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HrblockonlineHrblockonline Other Methods of Depreciation Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: How To Figure the DeductionBasis Useful Life Salvage Value Methods To UseStraight Line Method Declining Balance Method Income Forecast Method How To Change Methods DispositionsSale or exchange. Hrblockonline Property not disposed of or abandoned. Hrblockonline Special rule for normal retirements from item accounts. Hrblockonline Abandoned property. Hrblockonline Single item accounts. Hrblockonline Multiple property account. Hrblockonline Topics - This chapter discusses: How to figure the deduction Methods to use How to change methods Dispositions Useful Items - You may want to see: Publication 544 Sales and Other Dispositions of Assets 551 Basis of Assets 583 Starting a Business and Keeping Records 946 How To Depreciate Property Form (and Instructions) 3115 Application for Change in Accounting Method 4562 Depreciation and Amortization Schedule C (Form 1040) Profit or Loss From Business If your property is being depreciated under ACRS, you must continue to use rules for depreciation that applied when you placed the property in service. Hrblockonline If your property qualified for MACRS, you must depreciate it under MACRS. Hrblockonline See Publication 946. Hrblockonline However, you cannot use MACRS for certain property because of special rules that exclude it from MACRS. Hrblockonline Also, you can elect to exclude certain property from being depreciated under MACRS. Hrblockonline Property that you cannot depreciate using MACRS includes: Intangible property, Property you can elect to exclude from MACRS that you properly depreciate under a method that is not based on a term of years, Certain public utility property, Any motion picture film or video tape, Any sound recording, and Certain real and personal property placed in service before 1987. Hrblockonline Intangible property. Hrblockonline You cannot depreciate intangible property under ACRS or MACRS. Hrblockonline You depreciate intangible property using any other reasonable method, usually, the straight line method. Hrblockonline Note. Hrblockonline The cost of certain intangible property that you acquire after August 10, 1993, must be amortized over a 15-year period. Hrblockonline For more information, see chapter 12 of Publication 535. Hrblockonline Public utility property. Hrblockonline The law excludes from MACRS any public utility property for which the taxpayer does not use a normalization method of accounting. Hrblockonline This type of property is subject to depreciation under a special rule. Hrblockonline Videocassettes. Hrblockonline If you are in the videocassette rental business, you can depreciate those videocassettes purchased for rental. Hrblockonline You can depreciate the cost less salvage value of those videocassettes that have a useful life over one year using either: The straight line method, or The income forecast method. Hrblockonline The straight line method, salvage value, and useful life are discussed later under Methods To Use. Hrblockonline You can deduct in the year of purchase as a business expense the cost of any cassette that has a useful life of one year or less. Hrblockonline How To Figure the Deduction Two other reasonable methods can be used to figure your deduction for property not covered under ACRS or MACRS. Hrblockonline These methods are straight line and declining balance. Hrblockonline To figure depreciation using these methods, you must generally determine three things about the property you intend to depreciate. Hrblockonline They are: The basis, The useful life, and The estimated salvage value at the end of its useful life. Hrblockonline The amount of the deduction in any year also depends on which method of depreciation you choose. Hrblockonline Basis To deduct the proper amount of depreciation each year, first determine your basis in the property you intend to depreciate. Hrblockonline The basis used for figuring depreciation is the same as the basis that would be used for figuring the gain on a sale. Hrblockonline Your original basis is usually the purchase price. Hrblockonline However, if you acquire property in some other way, such as inheriting it, getting it as a gift, or building it yourself, you have to figure your original basis in a different way. Hrblockonline Adjusted basis. Hrblockonline Events will often change the basis of property. Hrblockonline When this occurs, the changed basis is called the adjusted basis. Hrblockonline Some events, such as improvements you make, increase basis. Hrblockonline Events such as deducting casualty losses and depreciation decrease basis. Hrblockonline If basis is adjusted, the depreciation deduction may also have to be changed, depending on the reason for the adjustment and the method of depreciation you are using. Hrblockonline Publication 551 explains how to figure basis for property acquired in different ways. Hrblockonline It also discusses what items increase and decrease basis, how to figure adjusted basis, and how to allocate cost if you buy several pieces of property at one time. Hrblockonline Useful Life The useful life of a piece of property is an estimate of how long you can expect to use it in your trade or business, or to produce income. Hrblockonline It is the length of time over which you will make yearly depreciation deductions of your basis in the property. Hrblockonline It is how long it will continue to be useful to you, not how long the property will last. Hrblockonline Many things affect the useful life of property, such as: Frequency of use, Age when acquired, Your repair policy, and Environmental conditions. Hrblockonline The useful life can also be affected by technological improvements, progress in the arts, reasonably foreseeable economic changes, shifting of business centers, prohibitory laws, and other causes. Hrblockonline Consider all these factors before you arrive at a useful life for your property. Hrblockonline The useful life of the same type of property varies from user to user. Hrblockonline When you determine the useful life of your property, keep in mind your own experience with similar property. Hrblockonline You can use the general experience of the industry you are in until you are able to determine a useful life of your property from your own experience. Hrblockonline Change in useful life. Hrblockonline You base your estimate of useful life on certain facts. Hrblockonline If these facts change significantly, you can adjust your estimate of the remaining useful life. Hrblockonline However, you redetermine the estimated useful life only when the change is substantial and there is a clear reason for making the change. Hrblockonline Salvage Value It is important for you to accurately determine the correct salvage value of the property you want to depreciate. Hrblockonline You generally cannot depreciate property below a reasonable salvage value. Hrblockonline Determining salvage value. Hrblockonline Salvage value is the estimated value of property at the end of its useful life. Hrblockonline It is what you expect to get for the property if you sell it after you can no longer use it productively. Hrblockonline You must estimate the salvage value of a piece of property when you first acquire it. Hrblockonline Salvage value is affected both by how you use the property and how long you use it. Hrblockonline If it is your policy to dispose of property that is still in good operating condition, the salvage value can be relatively large. Hrblockonline However, if your policy is to use property until it is no longer usable, its salvage value can be its junk value. Hrblockonline Changing salvage value. Hrblockonline Once you determine the salvage value for property, you should not change it merely because prices have changed. Hrblockonline However, if you redetermine the useful life of property, as discussed earlier under Change in useful life, you can also redetermine the salvage value. Hrblockonline When you redetermine the salvage value, take into account the facts that exist at the time. Hrblockonline Net salvage. Hrblockonline Net salvage is the salvage value of property minus what it costs to remove it when you dispose of it. Hrblockonline You can choose either salvage value or net salvage when you figure depreciation. Hrblockonline You must consistently use the one you choose and the treatment of the costs of removal must be consistent with the practice adopted. Hrblockonline However, if the cost to remove the property is more than the estimated salvage value, then net salvage is zero. Hrblockonline Your salvage value can never be less than zero. Hrblockonline Ten percent rule. Hrblockonline If you acquire personal property that has a useful life of 3 years or more, you can use an amount for salvage value that is less than your actual estimate. Hrblockonline You can subtract from your estimate of salvage value an amount equal to 10% of your basis in the property. Hrblockonline If salvage value is less than 10% of basis, you can ignore salvage value when you figure depreciation. Hrblockonline Methods To Use Two methods of depreciation are the straight line and declining balance methods. Hrblockonline If ACRS or MACRS does not apply, you can use one of these methods. Hrblockonline The straight line and declining balance methods discussed in this section are not figured in the same way as straight line or declining balance methods under MACRS. Hrblockonline Straight Line Method Before 1981, you could use any reasonable method for every kind of depreciable property. Hrblockonline One of these methods was the straight line method. Hrblockonline This method was also used for intangible property. Hrblockonline It lets you deduct the same amount of depreciation each year. Hrblockonline To figure your deduction, determine the adjusted basis of your property, its salvage value, and its estimated