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My free tax 1. My free tax   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. My free tax It is an allowance for the wear and tear, deterioration, or obsolescence of the property. My free tax This chapter discusses the general rules for depreciating property and answers the following questions. My free tax 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. My free tax What Property Can Be Depreciated? You can depreciate most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. My free tax You also can depreciate certain intangible property, such as patents, copyrights, and computer software. My free tax To be depreciable, the property must meet all the following requirements. My free tax It must be property you own. My free tax It must be used in your business or income-producing activity. My free tax It must have a determinable useful life. My free tax It must be expected to last more than one year. My free tax The following discussions provide information about these requirements. My free tax Property You Own To claim depreciation, you usually must be the owner of the property. My free tax You are considered as owning property even if it is subject to a debt. My free tax Example 1. My free tax You made a down payment to purchase rental property and assumed the previous owner's mortgage. My free tax You own the property and you can depreciate it. My free tax Example 2. My free tax You bought a new van that you will use only for your courier business. My free tax You will be making payments on the van over the next 5 years. My free tax You own the van and you can depreciate it. My free tax Leased property. My free tax   You can depreciate leased property only if you retain the incidents of ownership in the property (explained below). My free tax This means you bear the burden of exhaustion of the capital investment in the property. My free tax 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. My free tax You can, however, depreciate any capital improvements you make to the property. My free tax See How Do You Treat Repairs and Improvements later in this chapter and Additions and Improvements under Which Recovery Period Applies in chapter 4. My free tax   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. My free tax 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. My free tax Incidents of ownership. My free tax   Incidents of ownership in property include the following. My free tax The legal title to the property. My free tax The legal obligation to pay for the property. My free tax The responsibility to pay maintenance and operating expenses. My free tax The duty to pay any taxes on the property. My free tax The risk of loss if the property is destroyed, condemned, or diminished in value through obsolescence or exhaustion. My free tax Life tenant. My free tax   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. My free tax However, see Certain term interests in property under Excepted Property, later. My free tax Cooperative apartments. My free tax   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. My free tax   Figure your depreciation deduction as follows. My free tax Figure the depreciation for all the depreciable real property owned by the corporation in which you have a proprietary lease or right of tenancy. My free tax If you bought your cooperative stock after its first offering, figure the depreciable basis of this property as follows. My free tax Multiply your cost per share by the total number of outstanding shares, including any shares held by the corporation. My free tax Add to the amount figured in (a) any mortgage debt on the property on the date you bought the stock. My free tax 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. My free tax 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. My free tax Divide the number of your shares of stock by the total number of outstanding shares, including any shares held by the corporation. My free tax Multiply the result of (2) by the percentage you figured in (3). My free tax This is your depreciation on the stock. My free tax   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. My free tax 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. My free tax Example. My free tax You figure your share of the cooperative housing corporation's depreciation to be $30,000. My free tax Your adjusted basis in the stock of the corporation is $50,000. My free tax You use one half of your apartment solely for business purposes. My free tax Your depreciation deduction for the stock for the year cannot be more than $25,000 (½ of $50,000). My free tax Change to business use. My free tax   If you change your cooperative apartment to business use, figure your allowable depreciation as explained earlier. My free tax The basis of all the depreciable real property owned by the cooperative housing corporation is the smaller of the following amounts. My free tax The fair market value of the property on the date you change your apartment to business use. My free tax This is considered to be the same as the corporation's adjusted basis minus straight line depreciation, unless this value is unrealistic. My free tax The corporation's adjusted basis in the property on that date. My free tax Do not subtract depreciation when figuring the corporation's adjusted basis. My free tax   If you bought the stock after its first offering, the corporation's adjusted basis in the property is the amount figured in (1), above. My free tax 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. My free tax   For a discussion of fair market value and adjusted basis, see Publication 551. My free tax 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. My free tax If you use property to produce income (investment use), the income must be taxable. My free tax You cannot depreciate property that you use solely for personal activities. My free tax Partial business or investment use. My free tax   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. My free tax 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. My free tax    You must keep records showing the business, investment, and personal use of your property. My free tax 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. My free tax    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. My free tax For information about qualified business use of listed property, see What Is the Business-Use Requirement in chapter 5. My free tax Office in the home. My free tax   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. My free tax For information about depreciating your home office, see Publication 587. My free tax Inventory. My free tax   You cannot depreciate inventory because it is not held for use in your business. My free tax Inventory is any property you hold primarily for sale to customers in the ordinary course of your business. My free tax   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. My free tax See Rent-to-own dealer under Which Property Class Applies Under GDS in chapter 4. My free tax   In some cases, it is not clear whether property is held for sale (inventory) or for use in your business. My free tax If it is unclear, examine carefully all the facts in the operation of the particular business. My free tax The following example shows how a careful examination of the facts in two similar situations results in different conclusions. My free tax Example. My free tax Maple Corporation is in the business of leasing cars. My free tax At the end of their useful lives, when the cars are no longer profitable to lease, Maple sells them. My free tax Maple does not have a showroom, used car lot, or individuals to sell the cars. My free tax Instead, it sells them through wholesalers or by similar arrangements in which a dealer's profit is not intended or considered. My free tax 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. My free tax 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. My free tax In this situation, the cars are held primarily for sale to customers in the ordinary course of business. My free tax Containers. My free tax   Generally, containers for the products you sell are part of inventory and you cannot depreciate them. My free tax However, you can depreciate containers used to ship your products if they have a life longer than one year and meet the following requirements. My free tax They qualify as property used in your business. My free tax Title to the containers does not pass to the buyer. My free tax   To determine if these requirements are met, consider the following questions. My free tax 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. My free tax This means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. My free tax 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. My free tax Example. My free tax You maintain a library for use in your profession. My free tax You can depreciate it. My free tax 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. My free tax Instead, you deduct their cost as a business expense. My free tax What Property Cannot Be Depreciated? Certain property cannot be depreciated. My free tax This includes land and certain excepted property. My free tax Land You cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up. My free tax The cost of land generally includes the cost of clearing, grading, planting, and landscaping. My free tax Although you cannot depreciate land, you can depreciate certain land preparation costs, such as landscaping costs, incurred in preparing land for business use. My free tax 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. My free tax Example. My free tax You constructed a new building for use in your business and paid for grading, clearing, seeding, and planting bushes and trees. My free tax Some of the bushes and trees were planted right next to the building, while others were planted around the outer border of the lot. My free tax If you replace the building, you would have to destroy the bushes and trees right next to it. My free tax These bushes and trees are closely associated with the building, so they have a determinable useful life. My free tax Therefore, you can depreciate them. My free tax Add your other land preparation costs to the basis of your land because they have no determinable life and you cannot depreciate them. My free tax Excepted Property Even if the requirements explained in the preceding discussions are met, you cannot depreciate the following property. My free tax Property placed in service and disposed of in the same year. My free tax Determining when property is placed in service is explained later. My free tax Equipment used to build capital improvements. My free tax You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements. My free tax See Uniform Capitalization Rules in Publication 551. My free tax Section 197 intangibles. My free tax You must amortize these costs. My free tax Section 197 intangibles are discussed in detail in Chapter 8 of Publication 535. My free tax Intangible property, such as certain computer software, that is not section 197 intangible property, can be depreciated if it meets certain requirements. My free tax See Intangible Property , later. My free tax Certain term interests. My free tax Certain term interests in property. My free tax   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. My free tax 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. My free tax Related persons. My free tax   For a description of related persons, see Related Persons, later. My free tax 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. My free tax Basis adjustments. My free tax   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. My free tax   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. My free tax However, do not increase your basis for depreciation not allowed for periods during which either of the following situations applies. My free tax The term interest is held by an organization exempt from tax. My free tax 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. My free tax Exceptions. My free tax   The above rules do not apply to the holder of a term interest in property acquired by gift, bequest, or inheritance. My free tax 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. My free tax 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. My free tax 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. My free tax 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. My free tax Even if you are not using the property, it is in service when it is ready and available for its specific use. My free tax Example 1. My free tax Donald Steep bought a machine for his business. My free tax The machine was delivered last year. My free tax However, it was not installed and operational until this year. My free tax It is considered placed in service this year. My free tax 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. My free tax Example 2. My free tax On April 6, Sue Thorn bought a house to use as residential rental property. My free tax She made several repairs and had it ready for rent on July 5. My free tax At that time, she began to advertise it for rent in the local newspaper. My free tax The house is considered placed in service in July when it was ready and available for rent. My free tax She can begin to depreciate it in July. My free tax Example 3. My free tax James Elm is a building contractor who specializes in constructing office buildings. My free tax He bought a truck last year that had to be modified to lift materials to second-story levels. My free tax The installation of the lifting equipment was completed and