Applicable Recovery Period
Basis for Depreciation: What is the basis of your depreciable property?
Corrections: How do you correct depreciation deductions?
Definition of Depreciation
- “Depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property. It is an allowance for the wear and tear, deterioration, or obsolescence of the property.” Pub 946 (2019 p.3).
- What method can you use to depreciate your property?
- Modified Accelerated Cost Recovery System (MACRS)
- “You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most property.” Pub 946 (2019 p.8).
- MACRS has two depreciation systems:
- the General Depreciation System (GDS)
- the Alternative Depreciation System (ADS)
- How do you determine which MACRS depreciation system applies to your property?
- “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. You must generally use GDS unless you are specifically required by law to use ADS or you elect to use ADS.” Pub. 946 (2019 p.28).
- What property can be depreciated? What property cannot?
- “You can depreciate most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. You can also depreciate certain intangible property, such as patents, copyrights, and computer software.” Pub 946 (2019 p.4).
Form 4562: Do you have to file Form 4562?
- Distinguish: Rental Expense v. Improvement
- Schedule L: Balance Sheet per Books 9a Buildings and other depreciable assets
- Form 4562 Depreciation and Amortization
- Deduct Improvements
From Pub 946 (2019), p.13:
How Do You Treat Repairs and Improvements?
If you improve depreciable property, you must treat the improvement as separate depreciable property. Improvement means an addition to or partial replacement of property that is a betterment to the property, restores the property, or adapts it to a new or different use. See section 1.263(a)-3 of the regulations.
You generally deduct the cost of repairing business property in the same way as any other business expense. However, if the cost is for a betterment to the property, to restore the property, or to adapt the property to a new or different use, you must treat it as an improvement and depreciate it.
Example. You repair a small section on one corner of the roof of a rental house. You deduct the cost of the repair as a rental expense. However, if you completely replace the roof, the new roof is an improvement because it is a restoration of the building. You depreciate the cost of the new roof.
From Pub 946 (2019), p.34:
Additions and Improvements
An addition or improvement you make to depreciable property is treated as separate depreciable property. See How Do You Treat Repairs and Improvements in chapter 1 for a definition of improvements. Its property class and recovery period are the same as those that would apply to the original property if you had placed it in service at the same time you placed the addition or improvement in service. The recovery period begins on the later of the following dates.
The date you place the addition or improvement in service.
The date you place in service the property to which you made the addition or improvement.
Example. You own a rental home that you have been renting out since 1981. If you put an addition on the home and place the addition in service this year, you would use MACRS to figure your depreciation deduction for the addition. Under GDS, the property class for the addition is residential rental property and its recovery period is 27.5 years because the home to which the addition is made would be residential rental property if you had placed it in service this year.
Tax Treatment of Capital Expenditures
Because capital expenditures increase the value of your property, the IRS doesn’t treat them as expenses. To claim them on your taxes, you will need to depreciate them. Depreciation, which gets done on Form 4562, requires that you divide the amount you spent by 27.5 and write that amount off every year for 27 years with a half deduction in the 28th year. You will get your money back in tax deductions – it’s just that it will take more than 27 years.
Property placed in service before 1987 have their own rules. See Pub. 534 Depreciating Property Placed in Service Before 1987.
- About Publication 946, How to Depreciate Property (“This publication explains how you can recover the cost of business or income-producing property through deductions for depreciation.”), IRS.
- Publication 946 (2020) (HTML, PDF)
Repairs v. Improvements: How do you treat repairs and improvements?
Section 179 Deduction
- You take a Section 179 Deduction instead of a depreciation deduction.
Special Depreciation Allowance
When does depreciation begin and end?