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Free state tax return only 1. Free state tax return only   Overview of Depreciation Table of Contents Introduction Useful Items - You may want to see: What Property Can Be Depreciated?Property You Own Property Used in Your Business or Income-Producing Activity Property Having a Determinable Useful Life Property Lasting More Than One Year What Property Cannot Be Depreciated?Land Excepted Property When Does Depreciation Begin and End?Placed in Service Idle Property Cost or Other Basis Fully Recovered Retired From Service What Method Can You Use To Depreciate Your Property?Property You Placed in Service Before 1987 Property Owned or Used in 1986 Intangible Property Corporate or Partnership Property Acquired in a Nontaxable Transfer Election To Exclude Property From MACRS What Is the Basis of Your Depreciable Property?Cost as Basis Other Basis Adjusted Basis How Do You Treat Repairs and Improvements? Do You Have To File Form 4562? How Do You Correct Depreciation Deductions?Filing an Amended Return Changing Your Accounting Method Introduction 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. Free state tax return only It is an allowance for the wear and tear, deterioration, or obsolescence of the property. Free state tax return only This chapter discusses the general rules for depreciating property and answers the following questions. Free state tax return only What property can be depreciated? What property cannot be depreciated? When does depreciation begin and end? What method can you use 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? Useful Items - You may want to see: Publication 534 Depreciating Property Placed in Service Before 1987 535 Business Expenses 538 Accounting Periods and Methods 551 Basis of Assets Form (and Instructions) Sch C (Form 1040) Profit or Loss From Business Sch C-EZ (Form 1040) Net Profit From Business 2106 Employee Business Expenses 2106-EZ Unreimbursed Employee Business Expenses 3115 Application for Change in Accounting Method 4562 Depreciation and Amortization See chapter 6 for information about getting publications and forms. Free state tax return only What Property Can Be Depreciated? You can depreciate most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. Free state tax return only You also can depreciate certain intangible property, such as patents, copyrights, and computer software. Free state tax return only To be depreciable, the property must meet all the following requirements. Free state tax return only It must be property you own. Free state tax return only It must be used in your business or income-producing activity. Free state tax return only It must have a determinable useful life. Free state tax return only It must be expected to last more than one year. Free state tax return only The following discussions provide information about these requirements. Free state tax return only Property You Own To claim depreciation, you usually must be the owner of the property. Free state tax return only You are considered as owning property even if it is subject to a debt. Free state tax return only Example 1. Free state tax return only You made a down payment to purchase rental property and assumed the previous owner's mortgage. Free state tax return only You own the property and you can depreciate it. Free state tax return only Example 2. Free state tax return only You bought a new van that you will use only for your courier business. Free state tax return only You will be making payments on the van over the next 5 years. Free state tax return only You own the van and you can depreciate it. Free state tax return only Leased property. Free state tax return only   You can depreciate leased property only if you retain the incidents of ownership in the property (explained below). Free state tax return only This means you bear the burden of exhaustion of the capital investment in the property. Free state tax return only 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 state tax return only You can, however, depreciate any capital improvements you make to the property. Free state tax return only See How Do You Treat Repairs and Improvements later in this chapter and Additions and Improvements under Which Recovery Period Applies in chapter 4. Free state tax return only   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 state tax return only However, 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, you cannot depreciate the cost of the property. Free state tax return only Incidents of ownership. Free state tax return only   Incidents of ownership in property include the following. Free state tax return only The legal title to the property. Free state tax return only The legal obligation to pay for the property. Free state tax return only The responsibility to pay maintenance and operating expenses. Free state tax return only The duty to pay any taxes on the property. Free state tax return only The risk of loss if the property is destroyed, condemned, or diminished in value through obsolescence or exhaustion. Free state tax return only Life tenant. Free state tax return only   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 state tax return only However, see Certain term interests in property under Excepted Property, later. Free state tax return only Cooperative apartments. Free state tax return only   If you are a tenant-stockholder in a cooperative housing corporation and use your cooperative apartment in your business or for the production of income, you can depreciate your stock in the corporation, even though the corporation owns the apartment. Free state tax return only   Figure your depreciation deduction as follows. Free state tax return only Figure the depreciation for all the depreciable real property owned by the corporation in which you have a proprietary lease or right of tenancy. Free state tax return only If you bought your cooperative stock after its first offering, figure the depreciable basis of this property as follows. Free state tax return only Multiply your cost per share by the total number of outstanding shares, including any shares held by the corporation. Free state tax return only Add to the amount figured in (a) any mortgage debt on the property on the date you bought the stock. Free state tax return only Subtract from the amount figured in (b) any mortgage debt that is not for the depreciable real property, such as the part for the land. Free state tax return only Subtract from the amount figured in (1) any depreciation for space owned by the corporation that can be rented but cannot be lived in by tenant-stockholders. Free state tax return only Divide the number of your shares of stock by the total number of outstanding shares, including any shares held by the corporation. Free state tax return only Multiply the result of (2) by the percentage you figured in (3). Free state tax return only This is your depreciation on the stock. Free state tax return only   Your depreciation deduction for the year cannot be more than the part of your adjusted basis in the stock of the corporation that is allocable to your business or income-producing property. Free state tax return only You must also reduce your depreciation deduction if only a portion of the property is used in a business or for the production of income. Free state tax return only Example. Free state tax return only You figure your share of the cooperative housing corporation's depreciation to be $30,000. Free state tax return only Your adjusted basis in the stock of the corporation is $50,000. Free state tax return only You use one half of your apartment solely for business purposes. Free state tax return only Your depreciation deduction for the stock for the year cannot be more than $25,000 (½ of $50,000). Free state tax return only Change to business use. Free state tax return only   If you change your cooperative apartment to business use, figure your allowable depreciation as explained earlier. Free state tax return only The basis of all the depreciable real property owned by the cooperative housing corporation is the smaller of the following amounts. Free state tax return only The fair market value of the property on the date you change your apartment to business use. Free state tax return only This is considered to be the same as the corporation's adjusted basis minus straight line depreciation, unless this value is unrealistic. Free state tax return only The corporation's adjusted basis in the property on that date. Free state tax return only Do not subtract depreciation when figuring the corporation's adjusted basis. Free state tax return only   If you bought the stock after its first offering, the corporation's adjusted basis in the property is the amount figured in (1), above. Free state tax return only The fair market value of the property is considered to be the same as the corporation's adjusted basis figured in this way minus straight line depreciation, unless the value is unrealistic. Free state tax return only   For a discussion of fair market value and adjusted basis, see Publication 551. Free state tax return only 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 state tax return only If you use property to produce income (investment use), the income must be taxable. Free state tax return only You cannot depreciate property that you use solely for personal activities. Free state tax return only Partial business or investment use. Free state tax return only   If you use property for business or investment purposes and for personal purposes, you can deduct depreciation based only on the business or investment use. Free state tax return only For example, you cannot deduct depreciation on a car used only for commuting, personal shopping trips, family vacations, driving children to and from school, or similar activities. Free state tax return only    You must keep records showing the business, investment, and personal use of your property. Free state tax return only For more information on the records you must keep for listed property, such as a car, see What Records Must Be Kept in chapter 5. Free state tax return only    Although you can combine business and investment use of property when figuring depreciation deductions, do not treat investment use as qualified business use when determining whether the business-use requirement for listed property is met. Free state tax return only For information about qualified business use of listed property, see What Is the Business-Use Requirement in chapter 5. Free state tax return only Office in the home. Free state tax return only   If you use part of your home as an office, you may be able to deduct depreciation on that part based on its business use. Free state tax return only For information about depreciating your home office, see Publication 587. Free state tax return only Inventory. Free state tax return only   You cannot depreciate inventory