James accepted delivery of the modified truck on January 10 of this year. My free tax 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. My free tax Conversion to business use. My free tax   If you place property in service in a personal activity, you cannot claim depreciation. My free tax 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. My free tax You place the property in service in the business or income-producing activity on the date of the change. My free tax Example. My free tax You bought a home and used it as your personal home several years before you converted it to rental property. My free tax 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. My free tax 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. My free tax 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). My free tax 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. My free tax Cost or Other Basis Fully Recovered You stop depreciating property when you have fully recovered your cost or other basis. My free tax You recover your basis when your section 179 and allowed or allowable depreciation deductions equal your cost or investment in the property. My free tax See What Is the Basis of Your Depreciable Property , later. My free tax 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. My free tax 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. My free tax You sell or exchange the property. My free tax You convert the property to personal use. My free tax You abandon the property. My free tax You transfer the property to a supplies or scrap account. My free tax The property is destroyed. My free tax 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. My free tax What Method Can You Use To Depreciate Your Property? You must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most property. My free tax MACRS is discussed in chapter 4. My free tax You cannot use MACRS to depreciate the following property. My free tax Property you placed in service before 1987. My free tax Certain property owned or used in 1986. My free tax Intangible property. My free tax Films, video tapes, and recordings. My free tax Certain corporate or partnership property acquired in a nontaxable transfer. My free tax Property you elected to exclude from MACRS. My free tax The following discussions describe the property listed above and explain what depreciation method should be used. My free tax 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). My free tax Property placed in service before 1987 must be depreciated under the methods discussed in Publication 534. My free tax For a discussion of when property is placed in service, see When Does Depreciation Begin and End , earlier. My free tax Use of real property changed. My free tax   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. My free tax Improvements made after 1986. My free tax   You must treat an improvement made after 1986 to property you placed in service before 1987 as separate depreciable property. My free tax Therefore, you can depreciate that improvement as separate property under MACRS if it is the type of property that otherwise qualifies for MACRS depreciation. My free tax 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. My free tax 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. My free tax If you cannot use MACRS, the property must be depreciated under the methods discussed in Publication 534. My free tax For the following discussions, do not treat property as owned before you placed it in service. My free tax If you owned property in 1986 but did not place it in service until 1987, you do not treat it as owned in 1986. My free tax Personal property. My free tax   You cannot use MACRS for personal property (section 1245 property) in any of the following situations. My free tax You or someone related to you owned or used the property in 1986. My free tax 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. My free tax You lease the property to a person (or someone related to this person) who owned or used the property in 1986. My free tax 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. My free tax Real property. My free tax   You generally cannot use MACRS for real property (section 1250 property) in any of the following situations. My free tax You or someone related to you owned the property in 1986. My free tax You lease the property to a person who owned the property in 1986 (or someone related to that person). My free tax You acquired the property in a like-kind exchange, involuntary conversion, or repossession of property you or someone related to you owned in 1986. My free tax MACRS applies only to that part of your basis in the acquired property that represents cash paid or unlike property given up. My free tax It does not apply to the carried-over part of the basis. My free tax Exceptions. My free tax   The rules above do not apply to the following. My free tax Residential rental property or nonresidential real property. My free tax 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. My free tax For information on how to figure depreciation under ACRS, see Publication 534. My free tax Property that was MACRS property in the hands of the person from whom you acquired it because of (2) above. My free tax Related persons. My free tax   For this purpose, the following are related persons. My free tax 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. My free tax A corporation and an individual who directly or indirectly owns more than 10% of the value of the outstanding stock of that corporation. My free tax Two corporations that are members of the same controlled group. My free tax 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. My free tax The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. My free tax 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. My free tax 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. My free tax 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. My free tax A corporation and a partnership if the same persons own both of the following. My free tax More than 10% of the value of the outstanding stock of the corporation. My free tax More than 10% of the capital or profits interest in the partnership. My free tax The executor and beneficiary of any estate. My free tax A partnership and a person who directly or indirectly owns more than 10% of the capital or profits interest in the partnership. My free tax Two partnerships, if the same persons directly or indirectly own more than 10% of the capital or profits interest in each. My free tax The related person and a person who is engaged in trades or businesses under common control. My free tax See section 52(a) and 52(b) of the Internal Revenue Code. My free tax When to determine relationship. My free tax   You must determine whether you are related to another person at the time you acquire the property. My free tax   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. My free tax 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. My free tax Constructive ownership of stock or partnership interest. My free tax   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. My free tax 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. My free tax 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. My free tax An individual is considered to own the stock or partnership interest directly or indirectly owned by or for the individual's family. My free tax 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. My free tax 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. My free tax 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. My free tax Intangible Property Generally, if you can depreciate intangible property, you usually use the straight line method of depreciation. My free tax However, you can choose to depreciate certain intangible property under the income forecast method (discussed later). My free tax 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. My free tax Straight Line Method This method lets you deduct the same amount of depreciation each year over the useful life of the property. My free tax To figure your deduction, first determine the adjusted basis, salvage value, and estimated useful life of your property. My free tax Subtract the salvage value, if any, from the adjusted basis. My free tax The balance is the total depreciation you can take over the useful life of the property. My free tax Divide the balance by the number of years in the useful life. My free tax This gives you your yearly depreciation deduction. My free tax 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. My free tax 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. My free tax Example. My free tax In April, Frank bought a patent for $5,100 that is not a section 197 intangible. My free tax He depreciates the patent under the straight line method, using a 17-year useful life and no salvage value. My free tax He divides the $5,100 basis by 17 years to get his $300 yearly depreciation deduction. My free tax 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. My free tax Next year, Frank can deduct $300 for the full year. My free tax Patents and copyrights. My free tax   If you can depreciate the cost of a patent or copyright, use the straight line method over the useful life. My free tax 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. My free tax 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. My free tax Computer software. My free tax   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. My free tax   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. My free tax It is readily available for purchase by the general public. My free tax It is subject to a nonexclusive license. My free tax It has not been substantially modified. My free tax   If the software meets the tests above, it may also qualify for the section 179 deduction and the special depreciation allowance, discussed later. My free tax If you can depreciate the cost of computer software, use the straight line method over a useful life of 36 months. My free tax    Tax-exempt use property subject to a lease. My free tax   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. My free tax Certain created intangibles. My free tax   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. My free tax For example, amounts paid to acquire memberships or privileges of indefinite duration, such as a trade association membership, are eligible costs. My free tax   The following are not eligible. My free tax Any intangible asset acquired from another person. My free tax Created financial interests. My free tax Any intangible asset that has a useful life that can be estimated with reasonable accuracy. My free tax 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. My free tax 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. My free tax   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. My free tax 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. My free tax Income Forecast Method You can choose to use the income forecast method instead of the straight line method to depreciate the following depreciable intangibles. My free tax Motion picture films or video tapes. My free tax Sound recordings. My free tax Copyrights. My free tax Books. My free tax Patents. My free tax Under the income forecast method, each year's depreciation deduction is equal to the cost of the property, multiplied by a fraction. My free tax 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. My free tax For more information, see section 167(g) of the Internal Revenue Code. My free tax Films, video tapes, and recordings. My free tax   You cannot use MACRS for motion picture films, video tapes, and sound recordings. My free tax For this purpose, sound recordings are discs, tapes, or other phonorecordings resulting from the fixation of a series of sounds. My free tax You can depreciate this property using either the straight line method or the income forecast method. My free tax Participations and residuals. My free tax   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. My free tax 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. My free tax 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. My free tax   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. My free tax Videocassettes. My free tax   If you are in the business of renting videocassettes, you can depreciate only those videocassettes bought for rental. My free tax If the videocassette has a useful life of one year or less, you can currently deduct the cost as a business expense. My free tax 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. My free tax You must continue to use the same depreciation method as the transferor and figure depreciation as if the transfer had not occurred. My free tax 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. My free tax The nontaxable transfers covered by this rule include the following. My free tax A distribution in complete liquidation of a subsidiary. My free tax A transfer to a corporation controlled by the transferor. My free tax An exchange of property solely for corporate stock or securities in a reorganization. My free tax A contribution of property to a partnership in exchange for a partnership interest. My free tax A partnership distribution of property to a partner. My free tax 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. My free tax 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. My free tax You must make this election by the return due date (including extensions) for the tax year you place your property in service. My free tax 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). My free tax Attach the election to the amended return and write “Filed pursuant to section 301. My free tax 9100-2” on the election statement. My free tax File the amended return at the same address you filed the original return. My free tax Use of standard mileage rate. My free tax   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. My free tax See Publication 463 for a discussion of the standard mileage rate. My free tax What Is the Basis of Your Depreciable Property? To figure your depreciation deduction, you must determine the basis of your property. My free tax To determine basis, you need to know the cost or other basis of your property. My free tax 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. My free tax The cost includes the amount you pay in cash, debt obligations, other property, or services. My free tax Exception. My free tax   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). My free tax If you make that choice, you cannot include those sales taxes as part of your cost basis. My free tax Assumed debt. My free tax   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. My free tax Example. My free tax You make a $20,000 down payment on property and assume the seller's mortgage of $120,000. My free tax Your total cost is $140,000, the cash you paid plus the mortgage you assumed. My free tax Settlement costs. My free tax   The basis of real property also includes certain fees and charges you pay in addition to the purchase price. My free tax These generally are shown on your settlement statement and include the following. My free tax Legal and recording fees. My free tax Abstract fees. My free tax Survey charges. My free tax Owner's title insurance. My free tax 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. My free tax   For fees and charges you cannot include in the basis of property, see Real Property in Publication 551. My free tax Property you construct or build. My free tax   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. My free tax For information about the uniform capitalization rules, see Publication 551 and the regulations under section 263A of the Internal Revenue Code. My free tax Other Basis Other basis usually refers to basis that is determined by the way you received the property. My free tax 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. My free tax If you acquired property in this or some other way, see Publication 551 to determine your basis. My free tax Property changed from personal use. My free tax   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. My free tax The fair market value (FMV) of the property on the date of the change in use. My free tax Your original cost or other basis adjusted as follows. My free tax Increased by the cost of any permanent improvements or additions and other costs that must be added to basis. My free tax Decreased by any deductions you claimed for casualty and theft losses and other items that reduced your basis. My free tax Example. My free tax Several years ago, Nia paid $160,000 to have her home built on a lot that cost her $25,000. My free tax 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. My free tax Land is not depreciable, so she includes only the cost of the house when figuring the basis for depreciation. My free tax Nia's adjusted basis in the house when she changed its use was $178,000 ($160,000 + $20,000 − $2,000). My free tax 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. My free tax 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). My free tax Property acquired in a nontaxable transaction. My free tax   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. My free tax 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. My free tax See Like-kind exchanges and involuntary conversions. My free tax under How Much Can You Deduct? in chapter 3 and Figuring the Deduction for Property Acquired in a Nontaxable Exchange in chapter 4. My free tax   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. My free tax See How Do You Use General Asset Accounts in chapter 4. My free tax 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. My free tax These events could include the following. My free tax Installing utility lines. My free tax Paying legal fees for perfecting the title. My free tax Settling zoning issues. My free tax Receiving rebates. My free tax Incurring a casualty or theft loss. My free tax For a discussion of adjustments to the basis of your property, see Adjusted Basis in Publication 551. My free tax 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. My free tax For more information, see What Is the Basis for Depreciation in chapter 4. My free tax . My free tax Basis adjustment for depreciation allowed or allowable. My free tax   You must reduce the basis of property by the depreciation allowed or allowable, whichever is greater. My free tax Depreciation allowed is depreciation you actually deducted (from which you received a tax benefit). My free tax Depreciation allowable is depreciation you are entitled to deduct. My free tax   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. My free tax   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). My free tax How Do You Treat Repairs and Improvements? If you improve depreciable property, you must treat the improvement as separate depreciable property. My free tax 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. My free tax You generally deduct the cost of repairing business property in the same way as any other business expense. My free tax 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. My free tax Example. My free tax You repair a small section on one corner of the roof of a rental house. My free tax You deduct the cost of the repair as a rental expense. My free tax 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. My free tax You depreciate the cost of the new roof. My free tax Improvements to rented property. My free tax   You can depreciate permanent improvements you make to business property you rent from someone else. My free tax Do You Have To File Form 4562? Use Form 4562 to figure your deduction for depreciation and amortization. My free tax Attach Form 4562 to your tax return for the current tax year if you are claiming any of the following items. My free tax A section 179 deduction for the current year or a section 179 carryover from a prior year. My free tax See chapter 2 for information on the section 179 deduction. My free tax Depreciation for property placed in service during the current year. My free tax Depreciation on any vehicle or other listed property, regardless of when it was placed in service. My free tax See chapter 5 for information on listed property. My free tax 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). My free tax Amortization of costs if the current year is the first year of the amortization period. My free tax Depreciation or amortization on any asset on a corporate income tax return (other than Form 1120S, U. My free tax S. My free tax Income Tax Return for an S Corporation) regardless of when it was placed in service. My free tax You must submit a separate Form 4562 for each business or activity on your return for which a Form 4562 is required. My free tax Table 1-1 presents an overview of the purpose of the various parts of Form 4562. My free tax Employee. My free tax   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. My free tax Instead, use either Form 2106 or Form 2106-EZ. My free tax Use Form 2106-EZ if you are claiming the standard mileage rate and you are not reimbursed by your employer for any expenses. My free tax 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. My free tax See Filing an Amended Return , next. My free tax 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. My free tax See Changing Your Accounting Method , later. My free tax 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. My free tax You claimed the incorrect amount because of a mathematical error made in any year. My free tax You claimed the incorrect amount because of a posting error made in any year. My free tax You have not adopted a method of accounting for property placed in service by you in tax years ending after December 29, 2003. My free tax You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003. My free tax Adoption of accounting method defined. My free tax   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. My free tax   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. My free tax irs. My free tax gov/pub/irs-irbs/irb11-04. My free tax pdf. My free tax (Note. My free tax Revenue Procedure 2011-14 is clarified and modified by Revenue Procedure 2012-20. My free tax For more information, see Revenue Procedure 2012-20 on page 700 of the Internal Revenue Bulletin 2012-14, available at www. My free tax irs. My free tax gov/pub/irs-irbs/irb12-14. My free tax pdf. My free tax )   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. My free tax irs. My free tax gov/pub/irs-irbs/irb07-29. My free tax pdf. My free tax When to file. My free tax   If an amended return is allowed, you must file it by the later of the following. My free tax 3 years from the date you filed your original return for the year in which you did not deduct the correct amount. My free tax A return filed before an unextended due date is considered filed on that due date. My free tax 2 years from the time you paid your tax for that year. My free tax Changing Your Accounting Method Generally, you must get IRS approval to change your method of accounting. My free tax You generally must file Form 3115, Application for Change in Accounting Method, to request a change in your method of accounting for depreciation. My free tax The following are examples of a change in method of accounting for depreciation. My free tax 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. My free tax A change in the treatment of an asset from nondepreciable to depreciable or vice versa. My free tax A change in the depreciation method, period of recovery, or convention of a depreciable asset. My free tax A change from not claiming to claiming the special depreciation allowance if you did not make the election to not claim any special allowance. My free tax 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). My free tax Changes in depreciation that are not a change in method of accounting (and may only be made on an amended return) include the following. My free tax An adjustment in the useful life of a depreciable asset for which depreciation is determined under section 167. My free tax A change in use of an asset in the hands of the same taxpayer. My free tax Making a late depreciation election or revoking a timely valid depreciation election (including the election not to deduct the special depreciation allowance). My free tax 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. My free tax Generally, you must get IRS approval to make a late depreciation election or revoke a depreciation election. My free tax You must submit a request for a letter ruling to make a late election or revoke an election. My free tax Any change in the placed in service date of a depreciable asset. My free tax See section 1. My free tax 446-1(e)(2)(ii)(d) of the regulations for more information and examples. My free tax IRS approval. My free tax   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. My free tax 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. My free tax B. My free tax 680. My free tax Also see the Instructions for Form 3115 for more information on getting approval, including lists of scope limitations and automatic accounting method changes. My free tax Additional guidance. My free tax    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. My free tax irs. My free tax gov/pub/irs-irbs/irb11-04. My free tax pdf. My free tax (Note. My free tax Revenue Procedure 2011-14 is clarified and modified by Revenue Procedure 2012-20. My free tax For more information, see Revenue Procedure 2012-20 on page 700 of the Internal Revenue Bulletin 2012-14, available at www. My free tax irs. My free tax gov/pub/irs-irbs/irb12-14. My free tax pdf. My free tax )   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. My free tax irs. My free tax gov/pub/irs-irbs/irb07-29. My free tax pdf. My free tax Table 1-1. My free tax Purpose of Form 4562 This table describes the purpose of the various parts of Form 4562. My free tax For more information, see Form 4562 and its instructions. My free tax 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. My free tax   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. My free tax 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. My free tax If no depreciation was deducted, the adjustment is the total depreciation allowable prior to the year of change. My free tax A negative section 481(a) adjustment results in a decrease in taxable income. My free tax It is taken into account in the year of change and is reported on your business tax returns as “other expenses. My free tax ” A positive section 481(a) adjustment results in an increase in taxable income. My free tax It is generally taken into account over 4 tax years and is reported on your business tax returns as “other income. My free tax ” 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. My free tax Make the election by completing the appropriate line on Form 3115. My free tax   If you file a Form 3115 and change from one permissible method to another permissible method, the section 481(a) adjustment is zero. My free tax Prev  Up  Next   Home   More Online Publications
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Tax Relief for Victims of Severe Storms in Illinois

