property, and you can't create your own system. The depreciation method is fixed at the time you first place the asset into service, and you must follow the rules or tables in effect for that year.

For example, if you purchased a computer in 2018, you would use the 5-year property table to calculate depreciation, even if you know the computer will be obsolete and replaced within three years.

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You can depreciate property that lasts more than a year, such as a library for your profession.

However, if you buy technical books, journals, or information services that have a useful life of 1 year or less, you can't depreciate them.

You'll need to deduct their cost as a business expense instead.

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The Alternative Depreciation System (ADS) is a necessary option for some taxpayers. It allows for a longer recovery period, which can reduce the annual depreciation deduction.

The ADS method can be used for most tangible property, including vehicles and equipment. This can be beneficial for businesses with a large fleet of vehicles or equipment that have a long lifespan.

The ADS method also allows for a 20-year recovery period for certain types of property, such as computers and software. This can be particularly useful for businesses that rely heavily on technology.

The ADS method can be more beneficial than the Modified Accelerated Cost Recovery System (MACRS) for certain types of property. This is because it allows for a longer recovery period, which can reduce the annual depreciation deduction.

Businesses with a large investment in tangible property may find the ADS method to be a more attractive option. This can help to reduce their tax liability and improve their cash flow.

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If you're planning to depreciate property, there are some exceptions you should be aware of. Property placed in service and disposed of in the same year cannot be depreciated.

You must add otherwise allowable depreciation on equipment used to build capital improvements to the basis of your improvements. This is in addition to the Uniform Capitalization Rules, which are explained in Pub. 551.

Section 197 intangibles, such as certain computer software, must be amortized, not depreciated. If it's not a Section 197 intangible, it can be depreciated if it meets certain requirements.

Certain term interests in property are also excepted from depreciation. If the holder of the remainder interest is related to you, you must reduce your basis in the term interest by any depreciation not allowed.

Here are some specific scenarios where the rules don't apply:

You can continue to claim a deduction for depreciation on property used in your business or for the production of income even if it's temporarily idle.

If you stop using a machine because there's a temporary lack of a market for a product made with that machine, you should still deduct depreciation on the machine.

You don't have to stop depreciating property just because it's not in use right now.

You place property in service when it's ready and available for a specific use, whether in a business, income-producing, tax-exempt, or personal activity. This is true even if you're not using the property, as long as it's ready to go.

Consider Donald Steep, who bought a machine for his business that wasn't installed and operational until this year. It's considered placed in service this year, not last year, because it was ready and available for use when it was delivered.

You can begin to depreciate property when it's placed in service, but only if it's used in a business or income-producing activity. If you place property in service in a personal activity, you can't claim depreciation. However, if you change the property's use to a business or income-producing activity, you can begin to depreciate it at the time of the change.

For example, if you bought a home and used it as your personal home before converting it to rental property, you can begin to claim depreciation in the year you made the change.

Here are some key dates to keep in mind:

Depreciation is a process of allocating the cost of assets over their useful life. You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income.

Depreciation ends when you dispose of an asset or you reach the end of the asset's recovery period, whichever comes first. This is an important rule to follow, as continuing to depreciate property beyond its recovery period is not permitted, except for luxury cars.

You can use the Modified Accelerated Cost Recovery System (MACRS) to depreciate your property, but there are some exceptions. For example, you cannot use MACRS to depreciate property you placed in service before 1987, or certain property owned or used in 1986.

The IRS provides tables and formulas to help calculate depreciation. For example, Table A-1 in IRS Publication 946 provides percentages to calculate the annual depreciation over a property's class life to recover the cost of 3-, 5-, 7-, 10-, 15-, and 20-year property using 200 percent declining balance.

Here are some key points to keep in mind: