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Free file alliance 9. Free file alliance   Depletion Table of Contents Introduction Topics - This chapter discusses: Who Can Claim Depletion? Mineral PropertyCost Depletion Percentage Depletion Oil and Gas Wells Mines and Geothermal Deposits Lessor's Gross Income TimberTimber units. Free file alliance Depletion unit. Free file alliance Introduction Depletion is the using up of natural resources by mining, drilling, quarrying stone, or cutting timber. Free file alliance The depletion deduction allows an owner or operator to account for the reduction of a product's reserves. Free file alliance There are two ways of figuring depletion: cost depletion and percentage depletion. Free file alliance For mineral property, you generally must use the method that gives you the larger deduction. Free file alliance For standing timber, you must use cost depletion. Free file alliance Topics - This chapter discusses: Who can claim depletion Mineral property Timber Who Can Claim Depletion? If you have an economic interest in mineral property or standing timber, you can take a deduction for depletion. Free file alliance More than one person can have an economic interest in the same mineral deposit or timber. Free file alliance In the case of leased property, the depletion deduction is divided between the lessor and the lessee. Free file alliance You have an economic interest if both the following apply. Free file alliance You have acquired by investment any interest in mineral deposits or standing timber. Free file alliance You have a legal right to income from the extraction of the mineral or cutting of the timber to which you must look for a return of your capital investment. Free file alliance A contractual relationship that allows you an economic or monetary advantage from products of the mineral deposit or standing timber is not, in itself, an economic interest. Free file alliance A production payment carved out of, or retained on the sale of, mineral property is not an economic interest. Free file alliance Individuals, corporations, estates, and trusts who claim depletion deductions may be liable for alternative minimum tax. Free file alliance Basis adjustment for depletion. Free file alliance   You must reduce the basis of your property by the depletion allowed or allowable, whichever is greater. Free file alliance Mineral Property Mineral property includes oil and gas wells, mines, and other natural deposits (including geothermal deposits). Free file alliance For this purpose, the term “property” means each separate interest you own in each mineral deposit in each separate tract or parcel of land. Free file alliance You can treat two or more separate interests as one property or as separate properties. Free file alliance See section 614 of the Internal Revenue Code and the related regulations for rules on how to treat separate mineral interests. Free file alliance There are two ways of figuring depletion on mineral property. Free file alliance Cost depletion. Free file alliance Percentage depletion. Free file alliance Generally, you must use the method that gives you the larger deduction. Free file alliance However, unless you are an independent producer or royalty owner, you generally cannot use percentage depletion for oil and gas wells. Free file alliance See Oil and Gas Wells , later. Free file alliance Cost Depletion To figure cost depletion you must first determine the following. Free file alliance The property's basis for depletion. Free file alliance The total recoverable units of mineral in the property's natural deposit. Free file alliance The number of units of mineral sold during the tax year. Free file alliance Basis for depletion. Free file alliance   To figure the property's basis for depletion, subtract all the following from the property's adjusted basis. Free file alliance Amounts recoverable through: Depreciation deductions, Deferred expenses (including deferred exploration and development costs), and Deductions other than depletion. Free file alliance The residual value of land and improvements at the end of operations. Free file alliance The cost or value of land acquired for purposes other than mineral production. Free file alliance Adjusted basis. Free file alliance   The adjusted basis of your property is your original cost or other basis, plus certain additions and improvements, and minus certain deductions such as depletion allowed or allowable and casualty losses. Free file alliance Your adjusted basis can never be less than zero. Free file alliance See Publication 551, Basis of Assets, for more information on adjusted basis. Free file alliance Total recoverable units. Free file alliance   The total recoverable units is the sum of the following. Free file alliance The number of units of mineral remaining at the end of the year (including units recovered but not sold). Free file alliance The number of units of mineral sold during the tax year (determined under your method of accounting, as explained next). Free file alliance   You must estimate or determine recoverable units (tons, pounds, ounces, barrels, thousands of cubic feet, or other measure) of mineral products using the current industry method and the most accurate and reliable information you can obtain. Free file alliance You must include ores and minerals that are developed, in sight, blocked out, or assured. Free file alliance You must also include probable or prospective ores or minerals that are believed to exist based on good evidence. Free file alliance But see Elective safe harbor for owners of oil and gas property , later. Free file alliance Number of units sold. Free file alliance   You determine the number of units sold during the tax year based on your method of accounting. Free file alliance Use the following table to make this determination. Free file alliance    IF you  use . Free file alliance . Free file alliance . Free file alliance THEN the units sold during the year are . Free file alliance . Free file alliance . Free file alliance The cash method of accounting The units sold for which you receive payment during the tax year (regardless of the year of sale). Free file alliance An accrual method of accounting The units sold based on your inventories and method of accounting for inventory. Free file alliance   The number of units sold during the tax year does not include any for which depletion deductions were allowed or allowable in earlier years. Free file alliance Figuring the cost depletion deduction. Free file alliance   Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you can figure your cost depletion deduction by taking the following steps. Free file alliance Step Action Result 1 Divide your property's basis for depletion by total recoverable units. Free file alliance Rate per unit. Free file alliance 2 Multiply the rate per unit by units sold during the tax year. Free file alliance Cost depletion deduction. Free file alliance You must keep accounts for the depletion of each property and adjust these accounts each year for units sold and depletion claimed. Free file alliance Elective safe harbor for owners of oil and gas property. Free file alliance   Instead of using the method described earlier to determine the total recoverable units, you can use an elective safe harbor. Free file alliance If you choose the elective safe harbor, the total recoverable units equal 105% of a property's proven reserves (both developed and undeveloped). Free file alliance For details, see Revenue Procedure 2004-19 on page 563 of Internal Revenue Bulletin 2004-10, available at www. Free file alliance irs. Free file alliance gov/pub/irs-irbs/irb04-10. Free file alliance pdf. Free file alliance   To make the election, attach a statement to your timely filed (including extensions) original return for the first tax year for which the safe harbor is elected. Free file alliance The statement must indicate that you are electing the safe harbor provided by Revenue Procedure 2004-19. Free file alliance The election, if made, is effective for the tax year in which it is made and all later years. Free file alliance It cannot be revoked for the tax year in which it is elected, but may be revoked in a later year. Free file alliance Once revoked, it cannot be re-elected for the next 5 years. Free file alliance Percentage Depletion To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the tax year. Free file alliance The rates to be used and other rules for oil and gas wells are discussed later under Independent Producers and Royalty Owners and under Natural Gas Wells . Free file alliance Rates and other rules for percentage depletion of other specific minerals are found later in Mines and Geothermal Deposits . Free file alliance Gross income. Free file alliance   When figuring percentage depletion, subtract from your gross income from the property the following amounts. Free file alliance Any rents or royalties you paid or incurred for the property. Free file alliance The part of any bonus you paid for a lease on the property allocable to the product sold (or that otherwise gives rise to gross income) for the tax year. Free file alliance A bonus payment includes amounts you paid as a lessee to satisfy a production payment retained by the lessor. Free file alliance   Use the following fraction to figure the part of the bonus you must subtract. Free file alliance No. Free file alliance of units sold in the tax year Recoverable units from the property × Bonus Payments For oil and gas wells and geothermal deposits, more information about the definition of gross income from the property is under Oil and Gas Wells , later. Free file alliance For other property, more information about the definition of gross income from the property is under Mines and Geothermal Deposits , later. Free file alliance Taxable income limit. Free file alliance   The percentage depletion deduction generally cannot be more than 50% (100% for oil and gas property) of your taxable income from the property figured without the depletion deduction and the domestic production activities deduction. Free file alliance   Taxable income from the property means gross income from the property minus all allowable deductions (except any deduction for depletion or domestic production activities) attributable to mining processes, including mining transportation. Free file alliance These deductible items include, but are not limited to, the following. Free file alliance Operating expenses. Free file alliance Certain selling expenses. Free file alliance Administrative and financial overhead. Free file alliance Depreciation. Free file alliance Intangible drilling and development costs. Free file alliance Exploration and development expenditures. Free file alliance Deductible taxes (see chapter 5), but not taxes that you capitalize or take as a credit. Free file alliance Losses sustained. Free file alliance   The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit. Free file alliance Do not deduct any net operating loss deduction from the gross income from the property. Free file alliance Corporations do not deduct charitable contributions from the gross income from the property. Free file alliance If, during the year, you dispose of an item of section 1245 property that was used in connection with mineral property, reduce any allowable deduction for mining expenses by the part of any gain you must report as ordinary income that is allocable to the mineral property. Free file alliance See section 1. Free file alliance 613-5(b)(1) of the regulations for information on how to figure the ordinary gain allocable to the property. Free file alliance Oil and Gas Wells You cannot claim percentage depletion for an oil or gas well unless at least one of the following applies. Free file alliance You are either an independent producer or a royalty owner. Free file alliance The well produces natural gas that is either sold under a fixed contract or produced from geopressured brine. Free file alliance If you are an independent producer or royalty owner, see Independent Producers and Royalty Owners , next. Free file alliance For information on the depletion deduction for wells that produce natural gas that is either sold under a fixed contract or produced from geopressured brine, see Natural Gas Wells , later. Free file alliance Independent Producers and Royalty Owners If you are an independent producer or royalty owner, you figure percentage depletion using a rate of 15% of the gross income from the property based on your average daily production of domestic crude oil or domestic natural gas up to your depletable oil or natural gas quantity. Free file alliance However, certain refiners, as explained next, and certain retailers and transferees of proven oil and gas properties, as explained next, cannot claim percentage depletion. Free file alliance For information on figuring the deduction, see Figuring percentage depletion , later. Free file alliance Refiners who cannot claim percentage depletion. Free file alliance   You cannot claim percentage depletion if you or a related person refine crude oil and you and the related person refined more than 75,000 barrels on any day during the tax year based on average (rather than actual) daily refinery runs for the tax year. Free file alliance The average daily refinery run is computed by dividing total refinery runs for the tax year by the total number of days in the tax year. Free file alliance Related person. Free file alliance   You and another person are related persons if either of you holds a significant ownership interest in the other person or if a third person holds a significant ownership interest in both of you. Free file alliance For example, a corporation, partnership, estate, or trust and anyone who holds a significant ownership interest in it are related persons. Free file alliance A partnership and a trust are related persons if one person holds a significant ownership interest in each of them. Free file alliance For purposes of the related person rules, significant ownership interest means direct or indirect ownership of 5% or more in any one of the following. Free file alliance The value of the outstanding stock of a corporation. Free file alliance The interest in the profits or capital of a partnership. Free file alliance The beneficial interests in an estate or trust. Free file alliance Any interest owned by or for a corporation, partnership, trust, or estate is considered to be owned directly both by itself and proportionately by its shareholders, partners, or beneficiaries. Free file alliance Retailers who cannot claim percentage depletion. Free file alliance   You cannot claim percentage depletion if both the following apply. Free file alliance You sell oil or natural gas or their by-products directly or through a related person in any of the following situations. Free file alliance Through a retail outlet operated by you or a related person. Free file alliance To any person who is required under an agreement with you or a related person to use a trademark, trade name, or service mark or name owned by you or a related person in marketing or distributing oil, natural gas, or their by-products. Free file alliance To any person given authority under an agreement with you or a related person to occupy any retail outlet owned, leased, or controlled by you or a related person. Free file alliance The combined gross receipts from sales (not counting resales) of oil, natural gas, or their by-products by all retail outlets taken into account in (1) are more than $5 million for the tax year. Free file alliance   For the purpose of determining if this rule applies, do not count the following. Free file alliance Bulk sales (sales in very large quantities) of oil or natural gas to commercial or industrial users. Free file alliance Bulk sales of aviation fuels to the Department of Defense. Free file alliance Sales of oil or natural gas or their by-products outside the United States if none of your domestic production or that of a related person is exported during the tax year or the prior tax year. Free file alliance Related person. Free file alliance   To determine if you and another person are related persons, see Related person under Refiners who cannot claim percentage depletion, earlier. Free file alliance Sales through a related person. Free file alliance   You are considered to be selling through a related person if any sale by the related person produces gross income from which you may benefit because of your direct or indirect ownership interest in the person. Free file alliance   You are not considered to be selling through a related person who is a retailer if all the following apply. Free file alliance You do not have a significant ownership interest in the retailer. Free file alliance You sell your production to persons who are not related to either you or the retailer. Free file alliance The retailer does not buy oil or natural gas from your customers or persons related to your customers. Free file alliance There are no arrangements for the retailer to acquire oil or natural gas you produced for resale or made available for purchase by the retailer. Free file alliance Neither you nor the retailer knows of or controls the final disposition of the oil or natural gas you sold or the original source of the petroleum products the retailer acquired for resale. Free file alliance Transferees who cannot claim percentage depletion. Free file alliance   You cannot claim percentage depletion if you received your interest in a proven oil or gas property by transfer after 1974 and before October 12, 1990. Free file alliance For a definition of the term “transfer,” see section 1. Free file alliance 613A-7(n) of the regulations. Free file alliance For a definition of the term “interest in proven oil or gas property,” see section 1. Free file alliance 613A-7(p) of the regulations. Free file alliance Figuring percentage depletion. Free file alliance   Generally, as an independent producer or royalty owner, you figure your percentage depletion by computing your average daily production of domestic oil or gas and comparing it to your depletable oil or gas quantity. Free file alliance If your average daily production does not exceed your depletable oil or gas quantity, you figure your percentage depletion by multiplying the gross income from the oil or gas property (defined later) by 15%. Free file alliance If your average daily production of domestic oil or gas exceeds your depletable oil or gas quantity, you must make an allocation as explained later under Average daily production. Free file alliance   In addition, there is a limit on the percentage depletion deduction. Free file alliance See Taxable income limit , later. Free file alliance Average daily production. Free file alliance   Figure your average daily production by dividing your total domestic production of oil or gas for the tax year by the number of days in your tax year. Free file alliance Partial interest. Free file alliance   If you have a partial interest in the production from a property, figure your share of the production by multiplying total production from the property by your percentage of interest in the revenues from the property. Free file alliance   You have a partial interest in the production from a property if you have a net profits interest in the property. Free file alliance To figure the share of production for your net profits interest, you must first determine your percentage participation (as measured by the net profits) in the gross revenue from the property. Free file alliance To figure this percentage, you divide the income you receive for your net profits interest by the gross revenue from the property. Free file alliance Then multiply the total production from the property by your percentage participation to figure your share of the production. Free file alliance Example. Free file alliance Javier Robles owns oil property in which Pablo Olmos owns a 20% net profits interest. Free file alliance During the year, the property produced 10,000 barrels of oil, which Javier sold for $200,000. Free file alliance Javier had expenses of $90,000 attributable to the property. Free file alliance The property generated a net profit of $110,000 ($200,000 − $90,000). Free file alliance Pablo received income of $22,000 ($110,000 × . Free file alliance 20) for his net profits interest. Free file alliance Pablo determined his percentage participation to be 11% by dividing $22,000 (the income he received) by $200,000 (the gross revenue from the property). Free file alliance Pablo determined his share of the oil production to be 1,100 barrels (10,000 barrels × 11%). Free file alliance Depletable oil or natural gas quantity. Free file alliance   Generally, your depletable oil quantity is 1,000 barrels. Free file alliance Your depletable natural gas quantity is 6,000 cubic feet multiplied by the number of barrels of your depletable oil quantity that you choose to apply. Free file alliance If you claim depletion on both oil and natural gas, you must reduce your depletable oil quantity (1,000 barrels) by the number of barrels you use to figure your depletable natural gas quantity. Free file alliance Example. Free file alliance You have both oil and natural gas production. Free file alliance To figure your depletable natural gas quantity, you choose to apply 360 barrels of your 1000-barrel depletable oil quantity. Free file alliance Your depletable natural gas quantity is 2. Free file alliance 16 million cubic feet of gas (360 × 6000). Free file alliance You must reduce your depletable oil quantity to 640 barrels (1000 − 360). Free file alliance If you have production from marginal wells, see section 613A(c)(6) of the Internal Revenue Code to figure your depletable oil or natural gas quantity. Free file alliance Also, see Notice 2012-50, available at www. Free file alliance irs. Free file alliance gov/irb/2012–31_IRB/index. Free file alliance html. Free file alliance Business entities and family members. Free file alliance   You must allocate the depletable oil or gas quantity among the following related persons in proportion to each entity's or family member's production of domestic oil or gas for the year. Free file alliance Corporations, trusts, and estates if 50% or more of the beneficial interest is owned by the same or related persons (considering only persons that own at least 5% of the beneficial interest). Free file alliance You and your spouse and minor children. Free file alliance A related person is anyone mentioned in the related persons discussion under Nondeductible loss in chapter 2 of Publication 544, except that for purposes of this allocation, item (1) in that discussion includes only an individual, his or her spouse, and minor children. Free file alliance Controlled group of corporations. Free file alliance   Members of the same controlled group of corporations are treated as one taxpayer when figuring the depletable oil or natural gas quantity. Free file alliance They share the depletable quantity. Free file alliance A controlled group of corporations is defined in section 1563(a) of the Internal Revenue Code, except that, for this purpose, the stock ownership requirement in that definition is “more than 50%” rather than “at least 80%. Free file alliance ” Gross income from the property. Free file alliance   For purposes of percentage depletion, gross income from the property (in the case of oil and gas wells) is the amount you receive from the sale of the oil or gas in the immediate vicinity of the well. Free file alliance If you do not sell the oil or gas on the property, but manufacture or convert it into a refined product before sale or transport it before sale, the gross income from the property is the representative market or field price (RMFP) of the oil or gas, before conversion or transportation. Free file alliance   If you sold gas after you removed it from the premises for a price that is lower than the RMFP, determine gross income from the property for percentage depletion purposes without regard to the RMFP. Free file alliance   Gross income from the property does not include lease bonuses, advance royalties, or other amounts payable without regard to production from the property. Free file alliance Average daily production exceeds depletable quantities. Free file alliance   If your average daily production for the year is more than your depletable oil or natural gas quantity, figure your allowance for depletion for each domestic oil or natural gas property as follows. Free file alliance Figure your average daily production of oil or natural gas for the year. Free file alliance Figure your depletable oil or natural gas quantity for the year. Free file alliance Figure depletion for all oil or natural gas produced from the property using a percentage depletion rate of 15%. Free file alliance Multiply the result figured in (3) by a fraction, the numerator of which is the result figured in (2) and the denominator of which is the result figured in (1). Free file alliance This is your depletion allowance for that property for the year. Free file alliance Taxable income limit. Free file alliance   If you are an independent producer or royalty owner of oil and gas, your deduction for percentage depletion is limited to the smaller of the following. Free file alliance 100% of your taxable income from the property figured without the deduction for depletion and the deduction for domestic production activities under section 199 of the Internal Revenue Code. Free file alliance For a definition of taxable income from the property, see Taxable income limit , earlier, under Mineral Property. Free file alliance 65% of your taxable income from all sources, figured without the depletion allowance, the deduction for domestic production activities, any net operating loss carryback, and any capital loss carryback. Free file alliance You can carry over to the following year any amount you cannot deduct because of the 65%-of-taxable-income limit. Free file alliance Add it to your depletion allowance (before applying any limits) for the following year. Free file alliance Partnerships and S Corporations Generally, each partner or S corporation shareholder, and not the partnership or S corporation, figures the depletion allowance separately. Free file alliance (However, see Electing large partnerships must figure depletion allowance , later. Free file alliance ) Each partner or shareholder must decide whether to use cost or percentage depletion. Free file alliance If a partner or shareholder uses percentage depletion, he or she must apply the 65%-of-taxable-income limit using his or her taxable income from all sources. Free file alliance Partner's or shareholder's adjusted basis. Free file alliance   The partnership or S corporation must allocate to each partner or shareholder his or her share of the adjusted basis of each oil or gas property held by the partnership or S corporation. Free file alliance The partnership or S corporation makes the allocation as of the date it acquires the oil or gas property. Free file alliance   Each partner's share of the adjusted basis of the oil or gas property generally is figured according to that partner's interest in partnership capital. Free file alliance However, in some cases, it is figured according to the partner's interest in partnership income. Free file alliance   The partnership or S corporation adjusts the partner's or shareholder's share of the adjusted basis of the oil and gas property for any capital expenditures made for the property and for any change in partnership or S corporation interests. Free file alliance Recordkeeping. Free file alliance Each partner or shareholder must separately keep records of his or her share of the adjusted basis in each oil and gas property of the partnership or S corporation. Free file alliance The partner or shareholder must reduce his or her adjusted basis by the depletion allowed or allowable on the property each year. Free file alliance The partner or shareholder must use that reduced adjusted basis to figure cost depletion or his or her gain or loss if the partnership or S corporation disposes of the property. Free file alliance Reporting the deduction. Free file alliance   Information that you, as a partner or shareholder, use to figure your depletion deduction on oil and gas properties is reported by the partnership or S corporation on Schedule K-1 (Form 1065) or on Schedule K-1 (Form 1120S). Free file alliance Deduct oil and gas depletion for your partnership or S corporation interest on Schedule E (Form 1040). Free file alliance The depletion deducted on Schedule E is included in figuring income or loss from rental real estate or royalty properties. Free file alliance The instructions for Schedule E explain where to report this income or loss and whether you need to file either of the following forms. Free file alliance Form 6198, At-Risk Limitations. Free file alliance Form 8582, Passive Activity Loss Limitations. Free file alliance Electing large partnerships must figure depletion allowance. Free file alliance   An electing large partnership, rather than each partner, generally must figure the depletion allowance. Free file alliance The partnership figures the depletion allowance without taking into account the 65-percent-of-taxable-income limit and the depletable oil or natural gas quantity. Free file alliance Also, the adjusted basis of a partner's interest in the partnership is not affected by the depletion allowance. Free file alliance   An electing large partnership is one that meets both the following requirements. Free file alliance The partnership had 100 or more partners in the preceding year. Free file alliance The partnership chooses to be an electing large partnership. Free file alliance Disqualified persons. Free file alliance   An electing large partnership does not figure the depletion allowance of its partners that are disqualified persons. Free file alliance Disqualified persons must figure it themselves, as explained earlier. Free file alliance   All the following are disqualified persons. Free file alliance Refiners who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners , earlier). Free file alliance Retailers who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners , earlier). Free file alliance Any partner whose average daily production of domestic crude oil and natural gas is more than 500 barrels during the tax year in which the partnership tax year ends. Free file alliance Average daily production is discussed earlier. Free file alliance Natural Gas Wells You can use percentage depletion for a well that produces natural gas that is either Sold under a fixed contract, or Produced from geopressured brine. Free file alliance Natural gas sold under a fixed contract. Free file alliance   Natural gas sold under a fixed contract qualifies for a percentage depletion rate of 22%. Free file alliance This is domestic natural gas sold by the producer under a contract that does not provide for a price increase to reflect any increase in the seller's tax liability because of the repeal of percentage depletion for gas. Free file alliance The contract must have been in effect from February 1, 1975, until the date of sale of the gas. Free file alliance Price increases after February 1, 1975, are presumed to take the increase in tax liability into account unless demonstrated otherwise by clear and convincing evidence. Free file alliance Natural gas from geopressured brine. Free file alliance   Qualified natural gas from geopressured brine is eligible for a percentage depletion rate of 10%. Free file alliance This is natural gas that is both the following. Free file alliance Produced from a well you began to drill after September 1978 and before 1984. Free file alliance Determined in accordance with section 503 of the Natural Gas Policy Act of 1978 to be produced from geopressured brine. Free file alliance Mines and Geothermal Deposits Certain mines, wells, and other natural deposits, including geothermal deposits, qualify for percentage depletion. Free file alliance Mines and other natural deposits. Free file alliance   For a natural deposit, the percentage of your gross income from the property that you can deduct as depletion depends on the type of deposit. Free file alliance   The following is a list of the percentage depletion rates for the more common minerals. Free file alliance DEPOSITS RATE Sulphur, uranium, and, if from deposits in the United States, asbestos, lead ore, zinc ore, nickel ore, and mica 22% Gold, silver, copper, iron ore, and certain oil shale, if from deposits in the United States 15% Borax, granite, limestone, marble, mollusk shells, potash, slate, soapstone, and carbon dioxide produced from a well 14% Coal, lignite, and sodium chloride 10% Clay and shale used or sold for use in making sewer pipe or bricks or used or sold for use as sintered or burned lightweight aggregates 7½% Clay used or sold for use in making drainage and roofing tile, flower pots, and kindred products, and gravel, sand, and stone (other than stone used or sold for use by a mine owner or operator as dimension or ornamental stone) 5%   You can find a complete list of minerals and their percentage depletion rates in section 613(b) of the Internal Revenue Code. Free file alliance Corporate deduction for iron ore and coal. Free file alliance   The percentage depletion deduction of a corporation for iron ore and coal (including lignite) is reduced by 20% of: The percentage depletion deduction for the tax year (figured without this reduction), minus The adjusted basis of the property at the close of the tax year (figured without the depletion deduction for the tax year). Free file alliance Gross income from the property. Free file alliance   For property other than a geothermal deposit or an oil or gas well, gross income from the property means the gross income from mining. Free file alliance Mining includes all the following. Free file alliance Extracting ores or minerals from the ground. Free file alliance Applying certain treatment processes described later. Free file alliance Transporting ores or minerals (generally, not more than 50 miles) from the point of extraction to the plants or mills in which the treatment processes are applied. Free file alliance Excise tax. Free file alliance   Gross income from mining includes the separately stated excise tax received by a mine operator from the sale of coal to compensate the operator for the excise tax the mine operator must pay to finance black lung benefits. Free file alliance Extraction. Free file alliance   Extracting ores or minerals from the ground includes extraction by mine owners or operators of ores or minerals from the waste or residue of prior mining. Free file alliance This does not apply to extraction from waste or residue of prior mining by the purchaser of the waste or residue or the purchaser of the rights to extract ores or minerals from the waste or residue. Free file alliance Treatment processes. Free file alliance   The processes included as mining depend on the ore or mineral mined. Free file alliance To qualify as mining, the treatment processes must be applied by the mine owner or operator. Free file alliance For a listing of treatment processes considered as mining, see section 613(c)(4) of the Internal Revenue Code and the related regulations. Free file alliance Transportation of more than 50 miles. Free file alliance   If the IRS finds that the ore or mineral must be transported more than 50 miles to plants or mills to be treated because of physical and other requirements, the additional authorized transportation is considered mining and included in the computation of gross income from mining. Free file alliance    If you wish to include transportation of more than 50 miles in the computation of gross income from mining, request an advance ruling from the IRS. Free file alliance Include in the request the facts about the physical and other requirements that prevented the construction and operation of the plant within 50 miles of the point of extraction. Free file alliance For more information about requesting an advance ruling, see Revenue Procedure 2013-1, available at www. Free file alliance irs. Free file alliance gov/irb/2013-01_IRB/ar11. Free file alliance html. Free file alliance Disposal of coal or iron ore. Free file alliance   You cannot take a depletion deduction for coal (including lignite) or iron ore mined in the United States if both the following apply. Free file alliance You disposed of it after holding it for more than 1 year. Free file alliance You disposed of it under a contract under which you retain an economic interest in the coal or iron ore. Free file alliance Treat any gain on the disposition as a capital gain. Free file alliance Disposal to related person. Free file alliance   This rule does not apply if you dispose of the coal or iron ore to one of the following persons. Free file alliance A related person (as listed in chapter 2 of Publication 544). Free file alliance A person owned or controlled by the same interests that own or control you. Free file alliance Geothermal deposits. Free file alliance   Geothermal deposits located in the United States or its possessions qualify for a percentage depletion rate of 15%. Free file alliance A geothermal deposit is a geothermal reservoir of natural heat stored in rocks or in a watery liquid or vapor. Free file alliance For percentage depletion purposes, a geothermal deposit is not considered a gas well. Free file alliance   Figure gross income from the property for a geothermal steam well in the same way as for oil and gas wells. Free file alliance See Gross income from the property , earlier, under Oil and Gas Wells. Free file alliance Percentage depletion on a geothermal deposit cannot be more than 50% of your taxable income from the property. Free file alliance Lessor's Gross Income In the case of leased property, the depletion deduction is divided between the lessor and the lessee. Free file alliance A lessor's gross income from the property that qualifies for percentage depletion usually is the total of the royalties received from the lease. Free file alliance Bonuses and advanced royalties. Free file alliance   Bonuses and advanced royalties are payments a lessee makes before production to a lessor for the grant of rights in a lease or for minerals, gas, or oil to be extracted from leased property. Free file alliance If you are the lessor, your income from bonuses and advanced royalties received is subject to an allowance for depletion, as explained in the next two paragraphs. Free file alliance Figuring cost depletion. Free file alliance   To figure cost depletion on a bonus, multiply your adjusted basis in the property by a fraction, the numerator of which is the bonus and the denominator of which is the total bonus and royalties expected to be received. Free file alliance To figure cost depletion on advanced royalties, use the computation explained earlier under Cost Depletion , treating the number of units for which the advanced royalty is received as the number of units sold. Free file alliance Figuring percentage depletion. Free file alliance   In the case of mines, wells, and other natural deposits other than gas, oil, or geothermal property, you may use the percentage rates discussed earlier under Mines and Geothermal Deposits . Free file alliance Any bonus or advanced royalty payments are generally part of the gross income from the property to which the rates are applied in making the calculation. Free file alliance However, for oil, gas, or geothermal property, gross income does not include lease bonuses, advanced royalties, or other amounts payable without regard to production from the property. Free file alliance Ending the lease. Free file alliance   If you receive a bonus on a lease that ends or is abandoned before you derive any income from mineral extraction, include in income the depletion deduction you took. Free file alliance Do this for the year the lease ends or is abandoned. Free file alliance Also increase your adjusted basis in the property to restore the depletion deduction you previously subtracted. Free file alliance   For advanced royalties, include in income the depletion claimed on minerals for which the advanced royalties were paid if the minerals were not produced before the lease ended. Free file alliance Include this amount in income for the year the lease ends. Free file alliance Increase your adjusted basis in the property by the amount you include in income. Free file alliance Delay rentals. Free file alliance   These are payments for deferring development of the property. Free file alliance Since delay rentals are ordinary rent, they are ordinary income that is not subject to depletion. Free file alliance These rentals can be avoided by either abandoning the lease, beginning development operations, or obtaining production. Free file alliance Timber You can figure timber depletion only by the cost method. Free file alliance Percentage depletion does not apply to timber. Free file alliance Base your depletion on your cost or other basis in the timber. Free file alliance Your cost does not include the cost of land or any amounts recoverable through depreciation. Free file alliance Depletion takes place when you cut standing timber. Free file alliance You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation. Free file alliance Figuring cost depletion. Free file alliance   To figure your cost depletion allowance, you multiply the number of timber units cut by your depletion unit. Free file alliance Timber units. Free file alliance   When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. Free file alliance You measure the timber using board feet, log scale, cords, or other units. Free file alliance If you later determine that you have more or less units of timber, you must adjust the original estimate. Free file alliance   The term “timber property” means your economic interest in standing timber in each tract or block representing a separate timber account. Free file alliance Depletion unit. Free file alliance   You figure your depletion unit each year by taking the following steps. Free file alliance Determine your cost or adjusted basis of the timber on hand at the beginning of the year. Free file alliance Adjusted basis is defined under Cost Depletion in the discussion on Mineral Property. Free file alliance Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital. Free file alliance Figure the number of timber units to take into account by adding the number of timber units acquired during the year to the number of timber units on hand in the account at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account. Free file alliance Divide the result of (2) by the result of (3). Free file alliance This is your depletion unit. Free file alliance Example. Free file alliance You bought a timber tract for $160,000 and the land was worth as much as the timber. Free file alliance Your basis for the timber is $80,000. Free file alliance Based on an estimated one million board feet (1,000 MBF) of standing timber, you figure your depletion unit to be $80 per MBF ($80,000 ÷ 1,000). Free file alliance If you cut 500 MBF of timber, your depletion allowance would be $40,000 (500 MBF × $80). Free file alliance When to claim depletion. Free file alliance   Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you choose to treat the cutting of timber as a sale or exchange (explained below). Free file alliance Include allowable depletion for timber products not sold during the tax year the timber is cut as a cost item in the closing inventory of timber products for the year. Free file alliance The inventory is your basis for determining gain or loss in the tax year you sell the timber products. Free file alliance Example. Free file alliance The facts are the same as in the previous example except that you sold only half of the timber products in the cutting year. Free file alliance You would deduct $20,000 of the $40,000 depletion that year. Free file alliance You would add the remaining $20,000 depletion to your closing inventory of timber products. Free file alliance Electing to treat the cutting of timber as a sale or exchange. Free file alliance   You can elect, under certain circumstances, to treat the cutting of timber held for more than 1 year as a sale or exchange. Free file alliance You must make the election on your income tax return for the tax year to which it applies. Free file alliance If you make this election, subtract the adjusted basis for depletion from the fair market value of the timber on the first day of the tax year in which you cut it to figure the gain or loss on the cutting. Free file alliance You generally report the gain as long-term capital gain. Free file alliance The fair market value then becomes your basis for figuring your ordinary gain or loss on the sale or other disposition of the products cut from the timber. Free file alliance For more information, see Timber in chapter 2 of Publication 544, Sales and Other Dispositions of Assets. Free file alliance   You may revoke an election to treat the cutting of timber as a sale or exchange without IRS's consent. Free file alliance The prior election (and revocation) is disregarded for purposes of making a subsequent election. Free file alliance See Form T (Timber), Forest Activities Schedule, for more information. Free file alliance Form T. Free file alliance   Complete and attach Form T (Timber) to your income tax return if you claim a deduction for timber depletion, choose to treat the cutting of timber as a sale or exchange, or make an outright sale of timber. Free file alliance Prev  Up  Next   Home   More Online Publications
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The Free File Alliance

Free file alliance 7. Free file alliance   Depreciation, Depletion, and Amortization Table of Contents What's New for 2013 Introduction Topics - This chapter discusses: Useful Items - You may want to see: Overview of DepreciationWhat Property Can Be Depreciated? What Property Cannot Be Depreciated? When Does Depreciation Begin and End? Can You Use MACRS To Depreciate Your Property? What Is the Basis of Your Depreciable Property? How Do You Treat Repairs and Improvements? Do You Have To File Form 4562? How Do You Correct Depreciation Deductions? Section 179 Expense DeductionWhat Property Qualifies? What Property Does Not Qualify? How Much Can You Deduct? How Do You Elect the Deduction? When Must You Recapture the Deduction? Claiming the Special Depreciation AllowanceWhat is Qualified Property? How Can You Elect Not To Claim the Allowance? When Must You Recapture an Allowance Figuring Depreciation Under MACRSWhich Depreciation System (GDS or ADS) Applies? Which Property Class Applies Under GDS? What Is the Placed-in-Service Date? What Is the Basis for Depreciation? Which Recovery Period Applies? Which Convention Applies? Which Depreciation Method Applies? How Is the Depreciation Deduction Figured? How Do You Use General Asset Accounts? When Do You Recapture MACRS Depreciation? Additional Rules for Listed PropertyWhat Is Listed Property? What Is the Business-Use Requirement? Do the Passenger Automobile Limits Apply? Depletion Who Can Claim Depletion? Figuring Depletion AmortizationBusiness Start-Up Costs Reforestation Costs Section 197 Intangibles What's New for 2013 Increased section 179 expense deduction dollar limits. Free file alliance  The maximum amount you can elect to deduct for most section 179 property you placed in service in 2013 is $500,000. Free file alliance This limit is reduced by the amount by which the cost of the property placed in service during the tax year exceeds $2 million. Free file alliance See Dollar Limits under Section 179 Expense Deduction , later. Free file alliance Extension of special depreciation allowance for certain qualified property acquired after December 31, 2007. Free file alliance . Free file alliance  You may be able to take a 50% special depreciation allowance for certain qualified property acquired after December 31, 2007, and placed in service before January 1, 2014. Free file alliance See Claiming the Special Depreciation Allowance , later. Free file alliance Expiration of the 3- year recovery period for certain race horses. Free file alliance  The 3-year recovery period for race horses two years old or younger will expire for such horses placed in service after December 31, 2013. Free file alliance Introduction If you buy or make improvements to farm property such as machinery, equipment, livestock, or a structure with a useful life of more than a year, you generally cannot deduct its entire cost in one year. Free file alliance Instead, you must spread the cost over the time you use the property and deduct part of it each year. Free file alliance For most types of property, this is called depreciation. Free file alliance This chapter gives information on depreciation methods that generally apply to property placed in service after 1986. Free file alliance For information on depreciating pre-1987 property, see Publication 534, Depreciating Property Placed in Service Before 1987. Free file alliance Topics - This chapter discusses: Overview of depreciation Section 179 expense deduction Special depreciation allowance Modified Accelerated Cost Recovery System (MACRS) Listed property Basic information on cost depletion (including timber depletion) and percentage depletion Amortization of the costs of going into business, reforestation costs, the costs of pollution control facilities, and the costs of section 197 intangibles Useful Items - You may want to see: Publication 463 Travel, Entertainment, Gift, and Car Expenses 534 Depreciating Property Placed in Service Before 1987 535 Business Expenses 544 Sales and Other Dispositions of Assets 551 Basis of Assets 946 How To Depreciate Property Form (and Instructions) T (Timber), Forest Activities Schedule 3115 Application for Change in Accounting Method 4562 Depreciation and Amortization 4797 Sales of Business Property See chapter 16 for information about getting publications and forms. Free file alliance It is important to keep good records for property you depreciate. Free file alliance Do not file these records with your return. Free file alliance Instead, you should keep them as part of the permanent records of the depreciated property. Free file alliance They will help you verify the accuracy of the depreciation of assets placed in service in the current and previous tax years. Free file alliance For general information on recordkeeping, see Publication 583, Starting a Business and Keeping Records. Free file alliance For specific information on keeping records for section 179 property and listed property, see Publication 946, How To Depreciate Property. Free file alliance Overview of Depreciation This overview discusses basic information on the following. Free file alliance What property can be depreciated. Free file alliance What property cannot be depreciated. Free file alliance When depreciation begins and ends. Free file alliance Whether MACRS can be used to figure depreciation. Free file alliance What is the basis of your depreciable property. Free file alliance How to treat repairs and improvements. Free file alliance When you must file Form 4562. Free file alliance How you can correct depreciation claimed incorrectly. Free file alliance What Property Can Be Depreciated? You can depreciate most types of tangible property (except land), such as buildings, machinery, equipment, vehicles, certain livestock, and furniture. Free file alliance You can also depreciate certain intangible property, such as copyrights, patents, and computer software. Free file alliance To be depreciable, the property must meet all the following requirements. Free file alliance It must be property you own. Free file alliance It must be used in your business or income-producing activity. Free file alliance It must have a determinable useful life. Free file alliance It must have a useful life that extends substantially beyond the year you place it in service. Free file alliance Property You Own To claim depreciation, you usually must be the owner of the property. Free file alliance You are considered as owning property even if it is subject to a debt. Free file alliance Leased property. Free file alliance   You can depreciate leased property only if you retain the incidents of ownership in the property. Free file alliance This means you bear the burden of exhaustion of the capital investment in the property. Free file alliance Therefore, if you lease property from someone to use in your trade or business or for the production of income, you generally cannot depreciate its cost because you do not retain the incidents of ownership. Free file alliance You can, however, depreciate any capital improvements you make to the leased property. Free file alliance See Additions and Improvements under Which Recovery Period Applies in chapter 4 of Publication 946. Free file alliance   If you lease property to someone, you generally can depreciate its cost even if the lessee (the person leasing from you) has agreed to preserve, replace, renew, and maintain the property. Free file alliance However, you cannot depreciate the cost of the property if the lease provides that the lessee is to maintain the property and return to you the same property or its equivalent in value at the expiration of the lease in as good condition and value as when leased. Free file alliance Life tenant. Free file alliance   Generally, if you hold business or investment property as a life tenant, you can depreciate it as if you were the absolute owner of the property. Free file alliance See Certain term interests in property , later, for an exception. Free file alliance Property Used in Your Business or Income-Producing Activity To claim depreciation on property, you must use it in your business or income-producing activity. Free file alliance If you use property to produce income (investment use), the income must be taxable. Free file alliance You cannot depreciate property that you use solely for personal activities. Free file alliance However, if you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the percentage of business or investment use. Free file alliance Example 1. Free file alliance   If you use your car for farm business, you can deduct depreciation based on its percentage of use in farming. Free file alliance If you also use it for investment purposes, you can depreciate it based on its percentage of investment use. Free file alliance Example 2. Free file alliance   If you use part of your home for business, you may be able to deduct depreciation on that part based on its business use. Free file alliance For more information, see Business Use of Your Home in chapter 4. Free file alliance Inventory. Free file alliance   You can never depreciate inventory because it is not held for use in your business. Free file alliance Inventory is any property you hold primarily for sale to customers in the ordinary course of your business. Free file alliance Livestock. Free file alliance   Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account. Free file alliance Livestock you raise usually has no depreciable basis because the costs of raising them are deducted and not added to their basis. Free file alliance However, see Immature livestock under When Does Depreciation Begin and End , later, for a special rule. Free file alliance Property Having a Determinable Useful Life To be depreciable, your property must have a determinable useful life. Free file alliance This means it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. Free file alliance Irrigation systems and water wells. Free file alliance   Irrigation systems and wells used in a trade or business can be depreciated if their useful life can be determined. Free file alliance You can depreciate irrigation systems and wells composed of masonry, concrete, tile, metal, or wood. Free file alliance In addition, you can depreciate costs for moving dirt to construct irrigation systems and water wells composed of these materials. Free file alliance However, land preparation costs for center pivot irrigation systems are not depreciable. Free file alliance Dams, ponds, and terraces. Free file alliance   In general, you cannot depreciate earthen dams, ponds, and terraces unless the structures have a determinable useful life. Free file alliance What Property Cannot Be Depreciated? Certain property cannot be depreciated, even if the requirements explained earlier are met. Free file alliance This includes the following. Free file alliance Land. Free file alliance You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. Free file alliance The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Free file alliance Although you cannot depreciate land, you can depreciate certain costs incurred in preparing land for business use. Free file alliance See chapter 1 of Publication 946. Free file alliance Property placed in service and disposed of in the same year. Free file alliance Determining when property is placed in service is explained later. Free file alliance Equipment used to build capital improvements. Free file alliance You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements. Free file alliance Intangible property such as section 197 intangibles. Free file alliance This property does not have a determinable useful life and generally cannot be depreciated. Free file alliance However, see Amortization , later. Free file alliance Special rules apply to computer software (discussed below). Free file alliance Certain term interests (discussed below). Free file alliance Computer software. Free file alliance   Computer software is generally not a section 197 intangible even if acquired in connection with the acquisition of a business, if it meets all of the following tests. Free file alliance It is readily available for purchase by the general public. Free file alliance It is subject to a nonexclusive license. Free file alliance It has not been substantially modified. Free file alliance   If the software meets the tests above, it can be depreciated and may qualify for the section 179 expense deduction and the special depreciation allowance (if applicable), discussed later. Free file alliance Certain term interests in property. Free file alliance   You cannot depreciate a term interest in property created or acquired after July 27, 1989, for any period during which the remainder interest is held, directly or indirectly, by a person related to you. Free file alliance This rule does not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. Free file alliance For more information, see chapter 1 of Publication 946. Free file alliance When Does Depreciation Begin and End? 