IL/KS/MO-2013-50, Nov. 27, 2013

ST. LOUIS — Victims of severe storms, straight-line winds and tornadoes that began on Nov. 17, 2013 in parts of Illinois may qualify for tax relief from the Internal Revenue Service.

Following recent disaster declarations for individual assistance issued by the Federal Emergency Management Agency, the IRS announced today that affected taxpayers in Illinois will receive tax relief, and other locations may be added in coming days based on additional damage assessments by FEMA.

The President has declared the counties of Champaign, Douglas, Fayette, Grundy, Jasper, La Salle, Massac, Pope, Tazewell, Vermilion, Wabash, Washington, Wayne, Will and Woodford a federal disaster area. Individuals who reside or have a business in these counties may qualify for tax relief.

The declaration permits the IRS to postpone certain deadlines for taxpayers who reside or have a business in the disaster area. For instance, certain deadlines falling on or after Nov. 17, and on or before Feb. 28, 2014, have been postponed to Feb. 28, 2014.

The IRS is also waiving the failure-to-deposit penalties for employment and excise tax deposits due on or after Nov. 17, and on or before Dec. 2, as long as the deposits are made by Dec. 2, 2013.

If an affected taxpayer receives a penalty notice from the IRS, the taxpayer should call the telephone number on the notice to have the IRS abate any interest and any late filing or late payment penalties that would otherwise apply. Penalties or interest will be abated only for taxpayers who have an original or extended filing, payment or deposit due date, including an extended filing or payment due date, that falls within the postponement period.

The IRS automatically identifies taxpayers located in the covered disaster area and applies automatic filing and payment relief. But affected taxpayers who reside or have a business located outside the covered disaster area must call the IRS disaster hotline at 866-562-5227 to request this tax relief.

Covered Disaster Area

The counties listed above constitute a covered disaster area for purposes of Treas. Reg. § 301.7508A-1(d)(2) and are entitled to the relief detailed below.

Affected Taxpayers

Taxpayers considered to be affected taxpayers eligible for the postponement of time to file returns, pay taxes and perform other time-sensitive acts are those taxpayers listed in Treas. Reg. § 301.7508A-1(d)(1), and include individuals who live, and businesses whose principal place of business is located, in the covered disaster area. Taxpayers not in the covered disaster area, but whose records necessary to meet a deadline listed in Treas. Reg. § 301.7508A-1(c) are in the covered disaster area, are also entitled to relief. In addition, all relief workers affiliated with a recognized government or philanthropic organization assisting in the relief activities in the covered disaster area and any individual visiting the covered disaster area who was killed or injured as a result of the disaster are entitled to relief.

Grant of Relief

Under section 7508A, the IRS gives affected taxpayers until Feb. 28, 2014, to file most tax returns (including individual, corporate, and estate and trust income tax returns; partnership returns, S corporation returns, and trust returns; estate, gift, and generation-skipping transfer tax returns; and employment and certain excise tax returns), or to make tax payments, including estimated tax payments, that have either an original or extended due date occurring on or after Nov. 17 and on or before Feb. 28, 2014.

The IRS also gives affected taxpayers until Feb. 28, 2014, to perform other time-sensitive actions described in Treas. Reg. § 301.7508A-1(c)(1) and Rev. Proc. 2007-56, 2007-34 I.R.B. 388 (Aug. 20, 2007), that are due to be performed on or after Nov. 17 and on or before Feb. 28, 2014.

This relief also includes the filing of Form 5500 series returns, in the manner described in section 8 of Rev. Proc. 2007-56. The relief described in section 17 of Rev. Proc. 2007-56, pertaining to like-kind exchanges of property, also applies to certain taxpayers who are not otherwise affected taxpayers and may include acts required to be performed before or after the period above.

The postponement of time to file and pay does not apply to information returns in the W-2, 1098, 1099 series, or to Forms 1042-S or 8027. Penalties for failure to timely file information returns can be waived under existing procedures for reasonable cause. Likewise, the postponement does not apply to employment and excise tax deposits. The IRS, however, will abate penalties for failure to make timely employment and excise tax deposits due on or after Nov. 17 and on or before Dec. 2 provided the taxpayer makes these deposits by Dec. 2.

Casualty Losses

Affected taxpayers in a federally declared disaster area have the option of claiming disaster-related casualty losses on their federal income tax return for either this year or last year. Claiming the loss on an original or amended return for last year will get the taxpayer an earlier refund, but waiting to claim the loss on this year’s return could result in a greater tax saving, depending on other income factors.

Individuals may deduct personal property losses that are not covered by insurance or other reimbursements. For details, see Form 4684 and its instructions.

Affected taxpayers claiming the disaster loss on last year’s return should put the Disaster Designation “Illinois/ Severe Storms, Straight-line Winds, and Tornadoes” at the top of the form so that the IRS can expedite the processing of the refund.

Other Relief

The IRS will waive the usual fees and expedite requests for copies of previously filed tax returns for affected taxpayers. Taxpayers should put the assigned Disaster Designation in red ink at the top of Form 4506, Request for Copy of Tax Return, or Form 4506-T, Request for Transcript of Tax Return, as appropriate, and submit it to the IRS.

Affected taxpayers who are contacted by the IRS on a collection or examination matter should explain how the disaster impacts them so that the IRS can provide appropriate consideration to their case.

Taxpayers may download forms and publications from the official IRS website, irs.gov, or order them by calling 800-TAX-FORM (800-829-3676). The IRS toll-free number for general tax questions is 800-829-1040.