because it is not held for use in your business. Free state tax return only Inventory is any property you hold primarily for sale to customers in the ordinary course of your business. Free state tax return only   If you are a rent-to-own dealer, you may be able to treat certain property held in your business as depreciable property rather than as inventory. Free state tax return only See Rent-to-own dealer under Which Property Class Applies Under GDS in chapter 4. Free state tax return only   In some cases, it is not clear whether property is held for sale (inventory) or for use in your business. Free state tax return only If it is unclear, examine carefully all the facts in the operation of the particular business. Free state tax return only The following example shows how a careful examination of the facts in two similar situations results in different conclusions. Free state tax return only Example. Free state tax return only Maple Corporation is in the business of leasing cars. Free state tax return only At the end of their useful lives, when the cars are no longer profitable to lease, Maple sells them. Free state tax return only Maple does not have a showroom, used car lot, or individuals to sell the cars. Free state tax return only Instead, it sells them through wholesalers or by similar arrangements in which a dealer's profit is not intended or considered. Free state tax return only Maple can depreciate the leased cars because the cars are not held primarily for sale to customers in the ordinary course of business, but are leased. Free state tax return only If Maple buys cars at wholesale prices, leases them for a short time, and then sells them at retail prices or in sales in which a dealer's profit is intended, the cars are treated as inventory and are not depreciable property. Free state tax return only In this situation, the cars are held primarily for sale to customers in the ordinary course of business. Free state tax return only Containers. Free state tax return only   Generally, containers for the products you sell are part of inventory and you cannot depreciate them. Free state tax return only However, you can depreciate containers used to ship your products if they have a life longer than one year and meet the following requirements. Free state tax return only They qualify as property used in your business. Free state tax return only Title to the containers does not pass to the buyer. Free state tax return only   To determine if these requirements are met, consider the following questions. Free state tax return only Does your sales contract, sales invoice, or other type of order acknowledgment indicate whether you have retained title? Does your invoice treat the containers as separate items? Do any of your records state your basis in the containers? Property Having a Determinable Useful Life To be depreciable, your property must have a determinable useful life. Free state tax return only This means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. Free state tax return only Property Lasting More Than One Year To be depreciable, property must have a useful life that extends substantially beyond the year you place it in service. Free state tax return only Example. Free state tax return only You maintain a library for use in your profession. Free state tax return only You can depreciate it. Free state tax return only However, if you buy technical books, journals, or information services for use in your business that have a useful life of one year or less, you cannot depreciate them. Free state tax return only Instead, you deduct their cost as a business expense. Free state tax return only What Property Cannot Be Depreciated? Certain property cannot be depreciated. Free state tax return only This includes land and certain excepted property. Free state tax return only Land You cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up. Free state tax return only The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Free state tax return only Although you cannot depreciate land, you can depreciate certain land preparation costs, such as landscaping costs, incurred in preparing land for business use. Free state tax return only These costs must be so closely associated with other depreciable property that you can determine a life for them along with the life of the associated property. Free state tax return only Example. Free state tax return only You constructed a new building for use in your business and paid for grading, clearing, seeding, and planting bushes and trees. Free state tax return only Some of the bushes and trees were planted right next to the building, while others were planted around the outer border of the lot. Free state tax return only If you replace the building, you would have to destroy the bushes and trees right next to it. Free state tax return only These bushes and trees are closely associated with the building, so they have a determinable useful life. Free state tax return only Therefore, you can depreciate them. Free state tax return only Add your other land preparation costs to the basis of your land because they have no determinable life and you cannot depreciate them. Free state tax return only Excepted Property Even if the requirements explained in the preceding discussions are met, you cannot depreciate the following property. Free state tax return only Property placed in service and disposed of in the same year. Free state tax return only Determining when property is placed in service is explained later. Free state tax return only Equipment used to build capital improvements. Free state tax return only You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements. Free state tax return only See Uniform Capitalization Rules in Publication 551. Free state tax return only Section 197 intangibles. Free state tax return only You must amortize these costs. Free state tax return only Section 197 intangibles are discussed in detail in Chapter 8 of Publication 535. Free state tax return only Intangible property, such as certain computer software, that is not section 197 intangible property, can be depreciated if it meets certain requirements. Free state tax return only See Intangible Property , later. Free state tax return only Certain term interests. Free state tax return only Certain term interests in property. Free state tax return only   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 state tax return only A term interest in property means a life interest in property, an interest in property for a term of years, or an income interest in a trust. Free state tax return only Related persons. Free state tax return only   For a description of related persons, see Related Persons, later. Free state tax return only For this purpose, however, treat as related persons only the relationships listed in items (1) through (10) of that discussion and substitute “50%” for “10%” each place it appears. Free state tax return only Basis adjustments. Free state tax return only   If you would be allowed a depreciation deduction for a term interest in property except that the holder of the remainder interest is related to you, you generally must reduce your basis in the term interest by any depreciation or amortization not allowed. Free state tax return only   If you hold the remainder interest, you generally must increase your basis in that interest by the depreciation not allowed to the term interest holder. Free state tax return only However, do not increase your basis for depreciation not allowed for periods during which either of the following situations applies. Free state tax return only The term interest is held by an organization exempt from tax. Free state tax return only The term interest is held by a nonresident alien individual or foreign corporation, and the income from the term interest is not effectively connected with the conduct of a trade or business in the United States. Free state tax return only Exceptions. Free state tax return only   The above rules do not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. Free state tax return only They also do not apply to the holder of dividend rights that were separated from any stripped preferred stock if the rights were purchased after April 30, 1993, or to a person whose basis in the stock is determined by reference to the basis in the hands of the purchaser. Free state tax return only 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 state tax return only 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 state tax return only Placed in Service You place property 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 state tax return only Even if you are not using the property, it is in service when it is ready and available for its specific use. Free state tax return only Example 1. Free state tax return only Donald Steep bought a machine for his business. Free state tax return only The machine was delivered last year. Free state tax return only However, it was not installed and operational until this year. Free state tax return only It is considered placed in service this year. Free state tax return only If the machine had been ready and available for use when it was delivered, it would be considered placed in service last year even if it was not actually used until this year. Free state tax return only Example 2. Free state tax return only On April 6, Sue Thorn bought a house to use as residential rental property. Free state tax return only She made several repairs and had it ready for rent on July 5. Free state tax return only At that time, she began to advertise it for rent in the local newspaper. Free state tax return only The house is considered placed in service in July when it was ready and available for rent. Free state tax return only She can begin to depreciate it in July. Free state tax return only Example 3. Free state tax return only James Elm is a building contractor who specializes in constructing office buildings. Free state tax return only He bought a truck last year that had to be modified to lift materials to second-story levels. Free state tax return only The installation of the lifting equipment was completed and James accepted delivery of the modified truck on January 10 of this year. Free state tax return only The truck was placed in service on January 10, the date it was ready and available to perform the function for which it was bought. Free state tax return only Conversion to business use. Free state tax return only   If you place property in service in a personal activity, you cannot claim depreciation. Free state tax return only However, if you change the property's use to use in a business or income-producing activity, then you can begin to depreciate it at the time of the change. Free state tax return only You place the property in service in the business or income-producing activity on the date of the change. Free state tax return only Example. Free state tax return only You bought a home and used it as your personal home several years before you converted it to rental property. Free state tax return only Although its specific use was personal and no depreciation was allowable, you placed the home in service when you began using it as your home. Free state tax return only You can begin to claim depreciation in the year you converted it to rental property because its use changed to an income-producing use at that time. Free state tax return only 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 (not in use). Free state tax return only 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 state tax return only Cost or Other Basis Fully Recovered You stop depreciating property when you have fully recovered your cost or other basis. Free state tax return only You recover your basis when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property. Free state tax return only See What Is the Basis of Your Depreciable Property , later. Free state tax return only 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 state tax return only 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 state tax return only You sell or exchange the property. Free state tax return only You convert the property to personal use. Free state tax return only You abandon the property. Free state tax return only You transfer the property to a supplies or scrap account. Free state tax return only The property is destroyed. Free state tax return only If you included the property in a general asset account, see How Do You Use General Asset Accounts in chapter 4 for the rules that apply when you dispose of that property. Free state tax return only What Method Can You Use To Depreciate Your Property? You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most property. Free state tax return only MACRS is discussed in chapter 4. Free state tax return only You cannot use MACRS to depreciate the following property. Free state tax return only Property you placed in service before 1987. Free state tax return only Certain property owned or used in 1986. Free state tax return only Intangible property. Free state tax return only Films, video tapes, and recordings. Free state tax return only Certain corporate or partnership property acquired in a nontaxable transfer. Free state tax return only Property you elected to exclude from MACRS. Free state tax return only The following discussions describe the property listed above and explain what depreciation method should be used. Free state tax return only Property You Placed in Service Before 1987 You cannot use MACRS for property you placed in service before 1987 (except property you placed in service after July 31, 1986, if MACRS was elected). Free state tax return only Property placed in service before 1987 must be depreciated under the methods discussed in Publication 534. Free state tax return only For a discussion of when property is placed in service, see When Does Depreciation Begin and End , earlier. Free state tax return only Use of real property changed. Free state tax return only   You generally must use MACRS to depreciate real property that you acquired for personal use before 1987 and changed to business or income-producing use after 1986. Free state tax return only Improvements made after 1986. Free state tax return only   You must treat an improvement made after 1986 to property you placed in service before 1987 as separate depreciable property. Free state tax return only Therefore, you can depreciate that improvement as separate property under MACRS if it is the type of property that otherwise qualifies for MACRS depreciation. Free state tax return only For more information about improvements, see How Do You Treat Repairs and Improvements , later and Additions and Improvements under Which Recovery Period Applies in chapter 4. Free state tax return only Property Owned or Used in 1986 You may not be able to use MACRS for property you acquired and placed in service after 1986 if any of the situations described below apply. Free state tax return only If you cannot use MACRS, the property must be depreciated under the methods discussed in Publication 534. Free state tax return only For the following discussions, do not treat property as owned before you placed it in service. Free state tax return only If you owned property in 1986 but did not place it in service until 1987, you do not treat it as owned in 1986. Free state tax return only Personal property. Free state tax return only   You cannot use MACRS for personal property (section 1245 property) in any of the following situations. Free state tax return only You or someone related to you owned or used the property in 1986. Free state tax return only You acquired the property from a person who owned it in 1986 and as part of the transaction the user of the property did not change. Free state tax return only You lease the property to a person (or someone related to this person) who owned or used the property in 1986. Free state tax return only You acquired the property in a transaction in which: The user of the property did not change, and The property was not MACRS property in the hands of the person from whom you acquired it because of (2) or (3) above. Free state tax return only Real property. Free state tax return only   You generally cannot use MACRS for real property (section 1250 property) in any of the following situations. Free state tax return only You or someone related to you owned the property in 1986. Free state tax return only You lease the property to a person who owned the property in 1986 (or someone related to that person). Free state tax return only You acquired the property in a like-kind exchange, involuntary conversion, or repossession of property you or someone related to you owned in 1986. Free state tax return only MACRS applies only to that part of your basis in the acquired property that represents cash paid or unlike property given up. Free state tax return only It does not apply to the carried-over part of the basis. Free state tax return only Exceptions. Free state tax return only   The rules above do not apply to the following. Free state tax return only Residential rental property or nonresidential real property. Free state tax return only Any property if, in the first tax year it is placed in service, the deduction under the Accelerated Cost Recovery System (ACRS) is more than the deduction under MACRS using the half-year convention. Free state tax return only For information on how to figure depreciation under ACRS, see Publication 534. Free state tax return only Property that was MACRS property in the hands of the person from whom you acquired it because of (2) above. Free state tax return only Related persons. Free state tax return only   For this purpose, the following are related persons. Free state tax return only An individual and a member of his or her family, including only a spouse, child, parent, brother, sister, half-brother, half-sister, ancestor, and lineal descendant. Free state tax return only A corporation and an individual who directly or indirectly owns more than 10% of the value of the outstanding stock of that corporation. Free state tax return only Two corporations that are members of the same controlled group. Free state tax return only A trust fiduciary and a corporation if more than 10% of the value of the outstanding stock is directly or indirectly owned by or for the trust or grantor of the trust. Free state tax return only The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Free state tax return only The fiduciaries of two different trusts, and the fiduciaries and beneficiaries of two different trusts, if the same person is the grantor of both trusts. Free state tax return only A tax-exempt educational or charitable organization and any person (or, if that person is an individual, a member of that person's family) who directly or indirectly controls the organization. Free state tax return only Two S corporations, and an S corporation and a regular corporation, if the same persons own more than 10% of the value of the outstanding stock of each corporation. Free state tax return only A corporation and a partnership if the same persons own both of the following. Free state tax return only More than 10% of the value of the outstanding stock of the corporation. Free state tax return only More than 10% of the capital or profits interest in the partnership. Free state tax return only The executor and beneficiary of any estate. Free state tax return only A partnership and a person who directly or indirectly owns more than 10% of the capital or profits interest in the partnership. Free state tax return only Two partnerships, if the same persons directly or indirectly own more than 10% of the capital or profits interest in each. Free state tax return only The related person and a person who is engaged in trades or businesses under common control. Free state tax return only See section 52(a) and 52(b) of the Internal Revenue Code. Free state tax return only When to determine relationship. Free state tax return only   You must determine whether you are related to another person at the time you acquire the property. Free state tax return only   A partnership acquiring property from a terminating partnership must determine whether it is related to the terminating partnership immediately before the event causing the termination. Free state tax return only For this rule, a terminating partnership is one that sells or exchanges, within 12 months, 50% or more of its total interest in partnership capital or profits. Free state tax return only Constructive ownership of stock or partnership interest. Free state tax return only   To determine whether a person directly or indirectly owns any of the outstanding stock of a corporation or an interest in a partnership, apply the following rules. Free state tax return only Stock or a partnership interest directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its shareholders, partners, or beneficiaries. Free state tax return only However, for a partnership interest owned by or for a C corporation, this applies only to shareholders who directly or indirectly own 5% or more of the value of the stock of the corporation. Free state tax return only An individual is considered to own the stock or partnership interest directly or indirectly owned by or for the individual's family. Free state tax return only An individual who owns, except by applying rule (2), any stock in a corporation is considered to own the stock directly or indirectly owned by or for the individual's partner. Free state tax return only For purposes of rules (1), (2), or (3), stock or a partnership interest considered to be owned by a person under rule (1) is treated as actually owned by that person. Free state tax return only However, stock or a partnership interest considered to be owned by an individual under rule (2) or (3) is not treated as owned by that individual for reapplying either rule (2) or (3) to make another person considered to be the owner of the same stock or partnership interest. Free state tax return only Intangible Property Generally, if you can depreciate intangible property, you usually use the straight line method of depreciation. Free state tax return only However, you can choose to depreciate certain intangible property under the income forecast method (discussed later). Free state tax return only You cannot depreciate intangible property that is a section 197 intangible or that otherwise does not meet all the requirements discussed earlier under What Property Can Be Depreciated. Free state tax return only Straight Line Method This method lets you deduct the same amount of depreciation each year over the useful life of the property. Free state tax return only To figure your deduction, first determine the adjusted basis, salvage value, and estimated useful life of your property. Free state tax return only Subtract the salvage value, if any, from the adjusted basis. Free state tax return only The balance is the total depreciation you can take over the useful life of the property. Free state tax return only Divide the balance by the number of years in the useful life. Free state tax return only This gives you your yearly depreciation deduction. Free state tax return only 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. Free state tax return only 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. Free state tax return only Example. Free state tax return only In April, Frank bought a patent for $5,100 that is not a section 197 intangible. Free state tax return only He depreciates the patent under the straight line method, using a 17-year useful life and no salvage value. Free state tax return only He divides the $5,100 basis by 17 years to get his $300 yearly depreciation deduction. Free state tax return only He only used the patent for 9 months during the first year, so he multiplies $300 by 9/12 to get his deduction of $225 for the first year. Free state tax return only Next year, Frank can deduct $300 for the full year. Free state tax return only Patents and copyrights. Free state tax return only   If you can depreciate the cost of a patent or copyright, use the straight line method over the useful life. Free state tax return only The useful life of a patent or copyright is the lesser of the life granted to it by the government or the remaining life when you acquire it. Free state tax return only However, if the patent or copyright becomes valueless before the end of its useful life, you can deduct in that year any of its remaining cost or other basis. Free state tax return only Computer software. Free state tax return only   Computer software is generally a section 197 intangible and cannot be depreciated if you acquired it in connection with the acquisition of assets constituting a business or a substantial part of a business. Free state tax return only   However, computer software is not a section 197 intangible and can be depreciated, even if acquired in connection with the acquisition of a business, if it meets all of the following tests. Free state tax return only It is readily available for purchase by the general public. Free state tax return only It is subject to a nonexclusive license. Free state tax return only It has not been substantially modified. Free state tax return only   If the software meets the tests above, it may also qualify for the section 179 deduction and the special depreciation allowance, discussed later. Free state tax return only If you can depreciate the cost of computer software, use the straight line method over a useful life of 36 months. Free state tax return only    Tax-exempt use property subject to a lease. Free state tax return only   The useful life of computer software leased under a lease agreement entered into after March 12, 2004, to a tax-exempt organization, governmental unit, or foreign person or entity (other than a partnership), cannot be less than 125% of the lease term. Free state tax return only Certain created intangibles. Free state tax return only   You can amortize certain intangibles created on or after December 31, 2003, over a 15-year period using the straight line method and no salvage value, even though they have a useful life that cannot be estimated with reasonable accuracy. Free state tax return only For example, amounts paid to acquire memberships or privileges of indefinite duration, such as a trade association membership, are eligible costs. Free state tax return only   The following are not eligible. Free state tax return only Any intangible asset acquired from another person. Free state tax return only Created financial interests. Free state tax return only Any intangible asset that has a useful life that can be estimated with reasonable accuracy. Free state tax return only Any intangible asset that has an amortization period or limited useful life that is specifically prescribed or prohibited by the Code, regulations, or other published IRS guidance. Free state tax return only Any amount paid to facilitate an acquisition of a trade or business, a change in the capital structure of a business entity, and certain other transactions. Free state tax return only   You must also increase the 15-year safe harbor amortization period to a 25-year period for certain intangibles related to benefits arising from the provision, production, or improvement of real property. Free state tax return only For this purpose, real property includes property that will remain attached to the real property for an indefinite period of time, such as roads, bridges, tunnels, pavements, and pollution control facilities. Free state tax return only Income Forecast Method You can choose to use the income forecast method instead of the straight line method to depreciate the following depreciable intangibles. Free state tax return only Motion picture films or video tapes. Free state tax return only Sound recordings. Free state tax return only Copyrights. Free state tax return only Books. Free state tax return only Patents. Free state tax return only Under the income forecast method, each year's depreciation deduction is equal to the cost of the property, multiplied by a fraction. Free state tax return only The numerator of the fraction is the current year's net income from the property, and the denominator is the total income anticipated from the property through the end of the 10th taxable year following the taxable year the property is placed in service. Free state tax return only For more information, see section 167(g) of the Internal Revenue Code. Free state tax return only Films, video tapes, and recordings. Free state tax return only   You cannot use MACRS for motion picture films, video tapes, and sound recordings. Free state tax return only For this purpose, sound recordings are discs, tapes, or other phonorecordings resulting from the fixation of a series of sounds. Free state tax return only You can depreciate this property using either the straight line method or the income forecast method. Free state tax return only Participations and residuals. Free state tax return only   You can include participations and residuals in the adjusted basis of the property for purposes of computing your depreciation deduction under the income forecast method. Free state tax return only The participations and residuals must relate to income to be derived from the property before the end of the 10th taxable year after the property is placed in service. Free state tax return only For this purpose, participations and residuals are defined as costs which by contract vary with the amount of income earned in connection with the property. Free state tax return only   Instead of including these amounts in the adjusted basis of the property, you can deduct the costs in the taxable year that they are paid. Free state tax return only Videocassettes. Free state tax return only   If you are in the business of renting videocassettes, you can depreciate only those videocassettes bought for rental. Free state tax return only If the videocassette has a useful life of one year or less, you can currently deduct the cost as a business expense. Free state tax return only Corporate or Partnership Property Acquired in a Nontaxable Transfer MACRS does not apply to property used before 1987 and transferred after 1986 to a corporation or partnership (except property the transferor placed in service after July 31, 1986, if MACRS was elected) to the extent its basis is carried over from the property's adjusted basis in the transferor's hands. Free state tax return only You must continue to use the same depreciation method as the transferor and figure depreciation as if the transfer had not occurred. Free state tax return only However, if MACRS would otherwise apply, you can use it to depreciate the part of the property's basis that exceeds the carried-over basis. Free state tax return only The nontaxable transfers covered by this rule include the following. Free state tax return only A distribution in complete liquidation of a subsidiary. Free state tax return only A transfer to a corporation controlled by the transferor. Free state tax return only An exchange of property solely for corporate stock or securities in a reorganization. Free state tax return only A contribution of property to a partnership in exchange for a partnership interest. Free state tax return only A partnership distribution of property to a partner. Free state tax return only Election To Exclude Property From MACRS If you can properly depreciate any property under a method not based on a term of years, such as the unit-of-production method, you can elect to exclude that property from MACRS. Free state tax return only You make the election by reporting your depreciation for the property on line 15 in Part II of Form 4562 and attaching a statement as described in the instructions for Form 4562. Free state tax return only You must make this election by the return due date (including extensions) for the tax year you place your property in service. Free state tax return only 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 six months of the due date of the return (excluding extensions). Free state tax return only Attach the election to the amended return and write “Filed pursuant to section 301. Free state tax return only 9100-2” on the election statement. Free state tax return only File the amended return at the same address you filed the original return. Free state tax return only Use of standard mileage rate. Free state tax return only   If you use the standard mileage rate to figure your tax deduction for your business automobile, you are treated as having made an election to exclude the automobile from MACRS. Free state tax return only See Publication 463 for a discussion of the standard mileage rate. Free state tax return only What Is the Basis of Your Depreciable Property? To figure your depreciation deduction, you must determine the basis of your property. Free state tax return only To determine basis, you need to know the cost or other basis of your property. Free state tax return only Cost as Basis The basis of property you buy is its cost plus amounts you paid for items such as sales tax (see Exception , below), freight charges, and installation and testing fees. Free state tax return only The cost includes the amount you pay in cash, debt obligations, other property, or services. Free state tax return only Exception. Free state tax return only   You can elect to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction on Schedule A (Form 1040). Free state tax return only If you make that choice, you cannot include those sales taxes as part of your cost basis. Free state tax return only Assumed debt. Free state tax return only   If you buy property and assume (or buy subject to) an existing mortgage or other debt on the property, your basis includes the amount you pay for the property plus the amount of the assumed debt. Free state tax return only Example. Free state tax return only You make a $20,000 down payment on property and assume the seller's mortgage of $120,000. Free state tax return only Your total cost is $140,000, the cash you paid plus the mortgage you assumed. Free state tax return only Settlement costs. Free state tax return only   The basis of real property also includes certain fees and charges you pay in addition to the purchase price. Free state tax return only These generally are shown on your settlement statement and include the following. Free state tax return only Legal and recording fees. Free state tax return only Abstract fees. Free state tax return only Survey charges. Free state tax return only Owner's title insurance. Free state tax return only Amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions. Free state tax return only   For fees and charges you cannot include in the basis of property, see Real Property in Publication 551. Free state tax return only Property you construct or build. Free state tax return only   If you construct, build, or otherwise produce property for use in your business, you may have to use the uniform capitalization rules to determine the basis of your property. Free state tax return only For information about the uniform capitalization rules, see Publication 551 and the regulations under section 263A of the Internal Revenue Code. Free state tax return only Other Basis Other basis usually refers to basis that is determined by the way you received the property. Free state tax return only For example, your basis is other than cost if you acquired the property in exchange for other property, as payment for services you performed, as a gift, or as an inheritance. Free state tax return only If you acquired property in this or some other way, see Publication 551 to determine your basis. Free state tax return only Property changed from personal use. Free state tax return only   If you held property for personal use and later use it in your business or income-producing activity, your depreciable basis is the lesser of the following. Free state tax return only The fair market value (FMV) of the property on the date of the change in use. Free state tax return only Your original cost or other basis adjusted as follows. Free state tax return only Increased by the cost of any permanent improvements or additions and other costs that must be added to basis. Free state tax return only Decreased by any deductions you claimed for casualty and theft losses and other items that reduced your basis. Free state tax return only Example. Free state tax return only Several years ago, Nia paid $160,000 to have her home built on a lot that cost her $25,000. Free state tax return only Before changing the property to rental use last year, she paid $20,000 for permanent improvements to the house and claimed a $2,000 casualty loss deduction for damage to the house. Free state tax return only Land is not depreciable, so she includes only the cost of the house when figuring the basis for depreciation. Free state tax return only Nia's adjusted basis in the house when she changed its use was $178,000 ($160,000 + $20,000 − $2,000). Free state tax return only On the same date, her property had an FMV of $180,000, of which $15,000 was for the land and $165,000 was for the house. Free state tax return only The basis for depreciation on the house is the FMV on the date of change ($165,000), because it is less than her adjusted basis ($178,000). Free state tax return only Property acquired in a nontaxable transaction. Free state tax return only   Generally, if you receive property in a nontaxable exchange, the basis of the property you receive is the same as the adjusted basis of the property you gave up. Free state tax return only Special rules apply in determining the basis and figuring the MACRS depreciation deduction and special depreciation allowance for property acquired in a like-kind exchange or involuntary conversion. Free state tax return only See Like-kind exchanges and involuntary conversions. Free state tax return only under How Much Can You Deduct? in chapter 3 and Figuring the Deduction for Property Acquired in a Nontaxable Exchange in chapter 4. Free state tax return only   There are also special rules for determining the basis of MACRS property involved in a like-kind exchange or involuntary conversion when the property is contained in a general asset account. Free state tax return only See How Do You Use General Asset Accounts in chapter 4. Free state tax return only Adjusted Basis 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 state tax return only These events could include the following. Free state tax return only Installing utility lines. Free state tax return only Paying legal fees for perfecting the title. Free state tax return only Settling zoning issues. Free state tax return only Receiving rebates. Free state tax return only Incurring a casualty or theft loss. Free state tax return only For a discussion of adjustments to the basis of your property, see Adjusted Basis in Publication 551. Free state tax return only If you depreciate your property under MACRS, you also may have to reduce your basis by certain deductions and credits with respect to the property. Free state tax return only For more information, see What Is the Basis for Depreciation in chapter 4. Free state tax return only . Free state tax return only Basis adjustment for depreciation allowed or allowable. Free state tax return only   You must reduce the basis of property by the depreciation allowed or allowable, whichever is greater. Free state tax return only Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). Free state tax return only Depreciation allowable is depreciation you are entitled to deduct. Free state tax return only   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 state tax return only   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 state tax return only How Do You Treat Repairs and Improvements? If you improve depreciable property, you must treat the improvement as separate depreciable property. Free state tax return only Improvement means an addition to or partial replacement of property that adds to its value, appreciably lengthens the time you can use it, or adapts it to a different use. Free state tax return only You generally deduct the cost of repairing business property in the same way as any other business expense. Free state tax return only 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 state tax return only Example. Free state tax return only You repair a small section on one corner of the roof of a rental house. Free state tax return only You deduct the cost of the repair as a rental expense. Free state tax return only However, if you completely replace the roof, the new roof is an improvement because it increases the value and lengthens the life of the property. Free state tax return only You depreciate the cost of the new roof. Free state tax return only Improvements to rented property. Free state tax return only   You can depreciate permanent improvements you make to business property you rent from someone else. Free state tax return only Do You Have To File Form 4562? Use Form 4562 to figure your deduction for depreciation and amortization. Free state tax return only Attach Form 4562 to your tax return for the current tax year if you are claiming any of the following items. Free state tax return only A section 179 deduction for the current year or a section 179 carryover from a prior year. Free state tax return only See chapter 2 for information on the section 179 deduction. Free state tax return only Depreciation for property placed in service during the current year. Free state tax return only Depreciation on any vehicle or other listed property, regardless of when it was placed in service. Free state tax return only See chapter 5 for information on listed property. Free state tax return only A deduction for any vehicle if the deduction is reported on a form other than Schedule C (Form 1040) or Schedule C-EZ (Form 1040). Free state tax return only Amortization of costs if the current year is the first year of the amortization period. Free state tax return only Depreciation or amortization on any asset on a corporate income tax return (other than Form 1120S, U. Free state tax return only S. Free state tax return only Income Tax Return for an S Corporation) regardless of when it was placed in service. Free state tax return only You must submit a separate Form 4562 for each business or activity on your return for which a Form 4562 is required. Free state tax return only Table 1-1 presents an overview of the purpose of the various parts of Form 4562. Free state tax return only Employee. Free state tax return only   Do not use Form 4562 if you are an employee and you deduct job-related vehicle expenses using either actual expenses (including depreciation) or the standard mileage rate. Free state tax return only Instead, use either Form 2106 or Form 2106-EZ. Free state tax return only Use Form 2106-EZ if you are claiming the standard mileage rate and you are not reimbursed by your employer for any expenses. Free state tax return only 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 state tax return only See Filing an Amended Return , next. Free state tax return only 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 state tax return only See Changing Your Accounting Method , later. Free state tax return only Filing an Amended Return You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations. Free state tax return only You claimed the incorrect amount because of a mathematical error made in any year. Free state tax return only You claimed the incorrect amount because of a posting error made in any year. Free state tax return only You have not adopted a method of accounting for property placed in service by you in tax years ending after December 29, 2003. Free state tax return only You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003. Free state tax return only Adoption of accounting method defined. Free state tax return only   Generally, you adopt a method of accounting for depreciation by using a permissible method of determining depreciation when you file your first tax return, or by using the same impermissible method of determining depreciation in two or more consecutively filed tax returns. Free state tax return only   For an exception to this 2-year rule, see Revenue Procedure 2011-14 on page 330 of the Internal Revenue Bulletin 2011-4, available at www. Free state tax return only irs. Free state tax return only gov/pub/irs-irbs/irb11-04. Free state tax return only pdf. Free state tax return only (Note. Free state tax return only Revenue Procedure 2011-14 is clarified and modified by Revenue Procedure 2012-20. Free state tax return only For more information, see Revenue Procedure 2012-20 on page 700 of the Internal Revenue Bulletin 2012-14, available at www. Free state tax return only irs. Free state tax return only gov/pub/irs-irbs/irb12-14. Free state tax return only pdf. Free state tax return only )   For a safe harbor method of accounting to treat rotable spare parts as depreciable assets and procedures to obtain automatic consent to change to the safe harbor method of accounting, see Revenue Procedure 2007-48 on page 110 of Internal Revenue Bulletin 2007-29, available at www. Free state tax return only irs. Free state tax return only gov/pub/irs-irbs/irb07-29. Free state tax return only pdf. Free state tax return only When to file. Free state tax return only   If an amended return is allowed, you must file it by the later of the following. Free state tax return only 3 years from the date you filed your original return for the year in which you did not deduct the correct amount. Free state tax return only A return filed before an unextended due date is considered filed on that due date. Free state tax return only 2 years from the time you paid your tax for that year. Free state tax return only Changing Your Accounting Method Generally, you must get IRS approval to change your method of accounting. Free state tax return only You generally must file Form 3115, Application for Change in Accounting Method, to request a change in your method of accounting for depreciation. Free state tax return only The following are examples of a change in method of accounting for depreciation. Free state tax return only A change from an impermissible method of determining depreciation for depreciable property, if the impermissible method was used in two or more consecutively filed tax returns. Free state tax return only A change in the treatment of an asset from nondepreciable to depreciable or vice versa. Free state tax return only A change in the depreciation method, period of recovery, or convention of a depreciable asset. Free state tax return only A change from not claiming to claiming the special depreciation allowance if you did not make the election to not claim any special allowance. Free state tax return only A change from claiming a 50% special depreciation allowance to claiming a 30% special depreciation allowance for qualified property (including property that is included in a class of property for which you elected a 30% special allowance instead of a 50% special allowance). Free state tax return only Changes in depreciation that are not a change in method of accounting (and may only be made on an amended return) include the following. Free state tax return only An adjustment in the useful life of a depreciable asset for which depreciation is determined under section 167. Free state tax return only A change in use of an asset in the hands of the same taxpayer. Free state tax return only Making a late depreciation election or revoking a timely valid depreciation election (including the election not to deduct the special depreciation allowance). Free state tax return only If you elected not to claim any special allowance, a change from not claiming to claiming the special allowance is a revocation of the election and is not an accounting method change. Free state tax return only Generally, you must get IRS approval to make a late depreciation election or revoke a depreciation election. Free state tax return only You must submit a request for a letter ruling to make a late election or revoke an election. Free state tax return only Any change in the placed in service date of a depreciable asset. Free state tax return only See section 1. Free state tax return only 446-1(e)(2)(ii)(d) of the regulations for more information and examples. Free state tax return only IRS approval. Free state tax return only   In some instances, you may be able to get approval from the IRS to change your method of accounting for depreciation under the automatic change request procedures generally covered in Revenue Procedure 2011-14. Free state tax return only If you do not qualify to use the automatic procedures to get approval, you must use the advance consent request procedures generally covered in Revenue Procedure 97-27, 1997-1 C. Free state tax return only B. Free state tax return only 680. Free state tax return only Also see the Instructions for Form 3115 for more information on getting approval, including lists of scope limitations and automatic accounting method changes. Free state tax return only Additional guidance. Free state tax return only    For additional guidance and special procedures for changing your accounting method, automatic change procedures, amending your return, and filing Form 3115, see Revenue Procedure 2011-14 on page 330 of the Internal Revenue Bulletin 2011-4, available at www. Free state tax return only irs. Free state tax return only gov/pub/irs-irbs/irb11-04. Free state tax return only pdf. Free state tax return only (Note. Free state tax return only Revenue Procedure 2011-14 is clarified and modified by Revenue Procedure 2012-20. Free state tax return only For more information, see Revenue Procedure 2012-20 on page 700 of the Internal Revenue Bulletin 2012-14, available at www. Free state tax return only irs. Free state tax return only gov/pub/irs-irbs/irb12-14. Free state tax return only pdf. Free state tax return only )   For a safe harbor method of accounting to treat rotable spare parts as depreciable assets, see Revenue Procedure 2007-48 on page 110 of Internal Revenue Bulletin 2007-29, available at www. Free state tax return only irs. Free state tax return only gov/pub/irs-irbs/irb07-29. Free state tax return only pdf. Free state tax return only Table 1-1. Free state tax return only Purpose of Form 4562 This table describes the purpose of the various parts of Form 4562. Free state tax return only For more information, see Form 4562 and its instructions. Free state tax return only Part Purpose I • Electing the section 179 deduction • Figuring the maximum section 179 deduction for the current year • Figuring any section 179 deduction carryover to the next year II • Reporting the special depreciation allowance for property (other than listed property) placed in service during the tax year • Reporting depreciation deductions on property being depreciated under any method other than Modified Accelerated Cost Recovery System (MACRS) III • Reporting MACRS depreciation deductions for property placed in service before this year • Reporting MACRS depreciation deductions for property (other than listed property) placed in service during the current year IV • Summarizing other parts V • Reporting the special depreciation allowance for automobiles and other listed property • Reporting MACRS depreciation on automobiles and other listed property • Reporting the section 179 cost elected for automobiles and other listed property • Reporting information on the use of automobiles and other transportation vehicles VI • Reporting amortization deductions Section 481(a) adjustment. Free state tax return only   If you file Form 3115 and change from an impermissible method to a permissible method of accounting for depreciation, you can make a section 481(a) adjustment for any unclaimed or excess amount of allowable depreciation. Free state tax return only The adjustment is the difference between the total depreciation actually deducted for the property and the total amount allowable prior to the year of change. Free state tax return only If no depreciation was deducted, the adjustment is the total depreciation allowable prior to the year of change. Free state tax return only A negative section 481(a) adjustment results in a decrease in taxable income. Free state tax return only It is taken into account in the year of change and is reported on your business tax returns as “other expenses. Free state tax return only ” A positive section 481(a) adjustment results in an increase in taxable income. Free state tax return only It is generally taken into account over 4 tax years and is reported on your business tax returns as “other income. Free state tax return only ” However, you can elect to use a one-year adjustment period and report the adjustment in the year of change if the total adjustment is less than $25,000. Free state tax return only Make the election by completing the appropriate line on Form 3115. Free state tax return only   If you file a Form 3115 and change from one permissible method to another permissible method, the section 481(a) adjustment is zero. Free state tax return only Prev  Up  Next   Home   More Online Publications
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Guidelines to Choose a Mover

Not all moving companies are the same. Although many are legitimate, there are some who attempt to take advantage of their clients. Follow these guidelines to help you choose the right mover:

Get a written estimate from several movers. Be wary of very low estimates. Some companies use the low price to get a contract and later ask for more money before they will remove your belongings from their truck.

Make sure the mover has an operating license. For moves from one state to another, visit protectyourmove.gov to verify a mover's license. For moves within a state, check your state, county or local consumer affairs agency.

Make sure the mover has insurance. If furniture is damaged during the move, the mover's insurance should cover it. Ask how to file a complaint if there are limits to the coverage.

Check the mover's track record. Contact your state or local consumer protection agency or Better Business Bureau to see if there is a history of complaints.

If you have a dispute with a moving company, you can file a complaint with the Federal Motor Carrier Safety Administration or by calling 1-800-832-5660. If you have a dispute about moving your household goods or vehicles internationally, contact the Federal Maritime Commission.