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. Free file alliance You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first. Free file alliance Placed in Service Property is placed in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. Free file alliance Even if you are not using the property, it is in service when it is ready and available for its specific use. Free file alliance Example. Free file alliance You bought a planter for use in your farm business. Free file alliance The planter was delivered in December 2012 after harvest was over. Free file alliance You begin to depreciate the planter for 2012 because it was ready and available for its specific use in 2012, even though it will not be used until the spring of 2013. Free file alliance If your planter comes unassembled in December 2012 and is put together in February 2013, it is not placed in service until 2013. Free file alliance You begin to depreciate it in 2013. Free file alliance If your planter was delivered and assembled in February 2013 but not used until April 2013, it is placed in service in February 2013, because this is when the planter was ready for its specified use. Free file alliance You begin to depreciate it in 2013. Free file alliance Fruit or nut trees and vines. Free file alliance   If you acquire an orchard, grove, or vineyard before the trees or vines have reached the income-producing stage, and they have a preproductive period of more than 2 years, you must capitalize the preproductive-period costs under the uniform capitalization rules (unless you elect not to use these rules). Free file alliance See chapter 6 for information about the uniform capitalization rules. Free file alliance Your depreciation begins when the trees and vines reach the income-producing stage (that is, when they bear fruit, nuts, or grapes in quantities sufficient to commercially warrant harvesting). Free file alliance Immature livestock. Free file alliance   Depreciation for livestock begins when the livestock reaches the age of maturity. Free file alliance If you bought immature livestock for drafting purposes, depreciation begins when they can be worked. Free file alliance If you bought immature livestock for dairy purposes, depreciation begins when they can be milked. Free file alliance If you bought immature livestock for breeding purposes, depreciation begins when they can be bred. Free file alliance Your basis for depreciation is your initial cost for the immature livestock. Free file alliance Idle Property Continue to claim a deduction for depreciation on property used in your business or for the production of income even if it is temporarily idle. Free file alliance For example, if you stop using a machine because there is a temporary lack of a market for a product made with that machine, continue to deduct depreciation on the machine. Free file alliance Cost or Other Basis Fully Recovered You stop depreciating property when you have fully recovered your cost or other basis. Free file alliance This happens when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property. Free file alliance Retired From Service You stop depreciating property when you retire it from service, even if you have not fully recovered its cost or other basis. Free file alliance You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events. Free file alliance You sell or exchange the property. Free file alliance You convert the property to personal use. Free file alliance You abandon the property. Free file alliance You transfer the property to a supplies or scrap account. Free file alliance The property is destroyed. Free file alliance For information on abandonment of property, see chapter 8. Free file alliance For information on destroyed property, see chapter 11 and Publication 547, Casualties, Disasters, and Thefts. Free file alliance Can You Use MACRS To Depreciate Your Property? You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most business and investment property placed in service after 1986. Free file alliance MACRS is explained later under Figuring Depreciation Under MACRS . Free file alliance You cannot use MACRS to depreciate the following property. Free file alliance Property you placed in service before 1987. Free file alliance Use the methods discussed in Publication 534. Free file alliance Certain property owned or used in 1986. Free file alliance See chapter 1 of Publication 946. Free file alliance Intangible property. Free file alliance Films, video tapes, and recordings. Free file alliance Certain corporate or partnership property acquired in a nontaxable transfer. Free file alliance Property you elected to exclude from MACRS. Free file alliance For more information, see chapter 1 of Publication 946. Free file alliance What Is the Basis of Your Depreciable Property? To figure your depreciation deduction, you must determine the basis of your property. Free file alliance To determine basis, you need to know the cost or other basis of your property. Free file alliance Cost or other basis. Free file alliance   The basis of property you buy is usually its cost plus amounts you paid for items such as sales tax, freight charges, and installation and testing fees. Free file alliance The cost includes the amount you pay in cash, debt obligations, other property, or services. Free file alliance   There are times when you cannot use cost as basis. Free file alliance In these situations, the fair market value (FMV) or the adjusted basis of the property may be used. Free file alliance Adjusted basis. Free file alliance   To find your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service. Free file alliance Basis adjustment for depreciation allowed or allowable. Free file alliance   After you place your property in service, you must reduce the basis of the property by the depreciation allowed or allowable, whichever is greater. Free file alliance Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). Free file alliance Depreciation allowable is depreciation you are entitled to deduct. Free file alliance   If you do not claim depreciation you are entitled to deduct, you must still reduce the basis of the property by the full amount of depreciation allowable. Free file alliance   If you deduct more depreciation than you should, you must reduce your basis by any amount deducted from which you received a tax benefit (the depreciation allowed). Free file alliance   For more information, see chapter 6. Free file alliance How Do You Treat Repairs and Improvements? You generally deduct the cost of repairing business property in the same way as any other business expense. Free file alliance However, if a repair or replacement increases the value of your property, makes it more useful, or lengthens its life, you must treat it as an improvement and depreciate it. Free file alliance Treat improvements as separate depreciable property. Free file alliance See chapter 1 of Publication 946 for more information. Free file alliance Example. Free file alliance You repair a small section on a corner of the roof of a barn that you rent to others. Free file alliance You deduct the cost of the repair as a business expense. Free file alliance However, if you replace the entire roof, the new roof is considered to be an improvement because it increases the value and lengthens the life for the property. Free file alliance You depreciate the cost of the new roof. Free file alliance Improvements to rented property. Free file alliance   You can depreciate permanent improvements you make to business property you rent from someone else. Free file alliance Do You Have To File Form 4562? Use Form 4562 to claim your deduction for depreciation and amortization. Free file alliance You must complete and attach Form 4562 to your tax return if you are claiming any of the following. Free file alliance A section 179 expense deduction for the current year or a section 179 carryover from a prior year. Free file alliance Depreciation for property placed in service during the current year. Free file alliance Depreciation on any vehicle or other listed property, regardless of when it was placed in service. Free file alliance Amortization of costs that began in the current year. Free file alliance For more information, see the Instructions for Form 4562. Free file alliance How Do You Correct Depreciation Deductions? If you deducted an incorrect amount of depreciation in any year, you may be able to make a correction by filing an amended return for that year. Free file alliance You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations. Free file alliance You claimed the incorrect amount because of a mathematical error made in any year. Free file alliance You claimed the incorrect amount because of a posting error made in any year, for example, omitting an asset from the depreciation schedule. Free file alliance You have not adopted a method of accounting for the property placed in service by you in tax years ending after December 29, 2003. Free file alliance You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003. Free file alliance Note. Free file alliance You have adopted a method of accounting if you used the same incorrect method of depreciation for two or more consecutively filed returns. Free file alliance If you are not allowed to make the correction on an amended return, you may be able to change your accounting method to claim the correct amount of depreciation. Free file alliance See the Instructions for Form 3115. Free file alliance Section 179 Expense Deduction You can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service. Free file alliance This is the section 179 expense deduction. Free file alliance You can elect the section 179 expense deduction instead of recovering the cost by taking depreciation deductions. Free file alliance This part of the chapter explains the rules for the section 179 expense deduction. Free file alliance It explains what property qualifies for the deduction, what property does not qualify for the deduction, the limits that may apply, how to elect the deduction, and when you may have to recapture the deduction. Free file alliance For more information, see chapter 2 of Publication 946. Free file alliance What Property Qualifies? To qualify for the section 179 expense deduction, your property must meet all the following requirements. Free file alliance It must be eligible property. Free file alliance It must be acquired for business use. Free file alliance It must have been acquired by purchase. Free file alliance Eligible Property To qualify for the section 179 expense deduction, your property must be one of the following types of depreciable property. Free file alliance Tangible personal property. Free file alliance Qualified real property. Free file alliance (Special rules apply to qualified real property that you elect to treat as qualified section 179 real property. Free file alliance For more information, see chapter 2 of Publication 946 and section 179(f) of the Internal Revenue Code. Free file alliance ) Other tangible property (except buildings and their structural components) used as: An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services; A research facility used in connection with any of the activities in (a) above; or A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities. Free file alliance Single purpose agricultural (livestock) or horticultural structures. Free file alliance Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product of petroleum. Free file alliance Off-the-shelf computer software that is readily available for purchase by the general public, is subject to a nonexclusive lease, and has not been substantially modified. Free file alliance Tangible personal property. Free file alliance   Tangible personal property is any tangible property that is not real property. Free file alliance It includes the following property. Free file alliance Machinery and equipment. Free file alliance Property contained in or attached to a building (other than structural components), such as milk tanks, automatic feeders, barn cleaners, and office equipment. Free file alliance Gasoline storage tanks and pumps at retail service stations. Free file alliance Livestock, including horses, cattle, hogs, sheep, goats, and mink and other fur-bearing animals. Free file alliance Facility used for the bulk storage of fungible commodities. Free file alliance   A facility used for the bulk storage of fungible commodities is qualifying property for purposes of the section 179 expense deduction if it is used in connection with any of the activities listed earlier in item (3)(a). Free file alliance Bulk storage means the storage of a commodity in a large mass before it is used. Free file alliance Grain bins. Free file alliance   A grain bin is an example of a storage facility that is qualifying section 179 property. Free file alliance It is a facility used in connection with the production of grain or livestock for the bulk storage of fungible commodities. Free file alliance Single purpose agricultural or horticultural structures. Free file alliance   A single purpose agricultural (livestock) or horticultural structure is qualifying property for purposes of the section 179 expense deduction. Free file alliance Agricultural structure. Free file alliance   A single purpose agricultural (livestock) structure is any building or enclosure specifically designed, constructed, and used for both the following reasons. Free file alliance To house, raise, and feed a particular type of livestock and its produce. Free file alliance To house the equipment, including any replacements, needed to house, raise, or feed the livestock. Free file alliance For this purpose, livestock includes poultry. Free file alliance   Single purpose structures are qualifying property if used, for example, to breed chickens or hogs, produce milk from dairy cattle, or produce feeder cattle or pigs, broiler chickens, or eggs. Free file alliance The facility must include, as an integral part of the structure or enclosure, equipment necessary to house, raise, and feed the livestock. Free file alliance Horticultural structure. Free file alliance   A single purpose horticultural structure is either of the following. Free file alliance A greenhouse specifically designed, constructed, and used for the commercial production of plants. Free file alliance A structure specifically designed, constructed, and used for the commercial production of mushrooms. Free file alliance Use of structure. Free file alliance   A structure must be used only for the purpose that qualified it. Free file alliance For example, a hog barn will not be qualifying property if you use it to house poultry. Free file alliance Similarly, using part of your greenhouse to sell plants will make the greenhouse nonqualifying property. Free file alliance   If a structure includes work space, the work space can be used only for the following activities. Free file alliance Stocking, caring for, or collecting livestock or plants or their produce. Free file alliance Maintaining the enclosure or structure. Free file alliance Maintaining or replacing the equipment or stock enclosed or housed in the structure. Free file alliance Property Acquired by Purchase To qualify for the section 179 expense deduction, your property must have been acquired by purchase. Free file alliance For example, property acquired by gift or inheritance does not qualify. Free file alliance Property acquired from a related person (that is, your spouse, ancestors, or lineal descendants) is not considered acquired by purchase. Free file alliance Example. Free file alliance Ken is a farmer. Free file alliance He purchased two tractors, one from his brother and one from his father. Free file alliance He placed both tractors in service in the same year he bought them. Free file alliance The tractor purchased from his father does not qualify for the section 179 expense deduction because he is a related person (as defined above). Free file alliance The tractor purchased from his brother does qualify for the deduction because Ken is not a related person (as defined above). Free file alliance What Property Does Not Qualify? Land and improvements. Free file alliance   Land and land improvements, do not qualify as section 179 property. Free file alliance Land improvements include nonagricultural fences, swimming pools, paved parking areas, wharves, docks, bridges, and fences. Free file alliance However, agricultural