1.  When property is used in a
business and expected to last
longer than one year, but will
eventually wear out or become
useless:
− It cannot be expensed in the
year that it was put into use
− The cost must be spread out
over its expected life with a
portion of the cost being
deducted each year
 The cost of most real and
personal property used for
business or for the production of
income can be recovered through
depreciation.
 Depreciation is an amount that can
be deducted annually.
 It allows the taxpayer to recover
the cost or other basis of certain
property over the time the
property is used in trade or
business.
Lesson I: Depreciation
IRS Publication 946

2. Eligible Property
To be depreciable:
Property must be owned by
the taxpayer
Property must lose its value
over time from any of the
following:
– Wear and tear
– Deterioration
– Obsolescence
– Natural causes
•Property that does not wear
out (such as land) cannot be
depreciated.

3. Eligible Property (Cont.)
 Depreciation is a business
expense deduction.
 Property used exclusively for
personal activities, or to
generate non-taxable income,
is not depreciable.
 Property that is placed in
service and disposed of in the
same year is also not
depreciable.
 Any addition or improvement
made to depreciable property
is treated as a separate
depreciable property.

4. • Tanya completely replaced the
roof of a rental property she
owns.
• The new roof is an improvement
and, for tax purposes, is a
different asset from the building.
• Tanya must depreciate the cost
of the new roof separately from
the building.
Note: Repairs and maintenance
costs are not depreciated.
Replacement of small items, such
as a faucet or a switch, are
considered maintenance.
Depreciation Example

5. Basis
Cost basis of property = Cost + Taxes,
Delivery, or setup or installation charges

6. Adjusted Basis
• When an asset’s cost basis is adjusted
by some event, such as an
improvement, the updated basis is
known as adjusted basis.
• When an asset is converted from
personal use to business use, its basis
is the lower of either the:
– Cost
– Fair market value (FMV) at the
time of conversion

7.  Bobbie bought a townhome four
years ago.
 The purchase price was $75,000,
which includes a land value of
$10,000.
 This year, Bobbie moved and
decided she would use her
townhome as rental property.
 When she began renting the
townhome it had an FMV of
$120,000, which includes a land
value of $15,000.
 Bobbie’s adjusted basis for
depreciation on the rental
townhome is $65,000, which is
the lower of the home’s original
cost or the FMV at the time she
converted its use.
 Because land does not wear out,
it is not considered in the basis
for purposes of depreciation.
Adjusted Basis Example

8. Allowed or Allowable Depreciation
The taxpayer’s basis in an
asset is reduced annually by
the greater of:
•Allowed Depreciation
The amount the taxpayer
actually took
•Allowable Depreciation
The amount the taxpayer
could have taken under the
depreciation rules
Note: When the taxpayer disposes of the
depreciable property, they are required to
recapture the allowable depreciation even if
they did not claim it during the life of the asset.
But they must depreciate property when it falls
into a category when depreciation is expected.

9. Allowed or Allowable
Depreciation Example
 Alice paid $2,000 for a
machine to use in her
business.
 The total allowable
depreciation was $776.
 But she did not actually
claim the depreciation.
 The adjusted basis for
calculating her gain or
loss if she sells the
machine is $1,224.

10. Fully Recovered Basis
 Property is generally
considered fully
depreciated when the
total amount depreciated
equals the adjusted basis
of the property.
 Once the property has
been fully depreciated,
no more depreciation is
allowed even the
taxpayer still uses the
property.

11. When Depreciation Begins and Ends
 Depreciation begins when the
taxpayer first places the
property in service for a
business or for the production
of income.
 Property is placed in service
when it is ready and available
for a specific use.
 It does not matter that the
property is not yet being used
for the intended purpose.

12. When Depreciation Begins
• Callie bought a key-making and Ends Example
machine for her hardware
store.
• She ordered it on May 1.
• It was delivered on June 16
and installed on July 7.
• Callie made her first key on
September 4.
• The date the key machine
was placed in service is July
7, which is the date it was
ready and available for its
intended purpose.
• The fact that Callie did not
use it until September does
not affect the date the
machine was placed in
service.

13. Property Temporarily Idle
Once the taxpayer has begun
depreciating property, they
continue to claim depreciation on
the property even if it is
temporarily idle.
Example: If Frank stops using a
machine because there is a
temporary lack of market for a
product made with that machine,
he continues to deduct
depreciation on it.

14. Depreciation End Time
• Once the taxpayer has fully recovered their
basis, or the property is no longer used in
business, depreciation ends.
• Depreciation also ends when the taxpayer
stops using the property because they retire
it.
• Property is considered retired when the
taxpayer stops using it entirely in their trade
or business because it has been:
– Sold
– Exchanged or destroyed
– Changed to personal use
– Abandoned
– Transferred to a supply or scrap account

15. Lesson II: MACRS
IRS Publication 946
 Modified Accelerated Cost Recovery
System (MACRS) is the cost recovery
system used to depreciate most property.
 Under MACRS, an asset is classified
according to its property type and the
period of time over which the cost can be
recovered.
 The recovery period depends on the
depreciation system the taxpayer
chooses.
 A recovery period is a predetermined
number of years in which the cost or the
other basis of the property is recovered.

16. Depreciation Systems
MACRS consists of two depreciation systems:
1. General Depreciation System (GDS)
2. Alternative Depreciation System (ADS)
GDS
Faster of the two depreciation systems under MACRS
Methods for calculating depreciation:
 200% declining balance
 150% declining balance
 Straight line methods
ADS
Slower of the two depreciation systems under MACRS
Method for calculating depreciation: straight line

17. GDS
• GDS is the default
system used under
MACRS, and is
sometimes referred to
as regular MACRS.
• GDS accelerates the
recovery of an asset’s
cost by taking greater
deductions in early
years, and uses the
shortest recovery period
allowable.

18. ADS
• ADS applies straight-line
depreciation, in which an equal
amount of an asset’s cost is
deducted each full year over its
useful life.
• ADS recovery periods can be longer
than regular MACRS recovery
periods.
• Using the ADS method is an election
for most properties, but is
mandatory in some situations.

19. Class Life
• The IRS groups similar assets into
classes according to the type of
property.
• Each class is assigned a class life,
which is the average number of
years the property is expected to
be functional and useful.
• Taxpayers must use the IRS
estimates of an asset’s class life.

20. Property Classes
• Under regular MACRS, assets
are assigned to one of nine
property classes.
• The property class generally
determines:
– Depreciation method
– Recovery period
– Convention
• A convention is a method
established under MACRS to
determine when the recovery
period begins and ends.
• The convention affects a
taxpayer’s depreciation
deduction for the year they
place the property in service
and for the year they dispose
of it.

21. Half-Year Convention
 The half-year (HY) convention
is the most common.
 All property placed into
service during the year is
considered to be placed at
the midpoint of the year,
regardless of when it was
actually placed into service.
 For the first year that the
property was placed into
service, only half of the
yearly depreciation is taken
when the property is disposed
of, no matter how long the
property was actually used
during the first and last year.

22. Half-Year Convention
 Latisha purchased a new over-the- Example
road tractor for her independent
trucking business on March 10 of
this year.
 This asset has a property class of
three years and a recovery period
of three years under GDS.
 Since Latisha is using the half-year
convention for this asset, she
depreciates it for 6 months in the
first year of ownership even though
she placed it in service for more
than 8 months.
 She does not lose the extra 2
months of depreciation because in
the final year of depreciation the
tractor will again be depreciated for
6 months.
Note: Use the half-year convention
when no other convention is
required.

23. Mid-Quarter Convention
 The mid-quarter (MQ) convention must be used
when 40% or more of depreciable property is
placed into service during the last quarter of
the tax year.
 This does not include residential rental property
or non-residential real property.
For example:
 Let’s say Latisha’s tractor had a depreciable
basis of $50,000.
 In addition to purchasing the tractor in March,
she also placed into service three additional
tractors for $30,000 each in November of the
same year.
 The total amount of depreciable assets placed
into service in the same year is 110,000 with
55% of the assets, 60,000 of the 110, placed
into service during the last quarter of the year.
 In this case, Latisha would have to use the mid-quarter
convention for all property placed into
service for the entire year; all four tractors. Not
just those placed into service during the last
quarter.
Note: A calendar year is divided
into quarters, as shown in the
graphic.

24. Mid-Quarter Convention
(continued)
 When the mid-quarter convention is
required, it must be used for all
property placed in service during the
year.
 There are different depreciation
percentage tables for each quarter.
 Under the mid-quarter convention,
all property placed in service or
disposed of during any quarter of a
tax year is treated as placed in
service or disposed of at the
midpoint of the quarter.
 This means that 1 ½ months of
depreciation for the quarter the
asset was placed into service would
be allowed the first year and 1 ½
months for the year it was disposed
of would be allowed.
 There are certain property classes
that allow specific conventions to be
used.
 The two property classes shown in
the table that require a specific
convention are Residential rental
property and Nonresidential real
property.

