Adjusted Gross Income

<div class="Section1">Each year, an individual’s basis is reduced by the amount of the depreciation deduction taken so that his adjusted basis in the property reflects accumulated depreciation deductions. If depreciation is not deducted, his basis must nonetheless be reduced by the amount of depreciation allowable, but the deduction may not be taken in a subsequent year.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <p style="text-align: center;"><strong>Recapture</strong></p><br /> Upon disposition of property, the seller often realizes more than return of basis after it has been reduced for depreciation. Legislative policy is that on certain dispositions of depreciated property the seller realizes a gain that is, at least in part, attributable to depreciation. To prevent a double benefit, the IRC requires that some of the gain that would otherwise generally be capital gain must be treated as ordinary income. In effect, it requires the seller to “recapture” some of the ordinary income earlier offset by the depreciation.<a href="#_ftn2" name="_ftnref2">²</a> In addition, if depreciated property ceases to be used predominantly in a trade or business before the end of its recovery period, the owner must recapture in the tax year of cessation any benefit derived from expensing such property.<a href="#_ftn3" name="_ftnref3">³</a> This provision is effective for property placed in service in tax years ending after January 25, 1993.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 1016(a)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC §§ 1245, 1250.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.179-1(e)(1).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.179-6.<br /> <br /> </div>

<div class="Section1">In order to claim bonus depreciation with respect to used property, the property must not be used by the taxpayer or a predecessor at any time before the taxpayer acquired the property (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>). This requirement raised questions as to whether bonus depreciation could be available with respect to property that the taxpayer previously leased, or in which the taxpayer previously held an interest but did not own entirely. See the heading below for a discussion of the short holding period exception proposed in the 2019 regulations.<div class="Section1"><br /> <br /> Under the regulations, bonus depreciation may now be available for property that a taxpayer previously leased and later acquired. In some situations, a taxpayer may make improvements to property that is leased and obtain a depreciable interest in the property as a result.&nbsp;If the taxpayer later acquires the property, bonus depreciation is unavailable with respect to the portion of the property in which the taxpayer held a depreciable interest during the lease period.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> Relatedly, if a taxpayer originally held a depreciable interest in property, and later acquires an additional depreciable interest in an additional portion of the same property, the additional depreciable interest is not treated as though it was used by the taxpayer prior to acquisition (i.e., it is eligible for bonus depreciation under the used property rules if all other requirements are satisfied). If the taxpayer previously had a depreciable interest in the subsequently acquired additional portion, bonus depreciation is not available. A different rule applies in situations where a taxpayer sells a partial interest in property and later buys a partial interest in the same property. If a taxpayer holds a depreciable interest in a portion of the property, sells that portion or a part of that portion, and later acquires a depreciable interest in another portion of the same property, the taxpayer is treated as previously having a depreciable interest in the property up to the amount of the portion for which the taxpayer held a depreciable interest in the property before the sale.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Under the 2019 regulations, the mere fact that a business leases property to a disqualified business (i.e., one that does not qualify to use bonus depreciation, such as certain businesses with floor plan financing interest) does not &ldquo;taint&rdquo; the property, meaning that such exclusion from the additional first year depreciation deduction does not apply to lessors of property to a trade or business described in IRC Section 168(k)(9) so long as the lessor is not described the section.<a href="#_ftn3" name="_ftnref3">³</a><br /> <p style="text-align: center;"><strong>Short Holding Period Exception</strong></p><br /> The 2019 regulations provide an exception to the depreciable interest rule in situations where the taxpayer disposes of the property within a short period of time after placing the property in service. If the following are true:<br /> <p style="padding-left: 40px;">(a)a taxpayer acquires and places in service property,</p><br /> <p style="padding-left: 40px;">(b)the taxpayer or a predecessor did not previously have a depreciable interest in the property,</p><br /> <p style="padding-left: 40px;">(c)the taxpayer disposes of the property to an unrelated party within 90 calendar days after the date the property was originally placed in service by the taxpayer (without taking into account the applicable convention), and</p><br /> <p style="padding-left: 40px;">(d)the taxpayer reacquires and again places in service the property, then</p><br /> the taxpayer&rsquo;s depreciable interest in the property during that 90-day period is not taken into account for determining whether the property was used by the taxpayer or a predecessor at any time prior to its reacquisition by the taxpayer.<a href="#_ftn4" name="_ftnref4">⁴</a> The proposed rule does not apply if the taxpayer reacquires and again places in service the property during the same taxable year the taxpayer disposed of the property.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(B)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(B)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;Treas. Reg. &sect; 1.168(k)- 2(b)(2)(ii)(F).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;Prop. Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(B)(4).<br /> <br /> </div></div><br />

<div class="Section1">The bonus depreciation rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>) may be applied to used property if the property was not used by the taxpayer (or a predecessor) prior to the acquisition. The property is considered to have been used by the taxpayer or a predecessor prior to the acquisition if the taxpayer or predecessor had a depreciable interest in the property at any time prior to the acquisition, regardless of whether depreciation deductions were actually claimed.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> Under the 2019 final regulations, &ldquo;predecessor&rdquo; is defined to include (i) a transferor of an asset to a transferee in a transaction to which IRC Section 381(a) applies, (ii) a transferor of an asset to a transferee in a transaction in which the transferee&rsquo;s basis in the asset is determined, in whole or in part, by reference to the basis of the asset in the hands of the transferor, (iii) a partnership that is considered as continuing under IRC Section 708(b)(2), (iv) the decedent in the case of an asset acquired by an estate, or (v) a transferor of an asset to a trust.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Further, all of the following must be true:<br /> <p style="padding-left: 40px;">(1)the property was not acquired from certain related parties, including: (a) the taxpayer&rsquo;s spouse, ancestors and descendants, (b) an individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the individual, (c) a grantor and a fiduciary of any trust, (d) a fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts, (e) a fiduciary and a beneficiary of a trust, (f) a fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts, (g) a fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust, (h) a person and an organization to which IRC Section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual, (i) a corporation and a partnership if the same person owns more than 50 percent of the outstanding stock in the corporation or capital interest or profits of the partnership, (j) an S corporation and another S corporation if the same person owns more than 50 percent of the outstanding stock of each corporation, (k) an S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation, (l) the executor and beneficiary of an estate, (m) two partnerships in which the same person owns more than 50 percent of the capital interests and profits or (n) a partnership and a person owning more than 50 percent of the capital interests and profits of the partnership.</p><br /> <br /> <br /> <hr><br /> <br /> <strong><strong>Planning Point:</strong></strong> The IRS regulations on the bonus depreciation rules contain a general anti-abuse rule that will apply to determine related party status. The rules provide that in a series of related transactions, the property is treated as though it was transferred directly from its original owner to its ultimate owner. The relationship between the original owner and the ultimate owner is tested immediately after the last transfer in the series of transactions. The 2019 final regulations provide for a five-year &ldquo;lookback&rdquo; period in making the determination as to whether the property was previously used by a prohibited party.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <hr><br /> <p style="padding-left: 40px;">(2)the property was not acquired by one member of a controlled group from another member of that group,</p><br /> <p style="padding-left: 40px;">(3)the property was acquired by purchase, within the meaning of IRC Section 179,</p><br /> <p style="padding-left: 40px;">(4)the basis of the property in the hands of the person acquiring it is not determined in whole or part by reference to the adjusted basis of the property in the hands of the person from whom it was acquired or under IRC Section 1014(a) (basis of property acquired from a decedent),</p><br /> <p style="padding-left: 40px;">(5)the cost of the property does not include the basis of the property as determined by reference to the basis of other property held by the taxpayer.<a href="#_ftn4" name="_ftnref4">⁴</a></p><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;Prop. Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(B)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;Treas. Reg. &sect; 1.168(k)-2(a)(2)(iv).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;Prop. Treas. Reg. &sect; 1.168(k)-2(b)(3)(iii)(C).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;IRC &sect;&sect; 168(k)(2)(E)(ii), 267(b), 707(b).<br /> <br /> </div></div><br />