The Free State Tax Return Only

Free state tax return only 10. Free state tax return only   Business Bad Debts Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Definition of Business Bad DebtAccrual method. Free state tax return only Cash method. Free state tax return only Debt acquired from a decedent. Free state tax return only Liquidation. Free state tax return only Types of Business Bad Debts When a Debt Becomes Worthless How To Claim a Business Bad DebtSpecific Charge-Off Method Nonaccrual-Experience Method Recovery of a Bad DebtNet operating loss (NOL) carryover. Free state tax return only Introduction You have a bad debt if you cannot collect money owed to you. Free state tax return only A bad debt is either a business bad debt or a nonbusiness bad debt. Free state tax return only This chapter discusses only business bad debts. Free state tax return only Generally, a business bad debt is one that comes from operating your trade or business. Free state tax return only You can deduct business bad debts on Schedule C (Form 1040) or your applicable business income tax return. Free state tax return only All other bad debts are nonbusiness bad debts and are deductible only as short-term capital losses. Free state tax return only For more information on nonbusiness bad debts, see Publication 550. Free state tax return only Topics - This chapter discusses: Definition of business bad debt When a debt becomes worthless How to claim a business bad debt Recovery of a bad debt Useful Items - You may want to see: Publication 525 Taxable and Nontaxable Income 536 Net Operating Losses (NOLs) for Individuals, Estates, and Trusts 544 Sales and Other Dispositions of Assets 550 Investment Income and Expenses 556 Examination of Returns, Appeal Rights, and Claims for Refund Form (and Instructions) Schedule C (Form 1040) Profit or Loss From Business 1040X Amended U. Free state tax return only S. Free state tax return only Individual Income Tax Return 1045 Application for Tentative Refund 1139 Corporation Application for Tentative Refund 3115 Application for Change in Accounting Method See chapter 12 for information about getting publications and forms. Free state tax return only Definition of Business Bad Debt A business bad debt is a loss from the worthlessness of a debt that was either: Created or acquired in your trade or business, or Closely related to your trade or business when it became partly or totally worthless. Free state tax return only A debt is closely related to your trade or business if your primary motive for incurring the debt is business related. Free state tax return only Bad debts of a corporation (other than an S corporation) are always business bad debts. Free state tax return only Credit sales. Free state tax return only   Business bad debts are mainly the result of credit sales to customers. Free state tax return only Goods that have been sold, but not yet paid for, and services that have been performed, but not yet paid for, are recorded in your books as either accounts receivable or notes receivable. Free state tax return only After a reasonable period of time, if you have tried to collect the amount due, but are unable to do so, the uncollectible part becomes a business bad debt. Free state tax return only   Accounts or notes receivable valued at fair market value (FMV) when received are deductible only at that value, even though the FMV may be less than the face value. Free state tax return only If you purchased an account receivable for less than its face value, and the receivable subsequently becomes worthless, the most you are allowed to deduct is the amount you paid to acquire it. Free state tax return only    You can claim a business bad debt deduction only if the amount owed to you was previously included in gross income. Free state tax return only This applies to amounts owed to you from all sources of taxable income, including sales, services, rents, and interest. Free state tax return only Accrual method. Free state tax return only   If you use the accrual method of accounting, you generally report income as you earn it. Free state tax return only You can only claim a bad debt deduction for an uncollectible receivable if you have previously included the uncollectible amount in income. Free state tax return only   If you qualify, you can use the nonaccrual-experience method of accounting discussed later. Free state tax return only Under this method, you do not have to accrue income that, based on your experience, you do not expect to collect. Free state tax return only Cash method. Free state tax return only   If you use the cash method of accounting, you generally report income when you receive payment. Free state tax return only You cannot claim a bad debt deduction for amounts owed to you because you never included those amounts in income. Free state tax return only For example, a cash basis architect cannot claim a bad debt deduction if a client fails to pay the bill because the architect's fee was never included in income. Free state tax return only Debts from a former business. Free state tax return only   If you sell your business but retain its receivables, these debts are business debts because they arose out of your trade or business. Free state tax return only If any of these receivables subsequently become worthless, the loss is still a business bad debt. Free state tax return only Debt acquired from a decedent. Free state tax return only   The character of a loss from debts of a business acquired from a decedent is determined in the same way as debts acquired on the purchase of a business. Free state tax return only The executor of the decedent's estate treats any loss from the debts as a business bad debt if the debts were closely related to the decedent's trade or business when they became worthless. Free state tax return only Otherwise, a loss from these debts becomes a nonbusiness bad debt for the decedent's estate. Free state tax return only Liquidation. Free state tax return only   If you liquidate your business and some of the accounts receivable that you retain become worthless, they become business bad debts. Free state tax return only Types of Business Bad Debts Business bad debts may result from the following. Free state tax return only Loans to clients and suppliers. Free state tax return only   If you loan money to a client, supplier, employee, or distributor for a business reason and you are unable to collect the loan after attempting to do so, you have a business bad debt. Free state tax return only Debts owed by political parties. Free state tax return only   If a political party (or other organization that accepts contributions or spends money to influence elections) owes you money and the debt becomes worthless, you can claim a bad debt deduction only if all of the following requirements are met. Free state tax return only You use the accrual method of accounting. Free state tax return only The debt arose from the sale of goods or services in the ordinary course of your trade or business. Free state tax return only More than 30% of your receivables accrued in the year of the sale were from sales to political parties. Free state tax return only You made substantial and continuing efforts to collect on the debt. Free state tax return only Loan or capital contribution. Free state tax return only   You cannot claim a bad debt deduction for a loan you made to a corporation if, based on the facts and circumstances, the loan is actually a contribution to capital. Free state tax return only Debts of an insolvent partner. Free state tax return only   If your business partnership breaks up and one of your former partners becomes insolvent, you may have to pay more than your pro rata share of the partnership's debts. Free state tax return only If you pay any part of the insolvent partner's share of the debts, you can claim a bad debt deduction for the amount you paid that is attributable to the insolvent partner's share. Free state tax return only Business loan guarantee. Free state tax return only   If you guarantee a debt that subsequently becomes worthless, the debt can qualify as a business bad debt if all the following requirements are met. Free state tax return only You made the guarantee in the course of your trade or business. Free state tax return only You have a legal duty to pay the debt. Free state tax return only You made the guarantee before the debt became worthless. Free state tax return only You meet this requirement if you reasonably expected you would not have to pay the debt without full reimbursement from the borrower. Free state tax return only You received reasonable consideration for making the guarantee. Free state tax return only You meet this requirement if you made the guarantee in accord with normal business practice or for a good faith business purpose. Free state tax return only Example. Free state tax return only Jane Zayne owns the Zayne Dress Company. Free state tax return only She guaranteed payment of a $20,000 note for Elegant Fashions, a dress outlet. Free state tax return only Elegant Fashions is one of Zayne's largest clients. Free state tax return only Elegant Fashions later defaulted on the loan. Free state tax return only As a result, Ms. Free state tax return only Zayne paid the remaining balance of the loan in full to the bank. Free state tax return only She can claim a business bad debt deduction only for the amount she paid, since her guarantee was made in the course of her trade or business for a good faith business purpose. Free state tax return only She was motivated by the desire to retain one of her better clients and keep a sales outlet. Free state tax return only Deductible in the year paid. Free state tax return only   If you make a payment on a loan you guaranteed, you can deduct it in the year paid, unless you have rights against the borrower. Free state tax return only Rights against a borrower. Free state tax return only   When you make payment on a loan you guaranteed, you may have the right to take the place of the lender. Free state tax return only The debt is then owed to you. Free state tax return only If you have this right, or some other right to demand payment from the borrower, you cannot claim a bad debt deduction until these rights become partly or totally worthless. Free state tax return only Joint debtor. Free state tax return only   If two or more debtors jointly owe you money, your inability to collect from one does not enable you to deduct a proportionate amount as a bad debt. Free