25. Mid-Month Convention
 Residential rental property and nonresidential
rental real property require the use of the mid-month
(MM) convention.
 Under this convention, all property placed in
service or disposed of during a month is treated as
placed in service or disposed of at the midpoint of
the month.
 This results in a half-month of depreciation for the
month in which the property is placed in service
and for the month in which it is disposed of, no
matter how many days that month it was actually
in service.

26. Mid-Month Convention
Example  Annorah bought a residential rental
apartment property for $200,000 on
June 19.
 The mid-month convention is
required for residential rental
property.
 On July 1, she purchased a
refrigerator for $700 for one of the
apartments.
 On November 9, Annorah purchased
three stoves for the property for
$1,500.
 She placed 68% of her qualified
assets in service during the last
quarter ($1,500 ÷ [$1,500 + $700]).
 Annorah must use the mid-quarter
convention for both the refrigerator
and the stoves.
 The cost of residential rental property
is not taken into consideration when
determining what percentage of
assets was placed in service during
the last quarter.

27. Depreciation Methods
 Depreciation is calculated
using either a straight-line
method or an accelerated
method.
 Under regular MACRS
(GDS), the methods are:
– Straight-line (S/L)
– 200% declining balance
(200 DB)
– 150% declining balance
(150 DB)

28. Straight-Line Method
 The straight-line method is a method for calculating the
depreciation of property that uses a percentage rate to deduct
the same amount for each year of the recovery period.
 The percentage rate is determined by the number of years in
the recovery period.
 Under the straight-line method, an equal amount of
depreciation is taken each full year during the asset’s useful
life.

29. Declining Balance Methods
 Under the declining balance
methods, the cost recovery rate of
an asset is accelerated.
 Under the 200% declining balance
method, 200% of the straight-line
rate is applied to the remaining
depreciable balance of an asset,
until the straight-line method
results in a larger deduction.
 Under the 150% declining balance
method, 150% of the straight-line
rate is applied to the remaining
depreciable balance of an asset.
 Accelerated methods result in a
higher amount of depreciation in
the first few years of use.
2010
2011
2012

30. Lesson III: Depreciation
Calculations
 The IRS has created depreciation
charts (also called percentage
tables) that incorporate
depreciation methods, and the
applicable recovery periods.
 These percentages are applied to
the beginning basis of the
depreciable assets.
 The MACRS tables automatically
provide for the change to straight-line
when it benefits the taxpayer.
IRS Publication 946

31. Calculating the Depreciation Deduction
 Before depreciation can the
calculated, the taxpayer must know
their basis.
 Basis is usually their cost, plus any
improvements to the property
before it was placed into service,
and decreased by the value of any
uninsured casualty losses.
 Certain property may be eligible to
have part or all of its cost recovered
in the year the taxpayer purchased
it.
 This is known as a Section 179
deduction.

32. Additional Depreciation Deductions
 At times, Congress increases certain benefits to taxpayers to help boost the economy.
 To accomplish this, they may increase limitations (such as the Section 179 deduction) or
make additional deductions available that allow taxpayers to take advantage of the
temporary changes.
 One such additional deduction is known as a special depreciation allowance (also known as
bonus depreciation or first-year additional depreciation allowance).
 This is an additional deduction taxpayers can take before calculating regular depreciation
on a new (not used) asset under MACRS, for the first year the property is placed in
service.
 When determining the basis for depreciation, reduce the original basis by any special
depreciation previously claimed.
 For qualified property acquired before May 6, 2003, the special depreciation allowance is 30%.
 For qualified property acquired after May 5, 2003 and before January 1, 2008, the special
depreciation allowance is 50% unless the taxpayer elects to use the 30% allowance.
 In 2008, the economic stimulus act eliminated the 30% allowance and made 50% the allowance
percentage.
 For qualified property acquired after September 8, 2010, the allowance is 100%.

33. Business Use
 Only the portion of the
taxpayer’s basis that
represents business use is
depreciable.
 Multiply the basis of the
asset by the percentage of
business use to determine
the depreciable basis.

34. Business Use Example
 Louis purchased a new
lawn mower for $800.
 He uses it 80% of the time
in his lawn care business.
 His depreciable basis for
business use is $640 ($800
× 0.80).
The taxpayer must maintain
records such as a calendar
or log book to substantiate
the determination of
business-use percentage.
The method used must be
reasonable and consistent.

35. Special Depreciation Allowance
 For qualified property acquired after September 8, 2010,
and placed in service before January 1, 2012, the special
depreciation allowance is 100% of the business-use
percentage.
 This special allowance is based on the depreciable basis of
the property after any Section 179 deduction is claimed and
before any regular depreciation is taken for the tax year.
 The 50% special depreciation allowance cannot alternatively
be selected for assets placed in service in 2011.
 If the taxpayer elects out of the 100% special depreciation
allowance for property acquired after September 8, 2010,
and placed in service before January 1, 2012, then the
property does not qualify for the 50% special depreciation
allowance.

36.  Property that qualifies under Qualifying Property
the special depreciation
allowance are:
– Tangible property
depreciated under MACRS
with a recovery period of
20 years or less
– Water utility property
– Off-the-shelf computer
software
– Qualified leasehold
improvement property
(LHI)
 The original use of the
property must begin with the
taxpayer.
 The allowance does not apply
to the purchase of used
assets.

37. Property that does not
qualify includes:
•Property placed in service
and disposed of in the same
tax year
•Property converted from
business use to personal use
in the same tax year it is
acquired
•Property required to be
depreciated under the
Alternative Depreciation
System (ADS)
•Property included in a class
of property for which the
taxpayer elected not to claim
the special depreciation
allowance
Nonqualifying Property

38. Special Depreciation
Allowance Example  On May 1, Tom bought
a business desk that
cost $7,000 and placed
it in service as qualified
property.
 He does not elect to
claim a Section 179
deduction.
 The special
depreciation allowance
is $7,000 (100%), if all
other requirements are
met.

39. Depreciation Tables
 To determine a property’s depreciation, apply the exact rates (as they
appear in the tables) to the property’s basis.
 Apply this rate each year.
 Do not reduce the basis by prior year deprecation when applying the
percentage.
 Once the tables are used for a property, the taxpayer must continue to use
them for the entire recovery period of the property.
 Computerized methods of calculating depreciation use rounding techniques
that sometimes result in slightly different amounts from those calculated
using the tables.

40. Depreciation Tables
Example
 Willis placed a new mechanic’s
toolbox in service for his
business on May 3.
 It was the only asset placed in
service during the year and he
uses it 100% for business.
 His basis in the toolbox is
$1,100.
 Under regular MACRS, a
toolbox is 7-year property and
the half-year convention
applies.
 With a recovery period of
seven years, Willis uses the
IRS MACRS Percentage Table
A-1.
 According to this table, the
depreciation rate for the year
he places the toolbox in
service is 14.29%.

41. Depreciation Tables
Example (Cont.)
 Willis placed a new mechanic’s
toolbox in service for his
business on May 3.
 It was the only asset placed in
service during the year and he
uses it 100% for business.
 His basis in the toolbox is
$1,100.
 Under regular MACRS, a
toolbox is 7-year property and
the half-year convention
applies.
 With a recovery period of
seven years, Willis uses the
IRS MACRS Percentage Table
A-1.
 According to this table, the
depreciation rate for the year
he places the toolbox in
service is 14.29%.
Depreciation Calculation
The total depreciation for this year is $157
($1,100 × 0.1429).
If Willis had chosen to claim the special
depreciation allowance, his total depreciation
for the first year would be $1,100.
Depreciation Calculation
The total depreciation for this year is $157
($1,100 × 0.1429).
If Willis had chosen to claim the special
depreciation allowance, his total depreciation
for the first year would be $1,100.

42. Depreciation Worksheet
 Taxpayers should keep detailed information about each depreciable asset with their return
documents.
 This information should include:
− The calculation of the original basis
− Any Section 179 deductions
− Any special allowance deductions
− Each year’s depreciation
 A depreciation worksheet or similar document should be used.
 Each business or investment activity that the taxpayer has should maintain a worksheet
that lists the assets associated with that activity.

43. Recapture
 When an asset is disposed
of prior to the end of its
depreciable life (recovery
period), some of the
previously deducted
depreciation may need to
be recaptured as taxable
income.
 The taxpayer needs
information from the
depreciation worksheet to
calculate the amount that
must be recaptured, and to
adjust their basis to
determine whether they
have a gain or a loss on
the disposition.

44. Illustration One
 Mabel Johnson bought
office furniture for $10,000
and placed it in service on
August 11.
 She uses the furniture only
for business.
 The furniture is the only
property she placed in
service this year, so the
half-year convention
applies.
 Under regular MACRS
(GDS), the furniture is 7-
year property.
 She uses MACRS
Percentage Table A-1.

