Table of Contents
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How to figure the deduction
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Methods to use
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How to change methods
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Dispositions
Publication
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544 Sales and Other Dispositions of Assets
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551 Basis of Assets
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583 Starting a Business and Keeping Records
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946 How To Depreciate Property
Form (and Instructions)
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3115 Application for Change in Accounting Method
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4562 Depreciation and Amortization
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Schedule C (Form 1040) Profit or Loss From Business
If your property is being depreciated under ACRS, you must continue to use rules for depreciation that applied when you placed the property in service. If your property qualified for MACRS, you must depreciate it under MACRS. See Publication 946.
However, you cannot use MACRS for certain property because of special rules that exclude it from MACRS. Also, you can elect to exclude certain property from being depreciated under MACRS. Property that you cannot depreciate using MACRS includes:
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Intangible property,
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Property you can elect to exclude from MACRS that you properly depreciate under a method that is not based on a term of years,
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Certain public utility property,
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Any motion picture film or video tape,
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Any sound recording, and
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Certain real and personal property placed in service before 1987.
Note.
The cost of certain intangible property that you acquire after August 10, 1993, must be amortized over a 15-year period. For more information, see chapter 12 of Publication 535.
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The straight line method, or
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The income forecast method.
Two other reasonable methods can be used to figure your deduction for property not covered under ACRS or MACRS. These methods are straight line and declining balance.
To figure depreciation using these methods, you must generally determine three things about the property you intend to depreciate. They are:
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The basis,
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The useful life, and
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The estimated salvage value at the end of its useful life.
The amount of the deduction in any year also depends on which method of depreciation you choose.
To deduct the proper amount of depreciation each year, first determine your basis in the property you intend to depreciate. The basis used for figuring depreciation is the same as the basis that would be used for figuring the gain on a sale. Your original basis is usually the purchase price. However, if you acquire property in some other way, such as inheriting it, getting it as a gift, or building it yourself, you have to figure your original basis in a different way.
The useful life of a piece of property is an estimate of how long you can expect to use it in your trade or business, or to produce income. It is the length of time over which you will make yearly depreciation deductions of your basis in the property. It is how long it will continue to be useful to you, not how long the property will last.
Many things affect the useful life of property, such as:
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Frequency of use,
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Age when acquired,
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Your repair policy, and
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Environmental conditions.
The useful life can also be affected by technological improvements, progress in the arts, reasonably foreseeable economic changes, shifting of business centers, prohibitory laws, and other causes. Consider all these factors before you arrive at a useful life for your property.
The useful life of the same type of property varies from user to user. When you determine the useful life of your property, keep in mind your own experience with similar property. You can use the general experience of the industry you are in until you are able to determine a useful life of your property from your own experience.
It is important for you to accurately determine the correct salvage value of the property you want to depreciate. You generally cannot depreciate property below a reasonable salvage value.
Two methods of depreciation are the straight line and declining balance methods. If ACRS or MACRS does not apply, you can use one of these methods. The straight line and declining balance methods discussed in this section are not figured in the same way as straight line or declining balance methods under MACRS.
Before 1981, you could use any reasonable method for every kind of depreciable property. One of these methods was the straight line method. This method was also used for intangible property. It lets you deduct the same amount of depreciation each year.
To figure your deduction, determine the adjusted basis of your property, its salvage value, and its estimated useful life. Subtract the salvage value, if any, from the adjusted basis. The balance is the total amount of depreciation you can take over the useful life of the property.
Divide the balance by the number of years remaining in the useful life. This gives you the amount of 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.
Example.
In April 1994, Frank bought a franchise for $5,600. It expires in 10 years. This property is intangible property that cannot be depreciated under MACRS. Frank depreciates the franchise under the straight line method, using a 10-year useful life and no salvage value. He takes the $5,600 basis and divides that amount by 10 years ($5,600 ÷ 10 = $560, a full year's use). He must prorate the $560 for his 9 months of use in 1994. This gives him a deduction of $420 ($560 ÷ 9/12). In 1995, Frank can deduct $560 for the full year.
The declining balance method allows you to recover a larger amount of the cost of the property in the early years of your use of the property. The rate cannot be more than twice the straight line rate.
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Divide the number 1 by the useful life of your property to get a straight line rate. (For example, if property has a useful life of 5 years, its normal straight line rate of depreciation is ⅕, or 20%.)
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Multiply this straight line rate by a number that is more than 1 but not more than 2 to determine the declining balance rate.
Example.
If your adjusted basis has been decreased to $1,000 and the rate of depreciation is 20%, your depreciation deduction should be $200. But if your estimate of salvage value was $900, you can only deduct $100. This is because $100 is the amount that would lower your adjusted basis to equal salvage value.
The income forecast method requires income projections for each videocassette or group of videocassettes. You can group the videocassettes by title for making this projection. You determine the depreciation by applying a fraction to the cost less salvage value of the cassette. The numerator is the income from the videocassette for the tax year and the denominator is the total projected income for the cassette. For more information on the income forecast method, see Revenue Ruling 60-358 in Cumulative Bulletin 1960, Volume 2, on page 68.
In some cases, you may change your method of depreciation for property depreciated under a reasonable method. If you change your method of depreciation, it is generally a change in your method of accounting. You must get IRS consent before making the change. However, you do not need permission for certain changes in your method of depreciation. The rules discussed in this section do not apply to property depreciated under ACRS or MACRS.
For information on ACRS elections,see Revocation of election, in chapter 1 under Alternate ACRS Method.
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When you acquired the property,
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Its original cost or other original basis,
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The total amount claimed for depreciation and other allowances since you acquired it,
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Its salvage value and remaining useful life, and
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A description of the property and its use.
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Property or an account where you made a change in depreciation within the last 10 tax years (unless the change was made under the Class Life System),
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Class Life Asset Depreciation Range System, and
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Public utility property.
Retirement is the permanent withdrawal of depreciable property from use in your trade or business or for the production of income. You can do this by selling, exchanging, or abandoning the item of property. You can also withdraw it from use without disposing of it. For example, you could place it in a supplies or scrap account. Retirements can be either normal or abnormal depending on all facts and circumstances. The rules discussed next do not apply to MACRS and ACRS property.
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The retirement is made within the useful life you estimated originally, and
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The property has reached a condition at which you customarily retire or would retire similar property from use.
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An abnormal retirement,
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A normal retirement from a single property account in which you determined the life of each item of property separately, or
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A normal retirement from a multiple property account in which the depreciation rate is based on the maximum expected life of the longest lived item of property and the loss occurs before the expiration of the full useful life. However, you are not allowed a loss if the depreciation rate is based on the average useful life of the items of property in the account.
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You account for each one in a separate account, and
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You use the average useful life to figure depreciation.
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