Related Information

Disaster Assistance and Emergency Relief for Individuals and Businesses

Recent IRS Disaster Relief Announcements

Page Last Reviewed or Updated: 27-Nov-2013

The My Free Tax

My free tax 3. My free tax   Investment Expenses Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: Limits on DeductionsPassive activity. My free tax Other income (nonpassive income). My free tax Expenses. My free tax Additional information. My free tax Interest ExpensesInvestment Interest Limit on Deduction Bond Premium AmortizationSpecial rules to determine amounts payable on a bond. My free tax Basis. My free tax How To Figure Amortization Choosing To Amortize How To Report Amortization Expenses of Producing IncomeFees to buy or sell. My free tax Including mutual fund or REMIC expenses in income. My free tax Nondeductible ExpensesUsed as collateral. My free tax Short-sale expenses. My free tax Expenses for both tax-exempt and taxable income. My free tax State income taxes. My free tax Nondeductible amount. My free tax Basis adjustment. My free tax How To Report Investment Expenses When To Report Investment Expenses Topics - This chapter discusses: Limits on Deductions , Interest Expenses , Bond Premium Amortization , Expenses of Producing Income , Nondeductible Expenses , How To Report Investment Expenses , and When To Report Investment Expenses . My free tax Useful Items - You may want to see: Publication 535 Business Expenses 925 Passive Activity and At-Risk Rules 929 Tax Rules for Children and Dependents Form (and Instructions) Schedule A (Form 1040) Itemized Deductions 4952 Investment Interest Expense Deduction See chapter 5, How To Get Tax Help , for information about getting these publications and forms. My free tax Limits on Deductions Your deductions for investment expenses may be limited by: The at-risk rules, The passive activity loss limits, The limit on investment interest, or The 2% limit on certain miscellaneous itemized deductions. My free tax The at-risk rules and passive activity rules are explained briefly in this section. My free tax The limit on investment interest is explained later in this chapter under Interest Expenses . My free tax The 2% limit is explained later in this chapter under Expenses of Producing Income . My free tax At-risk rules. My free tax   Special at-risk rules apply to most income-producing activities. My free tax These rules limit the amount of loss you can deduct to the amount you risk losing in the activity. My free tax Generally, this is the cash and the adjusted basis of property you contribute to the activity. My free tax It also includes money you borrow for use in the activity if you are personally liable for repayment or if you use property not used in the activity as security for the loan. My free tax For more information, see Publication 925. My free tax Passive activity losses and credits. My free tax   The amount of losses and tax credits you can claim from passive activities is limited. My free tax Generally, you are allowed to deduct passive activity losses only up to the amount of your passive activity income. My free tax Also, you can use credits from passive activities only against tax on the income from passive activities. My free tax There are exceptions for certain activities, such as rental real estate activities. My free tax Passive activity. My free tax   A passive activity generally is any activity involving the conduct of any trade or business in which you do not materially participate and any rental activity. My free tax However, if you are involved in renting real estate, the activity is not a passive activity if both of the following are true. My free tax More than one-half of the personal services you perform during the year in all trades or businesses are performed in real property trades or businesses in which you materially participate. My free tax You perform more than 750 hours of services during the year in real property trades or businesses in which you materially participate. My free tax  The term “trade or business” generally means any activity that involves the conduct of a trade or business, is conducted in anticipation of starting a trade or business, or involves certain research or experimental expenditures. My free tax However, it does not include rental activities or certain activities treated as incidental to holding property for investment. My free tax   You are considered to materially participate in an activity if you are involved on a regular, continuous, and substantial basis in the operations of the activity. My free tax Other income (nonpassive income). My free tax    Generally, you can use losses from passive activities only to offset income from passive activities. My free tax You cannot use passive activity losses to offset your other income, such as your wages or your portfolio income. My free tax Portfolio income includes gross income from interest, dividends, annuities, or royalties that is not derived in the ordinary course of a trade or business. My free tax It also includes gains or losses (not derived in the ordinary course of a trade or business) from the sale or trade of property (other than an interest in a passive activity) producing portfolio income or held for investment. My free tax This includes capital gain distributions from mutual funds (and other regulated investment companies) and real estate investment trusts. My free tax   You cannot use passive activity losses to offset Alaska Permanent Fund dividends. My free tax Expenses. My free tax   Do not include in the computation of your passive activity income or loss: Expenses (other than interest) that are clearly and directly allocable to your portfolio income, or Interest expense properly allocable to portfolio income. My free tax However, this interest and other expenses may be subject to other limits. My free tax These limits are explained in the rest of this chapter. My free tax Additional information. My free tax   For more information about determining and reporting income and losses from passive activities, see Publication 925. My free tax Interest Expenses This section discusses interest expenses you may be able to deduct as an investor. My free tax For information on business interest, see chapter 4 of Publication 535. My free tax You cannot deduct personal interest expenses other than qualified home mortgage interest, as explained in Publication 936, Home Mortgage Interest Deduction, and interest on certain student loans, as explained in Publication 970. My free tax Investment Interest If you borrow money to buy property you hold for investment, the interest you pay is investment interest. My free tax You can deduct investment interest subject to the limit discussed later. My free tax However, you cannot deduct interest you incurred to produce tax-exempt income. My free tax See Tax-exempt income under Nondeductible Expenses, later. My free tax You also cannot deduct interest expenses on straddles discussed under Interest expense and carrying charges on straddles , later. My free tax Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity. My free tax Investment property. My free tax   Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. My free tax It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). My free tax Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity). My free tax Partners, shareholders, and beneficiaries. My free tax   To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your other investment interest. My free tax Allocation of Interest Expense If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. My free tax Only the interest expense on the part of the debt used for investment purposes is treated as investment interest. My free tax The allocation is not affected by the use of property that secures the debt. My free tax Example 1. My free tax You borrow $10,000 and use $8,000 to buy stock. My free tax You use the other $2,000 to buy items for your home. My free tax Since 80% of the debt is used for, and allocated to, investment purposes, 80% of the interest on that debt is investment interest. My free tax The other 20% is nondeductible personal interest. My free tax Debt proceeds received in cash. My free tax   If you receive debt proceeds in cash, the proceeds are generally not treated as investment property. My free tax Debt proceeds deposited in account. My free tax   If you deposit debt proceeds in an account, that deposit is treated as investment property, regardless of whether the account bears interest. My free tax But, if you withdraw the funds and use them for another purpose, you must reallocate the debt to determine the amount considered to be for investment purposes. My free tax Example 2. My free tax Assume in Example 1 that you borrowed the money on March 1 and immediately bought the stock for $8,000. My free tax You did not buy the household items until June 1. My free tax You had deposited the $2,000 in the bank. My free tax You had no other transactions on the bank account until June. My free tax You did not sell the stock, and you made no principal payments on the debt. My free tax You paid interest from another account. My free tax The $8,000 is treated as being used for an investment purpose. My free tax The $2,000 is treated as being used for an investment purpose for the 3-month period. My free tax Your total interest expense for 3 months on this debt is investment interest. My free tax In June, when you spend the $2,000 for household items, you must begin to allocate 80% of the debt and the interest expense to investment purposes and 20% to personal purposes. My free tax Amounts paid within 30 days. My free tax   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. My free tax This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. My free tax   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. My free tax Payments on debt may require new allocation. My free tax   As you repay a debt used for more than one purpose, you must reallocate the balance. My free tax You must first reduce the amount allocated to personal purposes by the repayment. My free tax You then reallocate the rest of the debt to find what part is for investment purposes. My free tax Example 3. My free tax If, in Example 2 , you repay $500 on November 1, the entire repayment is applied against the amount allocated to personal purposes. My free tax The debt balance is now allocated as $8,000 for investment purposes and $1,500 for personal purposes. My free tax Until the next reallocation is necessary, 84% ($8,000 ÷ $9,500) of the debt and the interest expense is allocated to investment. My free tax Pass-through entities. My free tax   If you use borrowed funds to buy an interest in a partnership or S corporation, then the interest on those funds must be allocated based on the assets of the entity. My free tax If you contribute to the capital of the entity, you can make the allocation using any reasonable method. My free tax Additional allocation rules. My free tax   For more information about allocating interest expense, see chapter 4 of Publication 535. My free tax When To Deduct Investment Interest If you use the cash method of accounting, you must pay the interest before you can deduct it. My free tax If you use an accrual method of accounting, you can deduct interest over the period it accrues, regardless of when you pay it. My free tax For an exception, see Unpaid expenses owed to related party under When To Report Investment Expenses, later in this chapter. My free tax Example. My free tax You borrowed $1,000 on August 26, 2013, payable in 90 days at 12% interest. My free tax On November 26, 2013, you paid this with a new note for $1,030, due on February 26, 2014. My free tax If you use the cash method of accounting, you cannot deduct any part of the $30 interest on your return for 2013 because you did not actually pay it. My free tax If you use an accrual method, you may be able to deduct a portion of the interest on the loans through December 31, 2013, on your return for 2013. My free tax Interest paid in advance. My free tax   Generally, if you pay interest in advance for a period that goes beyond the end of the tax year, you must spread the interest over the tax years to which it belongs under the OID rules discussed in chapter 1. My free tax You can deduct in each year only the interest for that year. My free tax Interest on margin accounts. My free tax   If you are a cash method taxpayer, you can deduct interest on margin accounts to buy taxable securities as investment interest in the year you paid it. My free tax You are considered to have paid interest on these accounts only when you actually pay the broker or when payment becomes available to the broker through your account. My free tax Payment may become available to the broker through your account when the broker collects dividends or interest for your account, or sells securities held for you or received from you. My free tax   You cannot deduct any interest on money borrowed for personal reasons. My free tax Limit on interest deduction for market discount bonds. My free tax   The amount you can deduct for interest expense you paid or accrued during the year to buy or carry a market discount bond may be limited. My free tax This limit does not apply if you accrue the market discount and include it in your income currently. My free tax   Under this limit, the interest is deductible only to the extent it is more than: The total interest and OID includible in gross income for the bond for the year, plus The market discount for the number of days you held the bond during the year. My free tax Figure the amount in (2) above using the rules for figuring accrued market discount in chapter 1 under Market Discount Bonds . My free tax Interest not deducted due to limit. My free tax   In the year you dispose of the bond, you can deduct any interest expense you were not allowed to deduct in earlier years because of the limit. My free tax Choosing to deduct disallowed interest expense before the year of disposition. My free tax   You can choose to deduct disallowed interest expense in any year before the year you dispose of the bond, up to your net interest income from the bond during the year. My free tax The rest of the disallowed interest expense remains deductible in the year you dispose of the bond. My free tax Net interest income. My free tax   This is the interest income (including OID) from the bond that you include in income for the year, minus the interest expense paid or accrued during the year to purchase or carry the bond. My free tax Limit on interest deduction for short-term obligations. My free tax   If the current income inclusion rules discussed in chapter 1 under Discount on Short-Term Obligations do not apply to you, the amount you can deduct for interest expense you paid or accrued during the year to buy or carry a short-term obligation is limited. My free tax   The interest is deductible only to the extent it is more than: The amount of acquisition discount or OID on the obligation for the tax year, plus The amount of any interest payable on the obligation for the year that is not included in income because of your accounting method (other than interest taken into account in determining the amount of acquisition discount or OID). My free tax The method of determining acquisition discount and OID for short-term obligations is discussed in chapter 1 under Discount on Short-Term Obligations . My free tax Interest not deducted due to limit. My free tax   In the year you dispose of the obligation, or, if you choose, in another year in which you have net interest income from the obligation, you can deduct any interest expense you were not allowed to deduct for an earlier year because of the limit. My free tax Follow the same rules provided in the earlier discussion under Limit on interest deduction for market discount bonds , earlier. My free tax Limit on Deduction Generally, your deduction for investment interest expense is limited to your net investment income. My free tax You can carry over the amount of investment interest you could not deduct because of this limit to the next tax year. My free tax The interest carried over is treated as investment interest paid or accrued in that next year. My free tax You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was paid or accrued. My free tax Net Investment Income Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment income. My free tax Investment income. My free tax   This generally includes your gross income from property held for investment (such as interest, dividends, annuities, and royalties). My free tax Investment income does not include Alaska Permanent Fund dividends. My free tax It also does not include qualified dividends or net capital gain unless you choose to include them. My free tax Choosing to include qualified dividends. My free tax   Investment income generally does not include qualified dividends, discussed in chapter 1. My free tax However, you can choose to include all or part of your qualified dividends in investment income. My free tax   You make this choice by completing Form 4952, line 4g, according to its instructions. My free tax   If you choose to include any of your qualified dividends in investment income, you must reduce your qualified dividends that are eligible for the lower capital gains tax rates by the same amount. My free tax Choosing to include net capital gain. My free tax    Investment income generally does not include net capital gain from disposing of investment property (including capital gain distributions from mutual funds). My free tax However, you can choose to include all or part of your net capital gain in investment income. My free tax   You make this choice by completing Form 4952, line 4g, according to its instructions. My free tax   If you choose to include any of your net capital gain in investment income, you must reduce your net capital gain that is eligible for the lower capital gains tax rates by the same amount. My free tax   For more information about the capital gains rates, see Capital Gain Tax Rates in chapter 4. My free tax    Before making either choice, consider the overall effect on your tax liability. My free tax Compare your tax if you make one or both of these choices with your tax if you do not. My free tax Investment income of child reported on parent's return. My free tax   Investment income includes the part of your child's interest and dividend income you choose to report on your return. My free tax If the child does not have qualified dividends, Alaska Permanent Fund dividends, or capital gain distributions, this is the amount on line 6 of Form 8814. My free tax Include it on line 4a of Form 4952. My free tax Example. My free tax Your 8-year-old son has interest income of $2,200, which you choose to report on your own return. My free tax You enter $2,200 on Form 8814, lines 1a and 4, and $200 on lines 6 and 12 and complete Part II. My free tax Also enter $200 on Form 1040, line 21. My free tax Your investment income includes this $200. My free tax Child's qualified dividends. My free tax   If part of the amount you report is your child's qualified dividends, that part (which is reported on Form 1040, line 9b) generally does not count as investment income. My free tax However, you can choose to include all or part of it in investment income, as explained under Choosing to include qualified dividends , earlier. My free tax   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured next under Child's Alaska Permanent Fund dividends). My free tax Child's Alaska Permanent Fund dividends. My free tax   If part of the amount you report is your child's Alaska Permanent Fund dividends, that part does not count as investment income. My free tax To figure the amount of your child's income that you can consider your investment income, start with the amount on Form 8814, line 6. My free tax Multiply that amount by a percentage that is equal to the Alaska Permanent Fund dividends divided by the total amount on Form 8814, line 4. My free tax Subtract the result from the amount on Form 8814, line 12. My free tax Example. My free tax Your 10-year-old child has taxable interest income of $4,000 and Alaska Permanent Fund dividends of $2,000. My free tax You choose to report this on your return. My free tax You enter $4,000 on Form 8814, line 1a, $2,000 on line 2a, and $6,000 on line 4. My free tax You then enter $4,000 on Form 8814, lines 6 and 12, and Form 1040, line 21. My free tax You figure the amount of your child's income that you can consider your investment income as follows: $4,000 − ($4,000 × ($2,000 ÷ $6,000)) = $2,667 You include the result, $2,667, on Form 4952, line 4a. My free tax Child's capital gain distributions. My free tax   If part of the amount you report is your child's capital gain distributions, that part (which is reported on Schedule D (Form 1040), line 13, or Form 1040, line 13) generally does not count as investment income. My free tax However, you can choose to include all or part of it in investment income, as explained in Choosing to include net capital gain , earlier. My free tax   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured under Child's Alaska Permanent Fund dividends , earlier). My free tax Investment expenses. My free tax   Investment expenses are your allowed deductions (other than interest expense) directly connected with the production of investment income. My free tax Investment expenses that are included as a miscellaneous itemized deduction on Schedule A (Form 1040) are allowable deductions after applying the 2% limit that applies to miscellaneous itemized deductions. My free tax Use the smaller of: The investment expenses included on Schedule A (Form 1040), line 23, or The amount on Schedule A (Form 1040), line 27. My free tax See Expenses of Producing Income , later, for a discussion of the 2% limit. My free tax Losses from passive activities. My free tax   Income or expenses that you used in computing income or loss from a passive activity are not included in determining your investment income or investment expenses (including investment interest expense). My free tax See Publication 925 for information about passive activities. My free tax Example. My free tax Ted is a partner in a partnership that operates a business. My free tax However, he does not materially participate in the partnership's business. My free tax Ted's interest in the partnership is considered a passive activity. My free tax Ted's investment income from interest and dividends (other than qualified dividends) is $10,000. My free tax His investment expenses (other than interest) are $3,200 after taking into account the 2% limit on miscellaneous itemized deductions. My free tax His investment interest expense is $8,000. My free tax Ted also has income from the partnership of $2,000. My free tax Ted figures his net investment income and the limit on his investment interest expense deduction in the following way: Total investment income $10,000 Minus: Investment expenses (other than interest) 3,200 Net investment income $6,800 Deductible investment interest expense for the year $6,800 The $2,000 of income from the passive activity is not used in determining Ted's net investment income. My free tax His investment interest deduction for the year is limited to $6,800, the amount of his net investment income. My free tax Form 4952 Use Form 4952 to figure your deduction for investment interest. My free tax See Form 4952 for more information. My free tax Exception to use of Form 4952. My free tax   You do not have to complete Form 4952 or attach it to your return if you meet all of the following tests. My free tax Your investment interest expense is not more than your investment income from interest and ordinary dividends minus any qualified dividends. My free tax You do not have any other deductible investment expenses. My free tax You have no carryover of investment interest expense from 2012. My free tax   If you meet all of these tests, you can deduct all of your investment interest. My free tax    Bond Premium Amortization If you pay a premium to buy a bond, the premium is part of your basis in the bond. My free tax If the bond yields taxable interest, you can choose to amortize the premium. My free tax This generally means that each year, over the life of the bond, you use a part of the premium to reduce the amount of interest includible in your income. My free tax If you make this choice, you must reduce your basis in the bond by the amortization for the year. My free tax If the bond yields tax-exempt interest, you must amortize the premium. My free tax This amortized amount is not deductible in determining taxable income. My free tax However, each year you must reduce your basis in the bond (and tax-exempt interest otherwise reportable on Form 1040, line 8b) by the amortization for the year. My free tax Bond premium. My free tax   Bond premium is the amount by which your basis in the bond right after you get it is more than the total of all amounts payable on the bond after you get it (other than payments of qualified stated interest). My free tax For example, a bond with a maturity value of $1,000 generally would have a $50 premium if you buy it for $1,050. My free tax Special rules to determine amounts payable on a bond. My free tax   For special rules that apply to determine the amounts payable on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. My free tax 171-3. My free tax Basis. My free tax   In general, your basis for figuring bond premium amortization is the same as your basis for figuring any loss on the sale of the bond. My free tax However, you may need to use a different basis for: Convertible bonds, Bonds you got in a trade, and Bonds whose basis has to be determined using the basis of the person who transferred the bond to you. My free tax See Regulations section 1. My free tax 171-1(e). My free tax Dealers. My free tax   A dealer in taxable bonds (or anyone who holds them mainly for sale to customers in the ordinary course of a trade or business or who