useful life. Hrblockonline Subtract the salvage value, if any, from the adjusted basis. Hrblockonline The balance is the total amount of depreciation you can take over the useful life of the property. Hrblockonline Divide the balance by the number of years remaining in the useful life. Hrblockonline This gives you the amount of your yearly depreciation deduction. Hrblockonline Unless there is a big change in adjusted basis, or useful life, this amount will stay the same throughout the time you depreciate the property. Hrblockonline If, in the first year, you use the property for less than a full year, you must prorate your depreciation deduction for the number of months in use. Hrblockonline Example. Hrblockonline In April 1994, Frank bought a franchise for $5,600. Hrblockonline It expires in 10 years. Hrblockonline This property is intangible property that cannot be depreciated under MACRS. Hrblockonline Frank depreciates the franchise under the straight line method, using a 10-year useful life and no salvage value. Hrblockonline He takes the $5,600 basis and divides that amount by 10 years ($5,600 ÷ 10 = $560, a full year's use). Hrblockonline He must prorate the $560 for his 9 months of use in 1994. Hrblockonline This gives him a deduction of $420 ($560 ÷ 9/12). Hrblockonline In 1995, Frank can deduct $560 for the full year. Hrblockonline Declining Balance Method The declining balance method allows you to recover a larger amount of the cost of the property in the early years of your use of the property. Hrblockonline The rate cannot be more than twice the straight line rate. Hrblockonline Rate of depreciation. Hrblockonline Under this method, you must determine your declining balance rate of depreciation. Hrblockonline The initial step is to: Divide the number 1 by the useful life of your property to get a straight line rate. Hrblockonline (For example, if property has a useful life of 5 years, its normal straight line rate of depreciation is ⅕, or 20%. Hrblockonline ) Multiply this straight line rate by a number that is more than 1 but not more than 2 to determine the declining balance rate. Hrblockonline Unless there is a change in the useful life during the time you depreciate the property, the rate of depreciation generally will not change. Hrblockonline Depreciation deductions. Hrblockonline After you determine the rate of depreciation, multiply the adjusted basis of the property by it. Hrblockonline This gives you the amount of your deduction. Hrblockonline For example, if your adjusted basis at the beginning of the first year is $10,000, and your declining balance rate is 20%, your depreciation deduction for the first year is $2,000 ($10,000 ÷ 20%). Hrblockonline To figure your depreciation deduction in the second year, you must first adjust the basis for the amount of depreciation you deducted in the first year. Hrblockonline Subtract the previous year's depreciation from your basis ($10,000 - $2,000 = $8,000). Hrblockonline Multiply this amount by the rate of depreciation ($8,000 ÷ 20% = $1,600). Hrblockonline Your depreciation deduction for the second year is $1,600. Hrblockonline As you can see from this example, your adjusted basis in the property gets smaller each year. Hrblockonline Also, under this method, deductions are larger in the earlier years and smaller in the later years. Hrblockonline You can make a change to the straight line method without consent. Hrblockonline Salvage value. Hrblockonline Do not subtract salvage value when you figure your yearly depreciation deductions under the declining balance method. Hrblockonline However, you cannot depreciate the property below its reasonable salvage value. Hrblockonline Determine salvage value using the rules discussed earlier, including the special 10% rule. Hrblockonline Example. Hrblockonline If your adjusted basis has been decreased to $1,000 and the rate of depreciation is 20%, your depreciation deduction should be $200. Hrblockonline But if your estimate of salvage value was $900, you can only deduct $100. Hrblockonline This is because $100 is the amount that would lower your adjusted basis to equal salvage value. Hrblockonline Income Forecast Method The income forecast method requires income projections for each videocassette or group of videocassettes. Hrblockonline You can group the videocassettes by title for making this projection. Hrblockonline You determine the depreciation by applying a fraction to the cost less salvage value of the cassette. Hrblockonline The numerator is the income from the videocassette for the tax year and the denominator is the total projected income for the cassette. Hrblockonline For more information on the income forecast method, see Revenue Ruling 60-358 in Cumulative Bulletin 1960, Volume 2, on page 68. Hrblockonline How To Change Methods In some cases, you may change your method of depreciation for property depreciated under a reasonable method. Hrblockonline If you change your method of depreciation, it