<div class="Section1">Assets that are subject to either the general depreciation system of IRC Section 168(a) or the alternative depreciation system of IRC Section 168(g) may be grouped in one or more general asset accounts. The assets in a particular general asset account are generally depreciable as a single asset. Such an account must include only assets that have the same depreciation method, recovery period, convention, and that are placed in service in the same tax year. An asset may not be included in a general asset account if the asset is used in a personal activity at any time before the end of the tax year in which it was placed in service.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> Upon disposition of an asset from a general asset account, the asset is treated as having an adjusted basis of zero, and the total amount realized on the disposition is generally recognized as ordinary income. However, the ordinary income treatment is limited to the unadjusted basis of the account less amounts previously recognized as ordinary income. The character of the amounts in excess of such ordinary income is determined under other applicable provisions of the IRC (other than IRC Sections 1245 and 1250). Because the basis of the property is considered to be zero, no loss is recognized on such a disposition. Generally, the basis in the account is recoverable only through depreciation, unless the taxpayer disposes of all the assets in the account.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.168(i)-1(c), as modified by T.D. 9564.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.168(i)-1(e).<br /> <br /> </div>

<div class="Section1">An <em>alternative depreciation system</em> is provided for (1) tangible property used predominately outside the United States, (2) tax-exempt use property, (3) tax-exempt bond financed property, (4) certain imported property covered by an executive order regarding countries engaging in unfair trade practices, and (5) property for which an election is made. The election may be made with respect to each property in the case of nonresidential real property and residential rental property. For all other property, the election is made with respect to all property placed in service within a recovery class during a taxable year.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> The alternative depreciation is determined using the straight line method and the applicable convention, above, over the following periods:<a href="#_ftn2" name="_ftnref2">²</a><br /> <table style="height: 344px;" border="1" width="520" align="center"><br /> <tbody><br /> <tr><br /> <td width="218"><br /> <p style="text-align: center;"><strong>tax-exempt use property subject to a lease</strong></p><br /> </td><br /> <td width="201"><br /> <p style="text-align: center;"><strong>longer of 125 percent of lease term or period below</strong></p><br /> </td><br /> </tr><br /> <tr><br /> <td style="text-align: center;" width="218">residential rental property</td><br /> <td style="text-align: center;" width="201"></td><br /> </tr><br /> <tr><br /> <td width="218">and nonresidential real property</td><br /> <td style="text-align: center;" width="201">40 years</td><br /> </tr><br /> <tr><br /> <td width="218">personal property with no class life</td><br /> <td style="text-align: center;" width="201">12 years</td><br /> </tr><br /> <tr><br /> <td style="text-align: center;" width="218">railroad grading or tunnel bore</td><br /> <td style="text-align: center;" width="201">50 years</td><br /> </tr><br /> <tr><br /> <td style="text-align: center;" width="218">all other property</td><br /> <td style="text-align: center;" width="201">the class life</td><br /> </tr><br /> </tbody><br /> </table><br /> TRA ’86 assigns certain property to recovery periods without regard to their class life, e.g., automobiles and light trucks.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 168(g).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 168(g)(2)(C).<br /> <br /> </div>

<div class="Section1"><em>Editor&rsquo;s Note:</em> See Q718-Q722 for a discussion of the bonus depreciation rules.<div class="Section1"><br /> <br /> Generally, the Accelerated Cost Recovery System (ACRS) was modified for property placed in service after 1986. An election could be made to apply the post-1986 ACRS to property that was placed in service between July 31, 1986 and January 1, 1987 (unless such property would have been subject to the anti-churning rules if it had been placed in service after 1986).<a href="#_ftn1" name="_ftnref1">¹</a> If real property is acquired before 1987 and converted from personal use to a depreciable use after 1986, the post-1986 ACRS is to be used.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> The post-1986 ACRS deduction is calculated by applying to the basis of the property either (1) a declining balance method that switches to the straight line method at a time which maximizes the deduction or (2) a straight line method.<a href="#_ftn3" name="_ftnref3">³</a> The initial basis in the property is the basis of the property upon acquisition (usually the cost of the property, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="692">692</a>), reduced by the amount, if any, elected for amortization or an IRC Section 179 deduction (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="725">725</a>), and further reduced by any basis reduction required in connection with taking the investment tax credit (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7893">7893</a>).<a href="#_ftn4" name="_ftnref4">⁴</a> The basis of the property is reduced each year by the amount of the depreciation allowable.<a href="#_ftn5" name="_ftnref5">⁵</a> Optional depreciation tables set out in Revenue Procedure 87-57 may be used in place of the methods above.