45. Illustration One:
Depreciation Deduction
 Mabel’s basis in the furniture
is its cost.
 For each year, the basis is
multiplied by the percentage
for 7-year property provided
in Table A-1.
 Mabel multiplies her
depreciable basis by the first-year
percentage to determine
her deduction for the year.
 Mabel’s depreciation
deduction for each year of the
recovery period is shown.

46. Illustration One:
 Mabel’s depreciation Depreciation Worksheet
deduction for years 1 and
8 of the property’s
recovery period are based
on a half-year.
 Mabel records the current
year’s deduction on a
depreciation worksheet,
as shown.
 Preparers should be sure
taxpayers understand the
requirement to maintain
accurate records and the
importance of providing
their records from
previous years to their
preparer.

47. Percentage of Business Use
 For some assets, the
percentage of business use
may change from year to
year.
 The taxpayer must maintain,
as a part of their permanent
records, the business-use
percentage for each year.
 A separate line of the
depreciation worksheet can
be used when the business
percentage changes.

48. Illustration Two
 Briggs Watkins has a laptop computer that he bought two years ago to use in his
management consulting business
 He has used it each year, as follows:
– First Year - Did not use it for any personal purpose
– Last Year - Used it to take three online courses in photography, his new hobby
– This Year - Took one online photography course
 He determined his business-use percentage according to the number of hours he spent
working on his courses.
 Each year his business-use percentage changes.
 A new line is used to track the depreciation on his depreciation worksheet, as shown

49. Illustration Two (Cont.)
 When he purchased the laptop in 2009, he purchased it with a cost of $4,322, which is listed under ‘cost’ on the depreciation worksheet.
 His business percentage was 100% so his appreciable basis is $4,322.
 With a five-year recovery period and 200db half-year as his method and convention, his percentage according to the tables is 20% so the amount
for 2009 is $866.
 His second year business percentage was only 84%.
 So we take the original depreciable basis of $4,322 multiply it by 84%, and we get the new depreciable basis of $3,630.
 We’re using the same recovery period, the same method and convention, the amount recovered in prior years is from 2009, which is $866.
 According to the percentage tables, the second year is 32%, which gives the 2010 amount, $1,162.
 In year three, he used it 93%.
 So we take the depreciable basis of $4,322 and multiply it by 93%, which gives us $4,019.
 The amount recovered in prior years is the $866 from 2009 and the $1,162 from 2010.
 So our recovered in prior years total now is $2,028.
 The percentage rate for the third year is 19.2%.
 So the total amount for 2011 is $772.

50. Lesson IV: Depreciation
Reporting
IRS Instructions for Form 4562
 Once you have calculated an
asset’s depreciation and entered it
onto the depreciation worksheet,
enter the depreciation on the
appropriate form for each asset’s
business use.
 Enter depreciation for an
employee’s assets on Form 2106,
Employee Business Expenses.
 If the taxpayer is self-employed,
enter depreciation related to their
business assets on Schedule C,
Profit or Loss From Business.

51. Purpose of Form 4562
 If the taxpayer has assets that were placed in service during the current year,
Form 4562, Depreciation and Amortization, is also required.
 A separate Form 4562 must be completed for each activity.
 The activity needs to be identified by entering it next to the taxpayer’s name
at the top of the Form 4562.
 Each part of the form has a separate purpose, as shown in the graphic.

52. Regular and ADS MACRS
 Most regular and ADS MACRS depreciation is summarized and reported in
Form 4562, Part III.
 When Form 4562 is required, enter the total depreciation deduction for
items placed in service in prior years on Section A, Line 17.

53. Form 4562, Part III, Section B
 Complete Form 4562, Part III, Section B, for assets placed in service during the
current year for which the regular MACRS (GDS) system is being used.
 For residential rental property and nonresidential real property, enter the month and
year the property was placed in service on Section B, Column (b), Line 19h or 19i.

54. Reporting the Convention and Method

55. Illustration Three
 Seth Stuart is self-employed
as a
carpenter.
 He has several tools
that he bought in prior
years, and a new
circular saw he bought
this year.
 Because he put assets
in service in the current
year, Seth must
complete Form 4562 to
take his depreciation
deduction.

56. Illustration Three: Worksheet

57. Illustration Three:
Form 4562

58. Illustration Four
Using the information from
Illustration Three, Seth
Stuart’s depreciation
deduction for his carpentry
business is entered on his
Schedule C, Line 13, as
shown.