is generally a change in your method of accounting. Hrblockonline You must get IRS consent before making the change. Hrblockonline However, you do not need permission for certain changes in your method of depreciation. Hrblockonline The rules discussed in this section do not apply to property depreciated under ACRS or MACRS. Hrblockonline For information on ACRS elections,see Revocation of election, in chapter 1 under Alternate ACRS Method. Hrblockonline Change to the straight line method. Hrblockonline You can change from the declining balance method to the straight line method at any time during the useful life of your property without IRS consent. Hrblockonline However, if you have a written agreement with the IRS that prohibits a change, you must first get IRS permission. Hrblockonline When the change is made, figure depreciation based on your adjusted basis in the property at that time. Hrblockonline Your adjusted basis takes into account all previous depreciation deductions. Hrblockonline Use the estimated remaining useful life of your property at the time of change and its estimated salvage value. Hrblockonline You can change from the declining balance method to straight line only on the original tax return for the year you first use the straight line method. Hrblockonline You cannot make the change on an amended return filed after the due date of the original return (including extensions). Hrblockonline When you make the change, attach a statement to your tax return showing: When you acquired the property, Its original cost or other original basis, The total amount claimed for depreciation and other allowances since you acquired it, Its salvage value and remaining useful life, and A description of the property and its use. Hrblockonline After you change to straight line, you cannot change back to the declining balance method or to any other method for a period of 10 years without written permission from the IRS. Hrblockonline Changes that require permission. Hrblockonline For most other changes in method of depreciation, you must get permission from the IRS. Hrblockonline To request a change in method of depreciation, file Form 3115. Hrblockonline File the application within the first 180 days of the tax year the change is to become effective. Hrblockonline In most cases, there is a user fee that must accompany Form 3115. Hrblockonline See the instructions for Form 3115 to determine if a fee is required. Hrblockonline Changes granted automatically. Hrblockonline The IRS automatically approves certain changes of a method of depreciation. Hrblockonline But, you must file Form 3115 for these automatic changes. Hrblockonline However, IRS can deny permission if Form 3115 is not filed on time. Hrblockonline For more information on automatic changes, see Revenue Procedure 74-11, 1974-1 C. Hrblockonline B. Hrblockonline 420. Hrblockonline Changes for which approval is not automatic. Hrblockonline The automatic change procedures do not apply to: Property or an account where you made a change in depreciation within the last 10 tax years (unless the change was made under the Class Life System), Class Life Asset Depreciation Range System, and Public utility property. Hrblockonline You must request and receive permission for these changes. Hrblockonline To make the request, file Form 3115 during the first 180 days of the tax year for which you want the change to be effective. Hrblockonline Change from an improper method. Hrblockonline If the IRS disallows the method you are using, you do not need permission to change to a proper method. Hrblockonline You can adopt the straight line method, or any other method that would have been permitted if you had used it from the beginning. Hrblockonline If you file your tax return using an improper method, but later file an amended return, you can use a proper method on the amended return without getting IRS permission. Hrblockonline However, you must file the amended return before the filing date for the next tax year. Hrblockonline Dispositions Retirement is the permanent withdrawal of depreciable property from use in your trade or business or for the production of income. Hrblockonline You can do this by selling, exchanging, or abandoning the item of property. Hrblockonline You can also withdraw it from use without disposing of it. Hrblockonline For example, you could place it in a supplies or scrap account. Hrblockonline Retirements can be either normal or abnormal depending on all facts and circumstances. Hrblockonline The rules discussed next do not apply to MACRS and ACRS property. Hrblockonline Normal retirement. Hrblockonline A normal retirement is a permanent withdrawal of depreciable property from use if the following apply: The retirement is made within the useful life you estimated originally, and The property has reached a condition at which you customarily retire or would retire similar property from use. Hrblockonline A retirement is generally considered normal