state tax return only Sale of mortgaged property. Free state tax return only   If mortgaged or pledged property is sold for less than the debt, the unpaid, uncollectible balance of the debt is a bad debt. Free state tax return only When a Debt Becomes Worthless A debt becomes worthless when there is no longer any chance the amount owed will be paid. Free state tax return only This may occur when the debt is due or prior to that date. Free state tax return only To demonstrate worthlessness, you must only show that you have taken reasonable steps to collect the debt but were unable to do so. Free state tax return only It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. Free state tax return only Bankruptcy of your debtor is generally good evidence of the worthlessness of at least a part of an unsecured and unpreferred debt. Free state tax return only Property received for debt. Free state tax return only   If you receive property in partial settlement of a debt, reduce the debt by the property's FMV, which becomes the property's basis. Free state tax return only You can deduct the remaining debt as a bad debt if and when it becomes worthless. Free state tax return only   If you later sell the property for more than its basis, any gain on the sale is due to the appreciation of the property. Free state tax return only It is not a recovery of a bad debt. Free state tax return only For information on the sale of an asset, see Publication 544. Free state tax return only How To Claim a Business Bad Debt There are two methods to claim a business bad debt. Free state tax return only The specific charge-off method. Free state tax return only The nonaccrual-experience method. Free state tax return only Generally, you must use the specific charge-off method. Free state tax return only However, you may use the nonaccrual-experience method if you meet the requirements discussed later under Nonaccrual-Experience Method . Free state tax return only Specific Charge-Off Method If you use the specific charge-off method, you can deduct specific business bad debts that become either partly or totally worthless during the tax year. Free state tax return only However, with respect to partly worthless bad debts, your deduction is limited to the amount you charged off on your books during the year. Free state tax return only Partly worthless debts. Free state tax return only   You can deduct specific bad debts that become partly uncollectible during the tax year. Free state tax return only Your tax deduction is limited to the amount you charge off on your books during the year. Free state tax return only You do not have to charge off and deduct your partly worthless debts annually. Free state tax return only You can delay the charge off until a later year. Free state tax return only However, you cannot deduct any part of a debt after the year it becomes totally worthless. Free state tax return only Significantly modified debt. Free state tax return only   An exception to the charge-off rule exists for debt which has been significantly modified and on which the holder recognized gain. Free state tax return only For more information, see Regulations section 1. Free state tax return only 166-3(a)(3). Free state tax return only Deduction disallowed. Free state tax return only   Generally, you can claim a partial bad debt deduction only in the year you make the charge-off on your books. Free state tax return only If, under audit, the IRS does not allow your deduction and the debt becomes partly worthless in a later tax year, you can deduct the amount you charged off in that year plus the disallowed amount charged off in the earlier year. Free state tax return only The charge-off in the earlier year, unless reversed on your books, fulfills the charge-off requirement for the later year. Free state tax return only Totally worthless debts. Free state tax return only   If a debt becomes totally worthless in the current tax year, you can deduct the entire amount, less any amount deducted in an earlier tax year when the debt was only partly worthless. Free state tax return only   You do not have to make an actual charge-off on your books to claim a bad debt deduction for a totally worthless debt. Free state tax return only However, you may want to do so. Free state tax return only If you do not and the IRS later rules the debt is only partly worthless, you will not be allowed a deduction for the debt in that tax year because a deduction of a partly worthless bad debt is limited to the amount actually charged off. Free state tax return only See Partly worthless debts, earlier. Free state tax return only Filing a claim for refund. Free state tax return only   If you did not deduct a bad debt on your original return for the year it became worthless, you can file a claim for a credit or refund. Free state tax return only If the bad debt was totally worthless, you must file the claim by the later of the following dates. Free state tax return only 7 years from the date your original return was due (not including extensions). Free state tax return only 2 years from the date you paid the tax. Free state tax return only   If the claim is for a partly worthless bad debt, you must file the claim by the later of the following dates. Free state tax return only 3 years from the date you filed your original return. Free state tax return only 2 years from the date you paid the tax. Free state tax return only You may have longer to file the claim if you were unable to manage your financial affairs due to a physical or mental impairment. Free state tax return only Such an impairment requires proof of existence. Free state tax return only   For details and more information about filing a claim, see Publication 556. Free state tax return only Use one of the following forms to file a claim. Free state tax return only For more information, see the instructions for the applicable form. Free state tax return only Table 10-1. Free state tax return only Forms Used To File a Claim IF you filed as a. Free state tax return only . Free state tax return only . Free state tax return only THEN file. Free state tax return only . Free state tax return only . Free state tax return only Sole proprietor or farmer Form 1040X Corporation Form 1120X S corporation Form 1120S and check box H(4) Partnership Form 1065X if filing on paper or  Form 1065 and check box G(5) if filing electronically Nonaccrual-Experience Method If you use an accrual method of accounting and qualify under the rules explained in this section, you can use the nonaccrual-experience method for bad debts. Free state tax return only Under this method, you do not accrue service related income you expect to be uncollectible. Free state tax return only Because the expected uncollectible amounts are not included in income, these amounts are not later deducted from income. Free state tax return only Generally, you can use the nonaccrual-experience method for accounts receivable for services you performed only if: The services are provided in the fields of accounting, actuarial science, architecture, consulting, engineering, health, law, or the performing arts, or You meet the $5 million gross receipts test for all prior years. Free state tax return only Service related income. Free state tax return only   You can use the nonaccrual-experience method only for amounts earned by performing services. Free state tax return only You cannot use this method for amounts owed to you from activities such as lending money, selling goods, or acquiring receivables or other rights to receive payment. Free state tax return only Gross receipts test. Free state tax return only   To find out if you meet the $5 million gross receipts test for all prior years, you must figure the average annual gross receipts for each prior year. Free state tax return only If your average annual gross receipts for any year exceeds $5 million, you cannot use the non-accural experience method. Free state tax return only   The average annual gross receipts for any year is the average of gross receipts from the year in question and the 2 previous years. Free state tax return only For example, if you were figuring the average annual gross receipts for 2013, you would average your gross receipts for 2011, 2012, and 2013. Free state tax return only Interest or penalty charged. Free state tax return only   Generally, you cannot use the nonaccrual-experience method for amounts due on which you charge interest or a late payment penalty. Free state tax return only However, do not treat a discount offered for early payment as the charging of interest or a penalty if both the following apply. Free state tax return only You otherwise accrue the full amount due as gross income at the time you provide the services. Free state tax return only You treat the discount allowed for early payment as an adjustment to gross income in the year of payment. Free state tax return only Change in accounting method. Free state tax return only   Generally, you must obtain consent to change to a nonaccrual-experience method (other than one of the safe harbor methods) or to change from one method to another. Free state tax return only See Form 3115 and the Instructions for Form 3115 for more information. Free state tax return only Recovery of a Bad Debt If you claim a deduction for a bad debt on your income tax return and later recover (collect) all or part of it, you may have to include all or part of the recovery in gross income. Free state tax return only The amount you include is limited to the amount you actually deducted. Free state tax return only However, you can exclude the amount deducted that did not reduce your tax. Free state tax return only Report the recovery as “Other income” on the appropriate business form or schedule. Free state tax return only See Recoveries in Publication 525 for more information. Free state tax return only Net operating loss (NOL) carryover. Free state tax return only   If a bad debt deduction increases an NOL carryover that has not expired before the beginning of the tax year in which the recovery takes place, you treat the deduction as having reduced your tax. Free state tax return only A bad debt deduction that contributes to a NOL helps lower taxes in the year to which you carry the NOL. Free state tax return only For more information about NOLs, see Publication 536. Free state tax return only Also, see the Instructions for Form 1045, and the Instructions for Form 1139. Free state tax return only Prev  Up  Next   Home   More Online Publications