fences do qualify as section 179 property. Free file alliance Similarly, field drainage tile also qualifies as section 179 property. Free file alliance Excepted property. Free file alliance   Even if the requirements explained in the preceding discussions are met, farmers cannot elect the section 179 expense deduction for the following property. Free file alliance Certain property you lease to others (if you are a noncorporate lessor). Free file alliance Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging. Free file alliance Property used by a tax-exempt organization (other than a tax-exempt farmers' cooperative) unless the property is used mainly in a taxable unrelated trade or business. Free file alliance Property used by governmental units or foreign persons or entities (except property used under a lease with a term of less than 6 months). Free file alliance How Much Can You Deduct? Your section 179 expense deduction is generally the cost of the qualifying property. Free file alliance However, the total amount you can elect to deduct under section 179 is subject to a dollar limit and a business income limit. Free file alliance These limits apply to each taxpayer, not to each business. Free file alliance However, see Married individuals under Dollar Limits , later. Free file alliance See also the special rules for applying the limits for partnerships and S corporations under Partnerships and S Corporations , later. Free file alliance If you deduct only part of the cost of qualifying property as a section 179 expense deduction, you can generally depreciate the cost you do not deduct. Free file alliance Use Part I of Form 4562 to figure your section 179 expense deduction. Free file alliance Partial business use. Free file alliance   When you use property for business and nonbusiness purposes, you can elect the section 179 expense deduction only if you use it more than 50% for business in the year you place it in service. Free file alliance If you used the property more than 50% for business, multiply the cost of the property by the percentage of business use. Free file alliance Use the resulting business cost to figure your section 179 expense deduction. Free file alliance Trade-in of other property. Free file alliance   If you buy qualifying property with cash and a trade-in, its cost for purposes of the section 179 expense deduction includes only the cash you paid. Free file alliance For example, if you buy (for cash and a trade-in) a new tractor for use in your business, your cost for the section 179 expense deduction is the cash you paid. Free file alliance It does not include the adjusted basis of the old tractor you trade for the new tractor. Free file alliance Example. Free file alliance J-Bar Farms traded two cultivators having a total adjusted basis of $6,800 for a new cultivator costing $13,200. Free file alliance They received an $8,000 trade-in allowance for the old cultivators and paid $5,200 cash for the new cultivator. Free file alliance J-Bar also traded a used pickup truck with an adjusted basis of $8,000 for a new pickup truck costing $35,000. Free file alliance They received a $5,000 trade-in allowance and paid $30,000 cash for the new pickup truck. Free file alliance Only the cash paid by J-Bar qualifies for the section 179 expense deduction. Free file alliance J-Bar's business costs that qualify for a section 179 expense deduction are $35,200 ($5,200 + $30,000). Free file alliance Dollar Limits The total amount you can elect to deduct under section 179 for most property placed in service in 2013 is $500,000. Free file alliance If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 expense deduction among the items in any way, as long as the total deduction is not more than $500,000. Free file alliance Qualified real property that you elect to treat as section 179 property is limited to $250,000 of the maximum section 179 deduction of $500,000 for 2013. Free file alliance You do not have to claim the full $500,000. Free file alliance For specific information on the section 179 dollar limits, see chapter 2 of Publication 946. Free file alliance Reduced dollar limit for cost exceeding $2 million. Free file alliance   If the cost of your qualifying section 179 property placed in service in 2013 is over $2 million, you must reduce the dollar limit (but not below zero) by the amount of cost over $2 million. Free file alliance If the cost of your section 179 property placed in service during 2013 is $2,500,000 or more, you cannot take a section 179 expense deduction and you cannot carry over the cost that is more than $2,500,000. Free file alliance Example. Free file alliance This year, James Smith placed in service machinery costing $2,050,000. Free file alliance Because this cost is $50,000 more than $2 million, he must reduce his dollar limit to $450,000 ($500,000 − $50,000). Free file alliance Limits for sport utility vehicles. Free file alliance   The total amount you can elect to deduct for certain sport utility vehicles and certain other vehicles placed in service in 2013 is $25,000. Free file alliance This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, and highways that is rated at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight. Free file alliance   For more information, see chapter 2 of Publication 946. Free file alliance Limits for passenger automobiles. Free file alliance   For a passenger automobile that is placed in service in 2013, the total section 179 and depreciation deduction is limited. Free file alliance See Do the Passenger Automobile Limits Apply , later. Free file alliance Married individuals. Free file alliance   If you are married, how you figure your section 179 expense deduction depends on whether you file jointly or separately. Free file alliance If you file a joint return, you and your spouse are treated as one taxpayer in determining any reduction to the dollar limit, regardless of which of you purchased the property or placed it in service. Free file alliance If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit, including the reduction for costs over $2 million. Free file alliance You must allocate the dollar limit (after any reduction) equally between you, unless you both elect a different allocation. Free file alliance If the percentages elected by each of you do not total 100%, 50% will be allocated to each of you. Free file alliance Joint return after separate returns. Free file alliance   If you and your spouse elect to amend your separate returns by filing a joint return after the due date for filing your return, the dollar limit on the joint return is the lesser of the following amounts. Free file alliance The dollar limit (after reduction for any cost of section 179 property over $2 million). Free file alliance The total cost of section 179 property you and your spouse elected to expense on your separate returns. Free file alliance Business Income Limit The total cost you can deduct each year after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Free file alliance Generally, you are considered to actively conduct a trade or business if you meaningfully participate in the management or operations of the trade or business. Free file alliance Any cost not deductible in one year under section 179 because of this limit can be carried to the next year. Free file alliance See Carryover of disallowed deduction , later. Free file alliance Taxable income. Free file alliance   In general, figure taxable income for this purpose by totaling the net income and losses from all trades and businesses you actively conducted during the year. Free file alliance In addition to net income or loss from a sole proprietorship, partnership, or S corporation, net income or loss derived from a trade or business also includes the following items. Free file alliance Section 1231 gains (or losses) as discussed in chapter 9. Free file alliance Interest from working capital of your trade or business. Free file alliance Wages, salaries, tips, or other pay earned by you (or your spouse if you file a joint return) as an employee of any employer. Free file alliance   In addition, figure taxable income without regard to any of the following. Free file alliance The section 179 expense deduction. Free file alliance The self-employment tax deduction. Free file alliance Any net operating loss carryback or carryforward. Free file alliance Any unreimbursed employee business expenses. Free file alliance Two different taxable income limits. Free file alliance   In addition to the business income limit for your section 179 expense deduction, you may have a taxable income limit for some other deduction (for example, charitable contributions). Free file alliance You may have to figure the limit for this other deduction taking into account the section 179 expense deduction. Free file alliance If so, complete the following steps. Free file alliance Step Action 1 Figure taxable income without the section 179 expense deduction or the other deduction. Free file alliance 2 Figure a hypothetical section 179 expense deduction using the taxable income figured in Step 1. Free file alliance 3 Subtract the hypothetical section 179 expense deduction figured in Step 2 from the taxable income figured in Step 1. Free file alliance 4 Figure a hypothetical amount for the other deduction using the amount figured in Step 3 as taxable income. Free file alliance 5 Subtract the hypothetical other deduction figured in Step 4 from the taxable income figured in  Step 1. Free file alliance 6 Figure your actual section 179 expense deduction using the taxable income figured in Step 5. Free file alliance 7 Subtract your actual section 179 expense deduction figured in Step 6 from the taxable income figured in Step 1. Free file alliance 8 Figure your actual other deduction using the taxable income figured in Step 7. Free file alliance Example. Free file alliance On February 1, 2013, the XYZ farm corporation purchased and placed in service qualifying section 179 property that cost $500,000. Free file alliance It elects to expense the entire $500,000 cost under section 179. Free file alliance In June, the corporation gave a charitable contribution of $10,000. Free file alliance A corporation's limit on charitable contributions is figured after subtracting any section 179 expense deduction. Free file alliance The business income limit for the section 179 expense deduction is figured after subtracting any allowable charitable contributions. Free file alliance XYZ's taxable income figured without the section 179 expense deduction or the deduction for charitable contributions is $520,000. Free file alliance XYZ figures its section 179 expense deduction and its deduction for charitable contributions as follows. Free file alliance Step 1. Free file alliance Taxable income figured without either deduction is $520,000. Free file alliance Step 2. Free file alliance Using $520,000 as taxable income, XYZ's hypothetical section 179 expense deduction is $500,000. Free file alliance Step 3. Free file alliance $20,000 ($520,000 − $500,000). Free file alliance Step 4. Free file alliance Using $20,000 (from Step 3) as taxable income, XYZ's hypothetical charitable contribution (limited to 10% of taxable income) is $2,000. Free file alliance Step 5. Free file alliance $518,000 ($520,000 − $2,000). Free file alliance Step 6. Free file alliance Using $518,000 (from Step 5) as taxable income, XYZ figures the actual section 179 expense deduction. Free file alliance Because the taxable income is at least $500,000, XYZ can take a $500,000 section 179 expense deduction. Free file alliance Step 7. Free file alliance $20,000 ($520,000 − $500,000). Free file alliance Step 8. Free file alliance Using $20,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable income) is $2,000. Free file alliance Carryover of disallowed deduction. Free file alliance   You can carry over for an unlimited number of years the cost of any section 179 property you elected to expense but were unable to because of the business income limit. Free file alliance   The amount you carry over is used in determining your section 179 expense deduction in the next year. Free file alliance However, it is subject to the limits in that year. Free file alliance If you place more than one property in service in a year, you can select the properties for which all or a part of the cost will be carried forward. Free file alliance Your selections must be shown in your books and records. Free file alliance Example. Free file alliance Last year, Joyce Jones placed in service a machine that cost $8,000 and elected to deduct all $8,000 under section 179. Free file alliance The taxable income from her business (determined without regard to both a section 179 expense deduction for the cost of the machine and the self-employment tax deduction) was $6,000. Free file alliance Her section 179 expense deduction was limited to $6,000. Free file alliance The $2,000 cost that was not allowed as a section 179 expense deduction (because of the business income limit) is carried to this year. Free file alliance This year, Joyce placed another machine in service that cost $9,000. Free file alliance Her taxable income from business (determined without regard to both a section 179 expense deduction for the cost of the machine and the self-employment tax deduction) is $10,000. Free file alliance Joyce can deduct the full cost of the machine ($9,000) but only $1,000 of the carryover from last year because of the business income limit. Free file alliance She can carry over the balance of $1,000 to next year. Free file alliance Partnerships and S Corporations The section 179 expense deduction limits apply both to the partnership or S corporation and to each partner or shareholder. Free file alliance The partnership or S corporation determines its section 179 expense deduction subject to the limits. Free file alliance It then allocates the deduction among its partners or shareholders. Free file alliance If you are a partner in a partnership or shareholder of an S corporation, you add the amount allocated from the partnership or S corporation to any section 179 costs not related to the partnership or S corporation and then apply the dollar limit to this total. Free file alliance To determine any reduction in the dollar limit for costs over $560,000, you do not include any of the cost of section 179 property placed in service by the partnership or S corporation. Free file alliance After you apply the dollar limit, you apply the business income limit to any remaining section 179 costs. Free file alliance For more information, see chapter 2 of Publication 946. Free file alliance Example. Free file alliance In 2013, Partnership P placed in service section 179 property with a total cost of $2,160,000. Free file alliance P must reduce its dollar limit by $160,000 ($2,160,000 − $2,000,000). Free file alliance Its maximum section 179 expense deduction is $340,000 ($500,000 − $160,000), and it elects to expense that amount. Free file alliance Because P's taxable income from the active conduct of all