unless you can show that you retired the property because of a reason you did not consider when you originally estimated the useful life of the property. Hrblockonline Abnormal retirement. Hrblockonline A retirement can be abnormal if you withdraw the property early or under other circumstances. Hrblockonline For example, if the property is damaged by a fire or suddenly becomes obsolete and is now useless. Hrblockonline Gain or loss on retirement. Hrblockonline There are special rules for figuring the gain or loss on retirement of property. Hrblockonline The gain or loss will depend on several factors. Hrblockonline These include the type of withdrawal, if the withdrawal was from a single property or multiple property account, and if the retirement was normal or abnormal. Hrblockonline A single property account contains only one item of property. Hrblockonline A multiple property account is one in which several items have been combined with a single rate of depreciation assigned to the entire account. Hrblockonline Sale or exchange. Hrblockonline If property is retired by sale or exchange, you figure gain or loss by the usual rules that apply to sales or other dispositions of property. Hrblockonline See Publication 544. Hrblockonline Property not disposed of or abandoned. Hrblockonline If property is retired permanently, but not disposed of or physically abandoned, you do not recognize gain. Hrblockonline You are allowed a loss in such a case, but only if the retirement is: An abnormal retirement, A normal retirement from a single property account in which you determined the life of each item of property separately, or A normal retirement from a multiple property account in which the depreciation rate is based on the maximum expected life of the longest lived item of property and the loss occurs before the expiration of the full useful life. Hrblockonline However, you are not allowed a loss if the depreciation rate is based on the average useful life of the items of property in the account. Hrblockonline To figure your loss, subtract the estimated salvage or fair market value of the property at the date of retirement, whichever is more, from its adjusted basis. Hrblockonline Special rule for normal retirements from item accounts. Hrblockonline You can generally deduct losses upon retirement of a few depreciable items of property with similar useful lives, if: You account for each one in a separate account, and You use the average useful life to figure depreciation. Hrblockonline However, you cannot deduct losses if you use the average useful life to figure depreciation and they have a wide range of useful lives. Hrblockonline If you have a large number of depreciable property items and use average useful lives to figure depreciation, you cannot deduct the losses upon normal retirements from these accounts. Hrblockonline Abandoned property. Hrblockonline If you physically abandon property, you can deduct as a loss the adjusted basis of the property at the time of its abandonment. Hrblockonline However, your intent must be to discard the property so that you will not use it again or retrieve it for sale, exchange, or other disposition. Hrblockonline Basis of property retired. Hrblockonline The basis for figuring gain or loss on the retirement of property is its adjusted basis at the time of retirement, as determined in the following discussions. Hrblockonline Single item accounts. Hrblockonline If an item of property is accounted for in a single item account, the adjusted basis is the basis you would use to figure gain or loss for a sale or exchange of the property. Hrblockonline This is generally the cost or other basis of the item of property less depreciation. Hrblockonline See Publication 551. Hrblockonline Multiple property account. Hrblockonline For a normal retirement from a multiple property account, if you figured depreciation using the average expected useful life, the adjusted basis is the salvage value estimated for the item of property when it was originally acquired. Hrblockonline If you figured depreciation using the maximum expected useful life of the longest lived item of property in the account, you must use the depreciation method used for the multiple property account and a rate based on the maximum expected useful life of the item of property retired. Hrblockonline You make the adjustment for depreciation for an abnormal retirement from a multiple property account at the rate that would be proper if the item of property was depreciated in a single property account. Hrblockonline The method of depreciation used for the multiple property account is used. Hrblockonline You base the rate on either the average expected useful life or the maximum expected useful life of the retired item of property, depending on the method used to determine the depreciation rate for the multiple property account. Hrblockonline Prev Up Next Home More Online Publications
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