would properly include bonds in inventory at the close of the tax year) cannot claim a deduction for amortizable bond premium. My free tax   See section 75 of the Internal Revenue Code for the treatment of bond premium by a dealer in tax-exempt bonds. My free tax How To Figure Amortization For bonds issued after September 27, 1985, you must amortize bond premium using a constant yield method on the basis of the bond's yield to maturity, determined by using the bond's basis and compounding at the close of each accrual period. My free tax Constant yield method. My free tax   Figure the bond premium amortization for each accrual period as follows. My free tax Step 1: Determine your yield. My free tax   Your yield is the discount rate that, when used in figuring the present value of all remaining payments to be made on the bond (including payments of qualified stated interest), produces an amount equal to your basis in the bond. My free tax Figure the yield as of the date you got the bond. My free tax It must be constant over the term of the bond and must be figured to at least two decimal places when expressed as a percentage. My free tax   If you do not know the yield, consult your broker or tax advisor. My free tax Databases available to them are likely to show the yield at the date of purchase. My free tax Step 2: Determine the accrual periods. My free tax   You can choose the accrual periods to use. My free tax They may be of any length and may vary in length over the term of the bond, but each accrual period can be no longer than 1 year and each scheduled payment of principal or interest must occur either on the first or the final day of an accrual period. My free tax The computation is simplest if accrual periods are the same as the intervals between interest payment dates. My free tax Step 3: Determine the bond premium for the accrual period. My free tax   To do this, multiply your adjusted acquisition price at the beginning of the accrual period by your yield. My free tax Then subtract the result from the qualified stated interest for the period. My free tax   Your adjusted acquisition price at the beginning of the first accrual period is the same as your basis. My free tax After that, it is your basis decreased by the amount of bond premium amortized for earlier periods and the amount of any payment previously made on the bond other than a payment of qualified stated interest. My free tax Example. My free tax On February 1, 2012, you bought a taxable bond for $110,000. My free tax The bond has a stated principal amount of $100,000, payable at maturity on February 1, 2019, making your premium $10,000 ($110,000 − $100,000). My free tax The bond pays qualified stated interest of $10,000 on February 1 of each year. My free tax Your yield is 8. My free tax 07439% compounded annually. My free tax You choose to use annual accrual periods ending on February 1 of each year. My free tax To find your bond premium amortization for the accrual period ending on February 1, 2013, you multiply the adjusted acquisition price at the beginning of the period ($110,000) by your yield. My free tax When you subtract the result ($8,881. My free tax 83) from the qualified stated interest for the period ($10,000), you find that your bond premium amortization for the period is $1,118. My free tax 17. My free tax Special rules to figure amortization. My free tax   For special rules to figure the bond premium amortization on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. My free tax 171-3. My free tax Bonds Issued Before September 28, 1985 For these bonds, you can amortize bond premium using any reasonable method. My free tax Reasonable methods include: The straight-line method, and The Revenue Ruling 82-10 method. My free tax Straight-line method. My free tax   Under this method, the amount of your bond premium amortization is the same each month. My free tax Divide the number of months you held the bond during the year by the number of months from the beginning of the tax year (or, if later, the date of acquisition) to the date of maturity or earlier call date. My free tax Then multiply the result by the bond premium (reduced by any bond premium amortization claimed in earlier years). My free tax This gives you your bond premium amortization for the year. My free tax Revenue Ruling 82-10 method. My free tax   Under this method, the amount of your bond premium amortization increases each month over the life of the bond. My free tax This method is explained in Revenue Ruling 82-10, 1982-1 C. My free tax B. My free tax 46. My free tax Choosing To Amortize You choose to amortize the premium on taxable bonds by reporting the amortization for the year on your income tax return for the first tax year you want the choice to apply. My free tax You should attach a statement to your return that you are making this choice under section 171. My free tax See How To Report Amortization, next. My free tax This choice is binding for the year you make it and for later tax years. My free tax It applies to all taxable bonds you own in the year you make the choice and also to those you acquire in later years. My free tax You can change your decision to amortize bond premium only with the written approval of the IRS. My free tax To request approval, use Form 3115. My free tax For more information on requesting approval, see section 5 of the Appendix to Revenue Procedure 2011-14 in Internal Revenue Bulletin 2011-4. My free tax You can find Revenue Procedure 2011-14 at www. My free tax irs. My free tax gov/irb/2011-04_IRB/ar08. My free tax html. My free tax How To Report Amortization Subtract the bond premium amortization from your interest income from these bonds. My free tax Report the bond's interest on Schedule B (Form 1040A or 1040), line 1. My free tax Under your last entry on line 1, put a subtotal of all interest listed on line 1. My free tax Below this subtotal, print “ABP Adjustment,” and the total interest you received. My free tax Subtract this amount from the subtotal, and enter the result on line 2. My free tax Bond premium amortization more than interest. My free tax   If the amount of your bond premium amortization for an accrual period is more than the qualified stated interest for the period, you can deduct the difference as a miscellaneous itemized deduction on Schedule A (Form 1040), line 28. My free tax    But your deduction is limited to the amount by which your total interest inclusions on the bond in prior accrual periods is more than your total bond premium deductions on the bond in prior periods. My free tax Any amount you cannot deduct because of this limit can be carried forward to the next accrual period. My free tax Pre-1998 election to amortize bond premium. My free tax   Generally, if you first elected to amortize bond premium before 1998, the above treatment of the premium does not apply to bonds you acquired before 1988. My free tax Bonds acquired before October 23, 1986. My free tax   The amortization of the premium on these bonds is a miscellaneous itemized deduction not subject to the 2%-of-adjusted-gross-income limit. My free tax Bonds acquired after October 22, 1986, but before 1988. My free tax    The amortization of the premium on these bonds is investment interest expense subject to the investment interest limit, unless you choose to treat it as an offset to interest income on the bond. My free tax Expenses of Producing Income You deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Schedule A (Form 1040). My free tax To be deductible, these expenses must be ordinary and necessary expenses paid or incurred: To produce or collect income, or To manage property held for producing income. My free tax The expenses must be directly related to the income or income-producing property, and the income must be taxable to you. My free tax The deduction for most income-producing expenses is subject to a 2% limit that also applies to certain other miscellaneous itemized deductions. My free tax The amount deductible is limited to the total of these miscellaneous deductions that is more than 2% of your adjusted gross income. My free tax For information on how to report expenses of producing income, see How To Report Investment Expenses , later. My free tax Attorney or accounting fees. My free tax   You can deduct attorney or accounting fees that are necessary to produce or collect taxable income. My free tax However, in some cases, attorney or accounting fees are part of the basis of property. My free tax See Basis of Investment Property in chapter 4. My free tax Automatic investment service and dividend reinvestment plans. My free tax   A bank may offer its checking account customers an automatic investment service so that, for a charge, each customer can choose to invest a part of the checking account each month in common stock. My free tax Or a bank that is a dividend disbursing agent for a number of publicly-owned corporations may set up an automatic dividend reinvestment service. My free tax Through that service, cash dividends are reinvested in more shares of stock after the bank deducts a service charge. My free tax   A corporation in which you own stock also may have a dividend reinvestment plan. My free tax This plan lets you choose to use your dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash. My free tax   You can deduct the monthly service charge you pay to a bank to participate in an automatic investment service. My free tax If you participate in a dividend reinvestment plan, you can deduct any service charge subtracted from your cash dividends before the dividends are used to buy more shares of stock. My free tax Deduct the charges in the year you pay them. My free tax Clerical help and office rent. My free tax   You can deduct office expenses, such as rent and clerical help, you incurred in connection with your investments and collecting the taxable income on your investments. My free tax Cost of replacing missing securities. My free tax   To replace your taxable securities that are mislaid, lost, stolen, or destroyed, you may have to post an indemnity bond. My free tax You can deduct the premium you pay to buy the indemnity bond and the related incidental expenses. My free tax   You may, however, get a refund of part of the bond premium if the missing securities are recovered within a specified time. My free tax Under certain types of insurance policies, you can recover some of the expenses. My free tax   If you receive the refund in the tax year you pay the amounts, you can deduct only the difference between the expenses paid and the amount refunded. My free tax If the refund is made in a later tax year, you must include the refund in income in the year you received it, but only to the extent that the expenses decreased your tax in the year you deducted them. My free tax Fees to collect income. My free tax   You can deduct fees you pay to a broker, bank, trustee, or similar agent to collect investment income, such as your taxable bond or mortgage interest, or your dividends on shares of stock. My free tax Fees to buy or sell. My free tax   You cannot deduct a fee you pay to a broker to acquire investment property, such as stocks or bonds. My free tax You must add the fee to the cost of the property. My free tax See Basis of Investment Property in chapter 4. My free tax    You cannot deduct any broker's fees, commissions, or option premiums you pay (or that were netted out) in connection with the sale of investment property. My free tax They can be used only to figure gain or loss from the sale. My free tax See Reporting Capital Gains and Losses , in chapter 4, for more information about the treatment of these sale expenses. My free tax Investment counsel and advice. My free tax   You can deduct fees you pay for counsel and advice about investments that produce taxable income. My free tax This includes amounts you pay for investment advisory services. My free tax Safe deposit box rent. My free tax   You can deduct rent you pay for a safe deposit box if you use the box to store taxable income-producing stocks, bonds, or other investment-related papers and documents. My free tax If you also use the box to store tax-exempt securities or personal items, you can deduct only part of the rent. My free tax See Tax-exempt income under Nondeductible Expenses, later, to figure what part you can deduct. My free tax State and local transfer taxes. My free tax   You cannot deduct the state and local transfer taxes you pay when you buy or sell securities. My free tax If you pay these transfer taxes when you buy securities, you must treat them as part of the cost of the property. My free tax If you pay these transfer taxes when you sell securities, you must treat them as a reduction in the amount realized. My free tax Trustee's commissions for revocable trust. My free tax   If you set up a revocable trust and have its income distributed to you, you can deduct the commission you pay the trustee for managing the trust to the extent it is to produce or collect taxable income or to manage property. My