its trades or businesses for the year was $400,000, it can deduct the full $340,000. Free file alliance P allocates $100,000 of its section 179 expense deduction and $110,000 of its taxable income to John, one of its partners. Free file alliance John also conducts a business as a sole proprietor and in 2013, placed in service in that business, section 179 property costing $28,000. Free file alliance John's taxable income from that business was $10,000. Free file alliance In addition to the $100,000 allocated from P, he elects to expense the $28,000 of his sole proprietorship's section 179 costs. Free file alliance However, John's deduction is limited to his business taxable income of $120,000 ($110,000 from P plus $10,000 from his sole proprietorship). Free file alliance He carries over $8,000 ($128,000 − $120,000) of the elected section 179 costs to 2014. Free file alliance How Do You Elect the Deduction? You elect to take the section 179 expense deduction by completing Part I of Form 4562. Free file alliance If you elect the deduction for listed property, complete Part V of  Form 4562 before completing Part I. Free file alliance   File Form 4562 with either of the following: Your original tax return (whether or not you filed it timely), or An amended return filed within the time prescribed by law. Free file alliance An election made on an amended return must specify the item of section 179 property to which the election applies and the part of the cost of each such item to be taken into account. Free file alliance The amended return must also include any resulting adjustments to taxable income. Free file alliance Revoking an election. Free file alliance   An election (or any specification made in the election) to take a section 179 expense deduction for 2013 can be revoked without IRS approval by filing an amended return. Free file alliance The amended return must be filed within the time prescribed by law. Free file alliance The amended return must also include any resulting adjustments to taxable income (for example, allowable depreciation in that tax year for the item of section 179 property for which the election pertains. Free file alliance ) Once made, the revocation is irrevocable. Free file alliance When Must You Recapture the Deduction? You may have to recapture the section 179 expense deduction if, in any year during the property's recovery period, the percentage of business use drops to 50% or less. Free file alliance In the year the business use drops to 50% or less, you include the recapture amount as ordinary income. Free file alliance You also increase the basis of the property by the recapture amount. Free file alliance Recovery periods for property are discussed later. Free file alliance If you sell, exchange, or otherwise dispose of the property, do not figure the recapture amount under the rules explained in this discussion. Free file alliance Instead, use the rules for recapturing depreciation explained in  chapter 9 under Section 1245 Property. Free file alliance   If the property is listed property, do not figure the recapture amount under the rules explained in this discussion when the percentage of business use drops to 50% or less. Free file alliance Instead, use the rules for recapturing depreciation explained in chapter 5 of Publication 946 under Recapture of Excess Depreciation. Free file alliance Figuring the recapture amount. Free file alliance   To figure the amount to recapture, take the following steps. Free file alliance Figure the allowable depreciation for the section 179 expense deduction you claimed. Free file alliance Begin with the year you placed the property in service and include the year of recapture. Free file alliance Subtract the depreciation figured in (1) from the section 179 expense deduction you actually claimed. Free file alliance The result is the amount you must recapture. Free file alliance Example. Free file alliance In January 2011, Paul Lamb, a calendar year taxpayer, bought and placed in service section 179 property costing $10,000. Free file alliance The property is not listed property. Free file alliance He elected a $5,000 section 179 expense deduction for the property and also elected not to claim a special depreciation allowance. Free file alliance He used the property only for business in 2011 and 2012. Free file alliance During 2013, he used the property 40% for business and 60% for personal use. Free file alliance He figures his recapture amount as follows. Free file alliance Section 179 expense deduction claimed (2011) $5,000 Minus: Allowable depreciation (instead of section 179 expense deduction):   2011 $1,250   2012 1,875   2013 ($1,250 × 40% (business)) 500 3,625 2013 — Recapture amount $1,375     Paul must include $1,375 in income for 2013. Free file alliance Where to report recapture. Free file alliance   Report any recapture of the section 179 expense deduction as ordinary income in Part IV of Form 4797 and include it in income on Schedule F (Form 1040). Free file alliance Recapture for qualified section 179 GO Zone property. Free file alliance   If any qualified section 179 GO Zone property ceases to be used in the GO Zone in a later year, you must recapture the benefit of the increased section 179 expense deduction as “other income. Free file alliance ” Claiming the Special Depreciation Allowance For qualified property (defined below) placed in service in 2013, you can take an additional 50% special depreciation allowance. Free file alliance The allowance is an additional deduction you can take after any section 179 expense deduction and before you figure regular depreciation under MACRS. Free file alliance Figure the special depreciation allowance by multiplying the depreciable basis of the qualified property by 50%. Free file alliance What is Qualified Property? For farmers, qualified property generally is certain qualified property acquired after December 31, 2007, and placed in service before January 1, 2014. Free file alliance Certain qualified property acquired after December 31, 2007, and placed in service before January 1, 2014. Free file alliance   Certain qualified property (defined below) acquired after December 31, 2007, and before January 1, 2014, is eligible for a 50% special depreciation allowance. Free file alliance   Qualified property includes the following: Tangible property depreciated under the Modified Accelerated Cost Recovery System (MACRS) with a recovery period of 20 years or less. Free file alliance Water utility property. Free file alliance Off-the-shelf computer software. Free file alliance Qualified leasehold improvement property. Free file alliance   Qualified property must also meet all of the following tests: You must have acquired qualified property by purchase after December 31, 2007. Free file alliance If a binding contract to acquire the property existed before January 1, 2008, the property does not qualify. Free file alliance Qualified property must be placed in service after December 31, 2007 and placed in service before January 1, 2014 (before January 1, 2015 for certain property with a long production period and for certain aircraft). Free file alliance The original use of the property must begin with you after December 31, 2007. Free file alliance For more information, see chapter 3 of Publication 946. Free file alliance How Can You Elect Not To Claim the Allowance? You can elect, for any class of property, not to deduct the special depreciation allowance for all property in such class placed in service during the tax year. Free file alliance To make the election, attach a statement to your return indicating the class of property for which you are making the election. Free file alliance Generally, you must make the election on a timely filed tax return (including extensions) for the year in which you place the property in service. Free file alliance However, if you timely filed your return for the year without making the election, you still can make the election by filing an amended return within 6 months of the due date of the original return (not including extensions). Free file alliance Attach the election statement to the amended return. Free file alliance On the amended return, write “Filed pursuant to section 301. Free file alliance 9100-2. Free file alliance ” Once made, the election may not be revoked without IRS consent. Free file alliance If you elect not to have the special depreciation allowance apply, the property may be subject to an alternative minimum tax adjustment for depreciation. Free file alliance When Must You Recapture an Allowance When you dispose of property for which you claimed a special depreciation allowance, any gain on the disposition is generally recaptured (included in income) as ordinary income up to the amount of the special depreciation allowance previously allowed or allowable. Free file alliance For more information, see chapter 3 of Publication 946. Free file alliance Figuring Depreciation Under MACRS The Modified Accelerated Cost Recovery System (MACRS) is used to recover the basis of most business and investment property placed in service after 1986. Free file alliance MACRS consists of two depreciation systems, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Free file alliance Generally, these systems provide different methods and recovery periods to use in figuring depreciation deductions. Free file alliance To be sure you can use MACRS to figure depreciation for your property, see Can You Use MACRS To Depreciate Your Property, earlier. Free file alliance This part explains how to determine which MACRS depreciation system applies to your property. Free file alliance It also discusses the following information that you need to know before you can figure depreciation under MACRS. Free file alliance Property's recovery class. Free file alliance Placed-in-service date. Free file alliance Basis for depreciation. Free file alliance Recovery period. Free file alliance Convention. Free file alliance Depreciation method. Free file alliance Finally, this part explains how to use this information to figure your depreciation deduction. Free file alliance Which Depreciation System (GDS or ADS) Applies? Your use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period you use. Free file alliance You generally must use GDS unless you are specifically required by law to use ADS or you elect to use ADS. Free file alliance Required use of ADS. Free file alliance   You must use ADS for the following property. Free file alliance All property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect. Free file alliance Listed property used 50% or less in a qualified business use. Free file alliance See Additional Rules for Listed Property , later. Free file alliance Any tax-exempt use property. Free file alliance Any tax-exempt bond-financed property. Free file alliance Any property imported from a foreign country for which an Executive Order is in effect because the country maintains trade restrictions or engages in other discriminatory acts. Free file alliance Any tangible property used predominantly outside the United States during the year. Free file alliance If you are required to use ADS to depreciate your property, you cannot claim the special depreciation allowance. Free file alliance Electing ADS. Free file alliance   Although your property may qualify for GDS, you can elect to use ADS. Free file alliance The election generally must cover all property in the same property class you placed in service during the year. Free file alliance However, the election for residential rental property and nonresidential real property can be made on a property-by-property basis. Free file alliance Once you make this election, you can never revoke it. Free file alliance   You make the election by completing line 20 in Part III of Form 4562. Free file alliance Which Property Class Applies Under GDS? The following is a list of the nine property classes under GDS. Free file alliance 3-year property. Free file alliance 5-year property. Free file alliance 7-year property. Free file alliance 10-year property. Free file alliance 15-year property. Free file alliance 20-year property. Free file alliance 25-year property. Free file alliance Residential rental property. Free file alliance Nonresidential real property. Free file alliance See Which Property Class Applies Under GDS in chapter 4 of Publication 946 for examples of the types of property included in each class. Free file alliance What Is the Placed-in-Service Date? You begin to claim depreciation when your property is placed in service for use either in a trade or business or for the production of income. Free file alliance The placed-in-service date for your property is the date the property is ready and available for a specific use. Free file alliance It is therefore not necessarily the date it is first used. Free file alliance If you converted property held for personal use to use in a trade or business or for the production of income, treat the property as being placed in service on the conversion date. Free file alliance See Placed in Service under When Does Depreciation Begin and End , earlier, for examples illustrating when property is placed in service. Free file alliance What Is the Basis for Depreciation? The basis for depreciation of MACRS property is the property's cost or other basis multiplied by the percentage of business/investment use. Free file alliance Reduce that amount by any credits and deductions allocable to the property. Free file alliance The following are examples of some of the credits and deductions that reduce basis. Free file alliance Any deduction for section 179 property. Free file alliance Any deduction for removal of barriers to the disabled and the elderly. Free file alliance Any disabled access credit, enhanced oil recovery credit, and credit for employer-provided childcare facilities and services. Free file alliance Any special depreciation allowance. Free file alliance Basis adjustment for investment credit property under section 50(c) of the Internal Revenue Code. Free file alliance For information about how to determine the cost or other basis of property, see What Is the Basis of Your Depreciable Property , earlier. Free file alliance Also, see chapter 6. Free file alliance For additional credits and deductions that affect basis, see section 1016 of the Internal Revenue Code. Free file alliance Which Recovery Period Applies? The recovery period of property is the number of years over which you recover its cost or other basis. Free file alliance It is determined based on the depreciation system (GDS or ADS) used. Free file alliance See Table 7-1 for recovery periods under both GDS and ADS for some commonly used assets. Free file alliance For a complete list of recovery periods, see the Table of Class Lives and Recovery Periods in Appendix B of Publication 946. Free file alliance House trailers for farm laborers. Free file alliance   To depreciate a house trailer you supply as housing for those who work on your farm, use one of the following recovery periods if the