free tax However, you cannot deduct any part of the commission used for producing or collecting tax-exempt income or for managing property that produces tax-exempt income. My free tax   If you are a cash-basis taxpayer and pay the commissions for several years in advance, you must deduct a part of the commission each year. My free tax You cannot deduct the entire amount in the year you pay it. My free tax Investment expenses from pass-through entities. My free tax   If you hold an interest in a partnership, S corporation, real estate mortgage investment conduit (REMIC), or a nonpublicly offered mutual fund, you can deduct your share of that entity's investment expenses. My free tax A partnership or S corporation will show your share of these expenses on your Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S). My free tax A nonpublicly offered mutual fund will indicate your share of these expenses in box 5 of Form 1099-DIV (or substitute statement). My free tax Publicly-offered mutual funds are discussed later. My free tax   If you hold an interest in a REMIC, any expenses relating to your residual interest investment will be shown on Schedule Q (Form 1066), line 3b. My free tax Any expenses relating to your regular interest investment will appear in box 5 of Form 1099-INT (or substitute statement) or box 9 of Form 1099-OID (or substitute statement). My free tax   Report your share of these investment expenses on Schedule A (Form 1040), subject to the 2% limit, in the same manner as your other investment expenses. My free tax Including mutual fund or REMIC expenses in income. My free tax   Your share of the investment expenses of a REMIC or a nonpublicly offered mutual fund, as described above, are considered to be indirect deductions through that pass-through entity. My free tax You must include in your gross income an amount equal to the expenses allocated to you, whether or not you are able to claim a deduction for those expenses. My free tax If you are a shareholder in a nonpublicly offered mutual fund, you must include on your return the full amount of ordinary dividends or other distributions of stock, as shown in box 1a of Form 1099-DIV (or substitute statement). My free tax If you are a residual interest holder in a REMIC, you must report as ordinary income on Schedule E (Form 1040) the total amounts shown on Schedule Q (Form 1066), lines 1b and 3b. My free tax If you are a REMIC regular interest holder, you must include the amount of any expense allocation you received on Form 1040, line 8a. My free tax Publicly-offered mutual funds. My free tax   Most mutual funds are publicly offered. My free tax These mutual funds, generally, are traded on an established securities exchange. My free tax These funds do not pass investment expenses through to you. My free tax Instead, the dividend income they report to you in box 1a of Form 1099-DIV (or substitute statement) is already reduced by your share of investment expenses. My free tax As a result, you cannot deduct the expenses on your return. My free tax   Include the amount from box 1a of Form 1099-DIV (or substitute statement) in your income. My free tax    A publicly offered mutual fund is one that: Is continuously offered pursuant to a public offering, Is regularly traded on an established securities market, and Is held by or for no fewer than 500 persons at any time during the year. My free tax Contact your mutual fund if you are not sure whether it is publicly offered. My free tax Nondeductible Expenses Some expenses that you incur as an investor are not deductible. My free tax Stockholders' meetings. My free tax   You cannot deduct transportation and other expenses you pay to attend stockholders' meetings of companies in which you have no interest other than owning stock. My free tax This is true even if your purpose in attending is to get information that would be useful in making further investments. My free tax Investment-related seminar. My free tax   You cannot deduct expenses for attending a convention, seminar, or similar meeting for investment purposes. My free tax Single-premium life insurance, endowment, and annuity contracts. My free tax   You cannot deduct interest on money you borrow to buy or carry a single-premium life insurance, endowment, or annuity contract. My free tax Used as collateral. My free tax   If you use a single premium annuity contract as collateral to obtain or continue a mortgage loan, you cannot deduct any interest on the loan that is collateralized by the annuity contract. My free tax Figure the amount of interest expense disallowed by multiplying the current interest rate on the mortgage loan by the lesser of the amount of the annuity contract used as collateral or the amount of the loan. My free tax Borrowing on insurance. My free tax   Generally, you cannot deduct interest on money you borrow to buy or carry a life insurance, endowment, or annuity contract if you plan to systematically borrow part or all of the increases in the cash value of the contract. My free tax This rule applies to the interest on the total amount borrowed to buy or carry the contract, not just the interest on the borrowed increases in the cash value. My free tax Tax-exempt income. My free tax   You cannot deduct expenses you incur to produce tax-exempt income. My free tax Nor can you deduct interest on money you borrow to buy tax-exempt securities or shares in a mutual fund or other regulated investment company that distributes only exempt-interest dividends. My free tax Short-sale expenses. My free tax   The rule disallowing a deduction for interest expenses on tax-exempt securities applies to amounts you pay in connection with personal property used in a short sale or amounts paid by others for the use of any collateral in connection with the short sale. My free tax However, it does not apply to the expenses you incur if you deposit cash as collateral for the property used in the short sale and the cash does not earn a material return during the period of the sale. My free tax Short sales are discussed in Short Sales in chapter 4. My free tax Expenses for both tax-exempt and taxable income. My free tax   You may have expenses that are for both tax-exempt and taxable income. My free tax If you cannot specifically identify what part of the expenses is for each type of income, you can divide the expenses, using reasonable proportions based on facts and circumstances. My free tax You must attach a statement to your return showing how you divided the expenses and stating that each deduction claimed is not based on tax-exempt income. My free tax   One accepted method for dividing expenses is to do it in the same proportion that each type of income is to the total income. My free tax If the expenses relate in part to capital gains and losses, include the gains, but not the losses, in figuring this proportion. My free tax To find the part of the expenses that is for the tax-exempt income, divide your tax-exempt income by the total income and multiply your expenses by the result. My free tax Example. My free tax You received $6,000 interest; $4,800 was tax-exempt and $1,200 was taxable. My free tax In earning this income, you had $500 of expenses. My free tax You cannot specifically identify the amount of each expense item that is for each income item, so you must divide your expenses. My free tax 80% ($4,800 tax-exempt interest divided by $6,000 total interest) of your expenses is for the tax-exempt income. My free tax You cannot deduct $400 (80% of $500) of the expenses. My free tax You can deduct $100 (the rest of the expenses) because they are for the taxable interest. My free tax State income taxes. My free tax   If you itemize your deductions, you can deduct, as taxes, state income taxes on interest income that is exempt from federal income tax. My free tax But you cannot deduct, as either taxes or investment expenses, state income taxes on other exempt income. My free tax Interest expense and carrying charges on straddles. My free tax   You cannot deduct interest and carrying charges allocable to personal property that is part of a straddle. My free tax The nondeductible interest and carrying charges are added to the basis of the straddle property. My free tax However, this treatment does not apply if: All the offsetting positions making up the straddle either consist of one or more qualified covered call options and the optioned stock, or consist of section 1256 contracts (and the straddle is not part of a larger straddle); or The straddle is a hedging transaction. My free tax  For information about straddles, including definitions of the terms used in this discussion, see Straddles in chapter 4. My free tax   Interest includes any amount you pay or incur in connection with personal property used in a short sale. My free tax However, you must first apply the rules discussed in Payments in lieu of dividends under Short Sales in chapter 4. My free tax   To determine the interest on market discount bonds and short-term obligations that are part of a straddle, you must first apply the rules discussed under Limit on interest deduction for market discount bonds and Limit on interest deduction for short-term obligations (both under Interest Expenses, earlier). My free tax Nondeductible amount. My free tax   Figure the nondeductible interest and carrying charges on straddle property as follows. My free tax Add: Interest on indebtedness incurred or continued to buy or carry the personal property, and All other amounts (including charges to insure, store, or transport the personal property) paid or incurred to carry the personal property. My free tax Subtract from the amount in (1): Interest (including OID) includible in gross income for the year on the personal property, Any income from the personal property treated as ordinary income on the disposition of short-term government obligations or as ordinary income under the market discount and short-term bond provisions — see Discount on Debt Instruments in chapter 1, The dividends includible in gross income for the year from the personal property, and Any payment on a loan of the personal property for use in a short sale that is includible in gross income. My free tax Basis adjustment. My free tax   Add the nondeductible amount to the basis of your straddle property. My free tax How To Report Investment Expenses To deduct your investment expenses, you must itemize deductions on Schedule A (Form 1040). My free tax Enter your deductible investment interest expense on Schedule A (Form1040), line 14. My free tax Include any deductible short sale expenses. My free tax (See Short Sales in chapter 4 for information on these expenses. My free tax ) Also attach a completed Form 4952 if you used that form to figure your investment interest expense. My free tax Enter the total amount of your other investment expenses (other than interest expenses) on Schedule A (Form 1040), line 23. My free tax List the type and amount of each expense on the dotted lines next to line 23. My free tax (If necessary, you can show the required information on an attached statement. My free tax ) For information on how to report amortizable bond premium, see Bond Premium Amortization , earlier in this chapter. My free tax When To Report Investment Expenses If you use the cash method to report income and expenses, you generally deduct your expenses, except for certain prepaid interest, in the year you pay them. My free tax If you use an accrual method, you generally deduct your expenses when you incur a liability for them, rather than when you pay them. My free tax Also see When To Deduct Investment Interest , earlier in this chapter. My free tax Unpaid expenses owed to related party. My free tax   If you use an accrual method, you cannot deduct interest and other expenses owed to a related cash-basis person until payment is made and the amount is includible in the gross income of that person. My free tax The relationship, for purposes of this rule, is determined as of the end of the tax year for which the interest or expense would otherwise be deductible. My free tax If a deduction is denied under this rule, this rule will continue to apply even if your relationship with the person ceases to exist before the amount is includible in the gross income of that person. My free tax   This rule generally applies to those relationships listed in chapter 4 under Related Party Transactions . My free tax It also applies to accruals by partnerships to partners, partners to partnerships, shareholders to S corporations, and S corporations to shareholders. My free tax   The postponement of deductions for unpaid expenses and interest under the related party rule does not apply to OID, regardless of when payment is made. My free tax This rule also does not apply to loans with below-market interest rates or to certain payments for the use of property and services when the lender or recipient has to include payments periodically in income, even if a payment has not been made. My free tax Prev  Up  Next   Home   More Online Publications