house trailer is mobile (it has wheels and a history of movement). Free file alliance A 7-year recovery period under GDS. Free file alliance A 10-year recovery period under ADS. Free file alliance   However, if the house trailer is not mobile (its wheels have been removed and permanent utilities and pipes attached to it), use one of the following recovery periods. Free file alliance A 20-year recovery period under GDS. Free file alliance A 25-year recovery period under ADS. Free file alliance Water wells. Free file alliance   Water wells used to provide water for raising poultry and livestock are land improvements. Free file alliance If they are depreciable, use one of the following recovery periods. Free file alliance A 15-year recovery period under GDS. Free file alliance A 20-year recovery period under ADS. Free file alliance   The types of water wells that can be depreciated were discussed earlier in Irrigation systems and water wells under Property Having a Determinable Useful Life . Free file alliance Table 7-1. Free file alliance Farm Property Recovery Periods   Recovery Period in Years Assets GDS ADS Agricultural structures (single purpose) 10 15 Automobiles 5 5 Calculators and copiers 5 6 Cattle (dairy or breeding) 5 7 Communication equipment1 7 10 Computer and peripheral equipment 5 5 Drainage facilities 15 20 Farm buildings2 20 25 Farm machinery and equipment 7 10 Fences (agricultural) 7 10 Goats and sheep (breeding) 5 5 Grain bin 7 10 Hogs (breeding) 3 3 Horses (age when placed in service)     Breeding and working (12 years or less) 7 10 Breeding and working (more than 12 years) 3 10 Racing horses 3 12 Horticultural structures (single purpose) 10 15 Logging machinery and equipment3 5 6 Nonresidential real property 394 40 Office furniture, fixtures, and equipment (not calculators, copiers, or typewriters) 7 10 Paved lots 15 20 Residential rental property 27. Free file alliance 5 40 Tractor units (over-the-road) 3 4 Trees or vines bearing fruit or nuts 10 20 Truck (heavy duty, unloaded weight 13,000 lbs. Free file alliance or more) 5 6 Truck (actual weight less than 13,000 lbs) 5 5 Water wells 15 20 1 Not including communication equipment listed in other classes. Free file alliance 2 Not including single purpose agricultural or horticultural structures. Free file alliance 3 Used by logging and sawmill operators for cutting of timber. Free file alliance 4 For property placed in service after May 12, 1993; for property placed in service before May 13, 1993,  the recovery period is 31. Free file alliance 5 years. Free file alliance Which Convention Applies? Under MACRS, averaging conventions establish when the recovery period begins and ends. Free file alliance 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. Free file alliance Use one of the following conventions. Free file alliance The half-year convention. Free file alliance The mid-month convention. Free file alliance The mid-quarter convention. Free file alliance For a detailed explanation of each convention, see Which Convention Applies in chapter 4 of Publication 946. Free file alliance Also, see the Instructions for Form 4562. Free file alliance Which Depreciation Method Applies? MACRS provides three depreciation methods under GDS and one depreciation method under ADS. Free file alliance The 200% declining balance method over a GDS recovery period. Free file alliance The 150% declining balance method over a GDS recovery period. Free file alliance The straight line method over a GDS recovery period. Free file alliance The straight line method over an ADS recovery period. Free file alliance Depreciation Table. Free file alliance   The following table lists the types of property you can depreciate under each method. Free file alliance The declining balance method is abbreviated as DB and the straight line method is abbreviated as SL. Free file alliance Depreciation Table System/Method   Type of Property GDS using  150% DB • All property used in a farming business (except real property)   • All 15- and 20-year property   • Nonfarm 3-, 5-, 7-, and 10-year property1 GDS using SL • Nonresidential real property   • Residential rental property   • Trees or vines bearing fruit or nuts   • All 3-, 5-, 7-, 10-, 15-, and 20-year property1 ADS using SL • Property used predomi- nantly outside the United States   • Farm property used when an election not to apply the uniform capitalization rules is in effect   • Tax-exempt property   • Tax-exempt bond-financed property   • Imported property2   • Any property for which you elect to use this method1 GDS using  200% DB • Nonfarm 3-, 5-, 7-, and 10-year property 1Elective method 2See section 168(g)(6) of the Internal Revenue  Code Property used in farming business. Free file alliance   For personal property placed in service after 1988 in a farming business, you must use the 150% declining balance method over a GDS recovery period or you can elect one of the following methods. Free file alliance The straight line method over a GDS recovery period. Free file alliance The straight line method over an ADS recovery period. Free file alliance For property placed in service before 1999, you could have elected to use the 150% declining balance method using the ADS recovery periods for certain property classes. Free file alliance If you made this election, continue to use the same method and recovery period for that property. Free file alliance Real property. Free file alliance   You can depreciate real property using the straight line method under either GDS or ADS. Free file alliance Switching to straight line. Free file alliance   If you use a declining balance method, you switch to the straight line method in the year it provides an equal or greater deduction. Free file alliance If you use the MACRS percentage tables, discussed later under How Is the Depreciation Deduction Figured , you do not need to determine in which year your deduction is greater using the straight line method. Free file alliance The tables have the switch to the straight line method built into their rates. Free file alliance Fruit or nut trees and vines. Free file alliance   Depreciate trees and vines bearing fruit or nuts under GDS using the straight line method over a 10-year recovery period. Free file alliance ADS required for some farmers. Free file alliance   If you elect not to apply the uniform capitalization rules to any plant shown in Table 6-1 of chapter 6 and produced in your farming business, you must use ADS for all property you place in service in any year the election is in effect. Free file alliance See chapter 6 for a discussion of the application of the uniform capitalization rules to farm property. Free file alliance Electing a different method. Free file alliance   As shown in the Depreciation Table , you can elect a different method for depreciation for certain types of property. Free file alliance You must make the election by the due date of the return (including extensions) for the year you placed the property in service. Free file alliance 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 6 months of the due date of your return (excluding extensions). Free file alliance Attach the election to the amended return and write “Filed pursuant to section 301. Free file alliance 9100-2” on the election statement. Free file alliance File the amended return at the same address you filed the original return. Free file alliance Once you make the election, you cannot change it. Free file alliance    If you elect to use a different method for one item in a property class, you must apply the same method to all property in that class placed in service during the year of the election. Free file alliance However, you can make the election on a property-by-property basis for residential rental and nonresidential real property. Free file alliance Straight line election. Free file alliance   Instead of using the declining balance method, you can elect to use the straight line method over the GDS recovery period. Free file alliance Make the election by entering “S/L” under column (f) in Part III of Form 4562. Free file alliance ADS election. Free file alliance   As explained earlier under Which Depreciation System (GDS or ADS) Applies , you can elect to use ADS even though your property may come under GDS. Free file alliance ADS uses the straight line method of depreciation over the ADS recovery periods, which are generally longer than the GDS recovery periods. Free file alliance The ADS recovery periods for many assets used in the business of farming are listed in Table 7–1. Free file alliance Additional ADS recovery periods for other classes of property may be found in the Table of Class Lives and Recovery Periods in Appendix B of Publication 946. Free file alliance How Is the Depreciation Deduction Figured? To figure your depreciation deduction under MACRS, you first determine the depreciation system, property class, placed-in-service date, basis amount, recovery period, convention, and depreciation method that applies to your property. Free file alliance Then you are ready to figure your depreciation deduction. Free file alliance You can figure it in one of two ways. Free file alliance You can use the percentage tables provided by the IRS. Free file alliance You can figure your own deduction without using the tables. Free file alliance Figuring your own MACRS deduction will generally result in a slightly different amount than using the tables. Free file alliance Using the MACRS Percentage Tables To help you figure your deduction under MACRS, the IRS has established percentage tables that incorporate the applicable convention and depreciation method. Free file alliance These percentage tables are in Appendix A of Publication 946. Free file alliance Rules for using the tables. Free file alliance   The following rules cover the use of the percentage tables. Free file alliance You must apply the rates in the percentage tables to your property's unadjusted basis. Free file alliance Unadjusted basis is the same basis amount you would use to figure gain on a sale but figured without reducing your original basis by any MACRS depreciation taken in earlier years. Free file alliance You cannot use the percentage tables for a short tax year. Free file alliance See chapter 4 of Publication 946 for information on how to figure the deduction for a short tax year. Free file alliance You generally must continue to use them for the entire recovery period of the property. Free file alliance You must stop using the tables if you adjust the basis of the property for any reason other than— Depreciation allowed or allowable, or An addition or improvement to the property, which is depreciated as a separate property. Free file alliance Basis adjustment due to casualty loss. Free file alliance   If you reduce the basis of your property because of a casualty, you cannot continue to use the percentage tables. Free file alliance For the year of the adjustment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year. Free file alliance See Figuring the Deduction Without Using the Tables in chapter 4 of Publication 946. Free file alliance Figuring depreciation using the 150% DB method and half-year convention. Free file alliance    Table 7-2 has the percentages for 3-, 5-, 7-, and 20-year property. Free file alliance The percentages are based on the 150% declining balance method with a change to the straight line method. Free file alliance This table covers only the half-year convention and the first 8 years for 20-year property. Free file alliance See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention. Free file alliance   The following examples show how to figure depreciation under MACRS using the percentages in Table 7-2 . Free file alliance Example 1. Free file alliance During the year, you bought an item of 7-year property for $10,000 and placed it in service. Free file alliance You do not elect a section 179 expense deduction for this property. Free file alliance In addition, the property is not qualified property for purposes of the special depreciation allowance. Free file alliance The unadjusted basis of the property is $10,000. Free file alliance You use the percentages in Table 7-2 to figure your deduction. Free file alliance Since this is 7-year property, you multiply $10,000 by 10. Free file alliance 71% to get this year's depreciation of $1,071. Free file alliance For next year, your depreciation will be $1,913 ($10,000 × 19. Free file alliance 13%). Free file alliance Example 2. Free file alliance You had a barn constructed on your farm at a cost of $20,000. Free file alliance You placed the barn in service this year. Free file alliance You elect not to claim the special depreciation allowance. Free file alliance The barn is 20-year property and you use the table percentages to figure your deduction. Free file alliance You figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 3. Free file alliance 75% to get $750. Free file alliance For next year, your depreciation will be $1,443. Free file alliance 80 ($20,000 × 7. Free file alliance 219%). Free file alliance Table 7-2. Free file alliance 150% Declining Balance Method (Half-Year Convention) Year 3-Year 5-Year 7-Year 20-Year 1 25. Free file alliance 0 % 15. Free file alliance 00 % 10. Free file alliance 71 % 3. Free file alliance 750 % 2 37. Free file alliance 5   25. Free file alliance 50   19. Free file alliance 13   7. Free file alliance 219   3 25. Free file alliance 0   17. Free file alliance 85   15. Free file alliance 03   6. Free file alliance 677   4 12. Free file alliance 5   16. Free file alliance 66   12. Free file alliance 25   6. Free file alliance 177   5     16. Free file alliance 66   12. Free file alliance 25   5. Free file alliance 713   6     8. Free file alliance 33   12. Free file alliance 25   5. Free file alliance 285   7         12. Free file alliance 25   4. Free file alliance 888   8         6. Free file alliance 13   4. Free file alliance 522   Figuring depreciation using the straight line method and half-year convention. Free file alliance   The following table has the straight line percentages for 3-, 5-, 7-, and 20-year property using the half-year convention. Free file alliance The table covers only the first 8 years for 20-year property. Free file alliance See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention. Free file alliance Table 7-3. Free file alliance Straight Line Method (Half-Year Convention) Year 3-Year 5-Year 7-Year 20-Year 1 16. Free file alliance 67 % 10 % 7. Free file alliance 14 % 2. Free file alliance 5 % 2 33. Free file alliance 33   20   14. Free file alliance 29   5. Free file alliance 0   3 33. Free file alliance 33   20   14. Free file alliance 29   5. Free file alliance 0   4 16. Free file alliance 67   20   14. Free file alliance 28   5. Free file alliance 0   5     20   14. Free file alliance 29   5. Free file alliance 0   6     10   14. Free file alliance 28   5. Free file alliance 0   7         14. Free file alliance 29   5. Free file alliance 0   8         7. Free file alliance 14   5. Free file alliance 0