<a href="#_ftn6" name="_ftnref6">⁶</a> Because land cannot be depreciated, the cost basis of improved land must be allocated between the land and improvements.<a href="#_ftn7" name="_ftnref7">⁷</a> The ACRS deduction is limited in the case of certain automobiles and other &ldquo;listed property&rdquo; placed in service after June 18, 1984. See &ldquo;Limitations,&rdquo; ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="726">726</a>).<br /> <br /> The classification of property by recovery period and depreciation method is as follows:<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td width="157">3 years 200% DB*</td><br /> <td width="382">class life of 4 years or less, certain horses, qualified rent-to-own<br /> property</td><br /> </tr><br /> <tr><br /> <td width="157">5 years 200% DB*</td><br /> <td width="382">class life of more than 4 but less than 10 (e.g., heavy trucks, buses, offshore drilling equipment, most computer and data handling equipment, cattle, helicopters and non-commercial aircraft, automobiles and light trucks)</td><br /> </tr><br /> <tr><br /> <td width="157">7 years 200% DB*</td><br /> <td width="382">class life of 10 or more but less than 16 (e.g., most office furnishings, most agricultural machinery and equipment, theme park structures, most railroad machinery, equipment and track, commercial aircraft), motorsports entertainment complexes, Alaska neutral gas pipelines, property without a class life and not otherwise classified under<br /> TRA &lsquo;86</td><br /> </tr><br /> <tr><br /> <td width="157">10 years 200% DB*</td><br /> <td width="382">class life of 16 or more but less than 20 (e.g., vessels, barges and similar water transportation equipment, petroleum refining equipment)</td><br /> </tr><br /> <tr><br /> <td width="157">15 years 150% DB*</td><br /> <td width="382">class life of 20 or more but less than 25 (e.g., industrial steam and electric generation/distribution systems, cement manufacturing equipment, commercial water transportation equipment (freight or passenger), nuclear power production plants)</td><br /> </tr><br /> <tr><br /> <td width="157">20 years 150% DB*</td><br /> <td width="382">class life of 25 or more (e.g., certain farm buildings, railroad structures and improvements, telephone central office buildings, gas utility production plants and distribution facilities), but excluding real property with class life of 27.5 years or more</td><br /> </tr><br /> <tr><br /> <td width="157">27.5 years straight line</td><br /> <td width="382">residential rental property</td><br /> </tr><br /> <tr><br /> <td width="157">39 years straight line</td><br /> <td width="382">nonresidential real property (class life of 27.5 years or more)</td><br /> </tr><br /> <tr><br /> <td width="157">50 years straight line</td><br /> <td width="382">railroad grading or tunnel bore</td><br /> </tr><br /> <tr><br /> <td colspan="2" width="539">* Declining balance method switching to the straight line method at a time to maximize the deduction. Substitute 150 percent DB for 200% DB if 3-, 5-, 7-, or 10-year property is used in a farming business. An election can be made to use the straight line method instead of the declining balance method. Also, with respect to 3-, 5-, 7-, and 10-year property, an election can be made to use 150 percent DB.</td><br /> </tr><br /> </tbody><br /> </table><br /> Property is assigned to various <em>class lives</em> in Revenue Procedure 87-56.<a href="#_ftn9" name="_ftnref9">⁹</a> These class lives<br /> can also be found in IRS Publication 946. The Tax Reform Act of 1986 assigned certain property to recovery periods without regard to their class life (e.g., automobiles and light trucks).<br /> <br /> Intangible property that is depreciable is subject to special recovery periods. If computer software is depreciable, the deduction is calculated using a straight line method over 36 months.<a href="#_ftn10" name="_ftnref10">¹⁰</a> Computer software acquired after August 10, 1993 is generally depreciable if it:<br /> <ol><br /> <li>is a program designed to cause a computer to perform a desired function, (but generally not a database); and</li><br /> <li>either (a) is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially modified, or (b) is not acquired in a transaction involving the acquisition of assets constituting a trade or business.<a href="#_ftn11" name="_ftnref11">¹¹</a></li><br /> </ol><br /> Certain mortgage servicing rights may be depreciated over 108 months using the straight line method.<a href="#_ftn12" name="_ftnref12">¹²</a><br /> <br /> Certain rights that are not acquired in a transaction involving the acquisition of a trade or business are subject to special rules for depreciation. Depreciation deductions for (1) rights to receive tangible property or services under a contract or a government grant; (2) interests in patents or copyrights; or (3) certain contracts of fixed duration or amount, are to be defined in the regulations.<a href="#_ftn13" name="_ftnref13">¹³</a><br /> <br /> Regulations generally require the amortization of the right to receive property under a contract or government grant by multiplying the basis of the right by a fraction. The numerator of the fraction is the amount of property or services received during the taxable year and the denominator is the total amount to be received under the contract or government grant. For a patent or copyright, the deduction is generally equal to the amount paid during a taxable year if the purchase price is paid on an annual basis as either a fixed amount per use or a fixed percentage of revenue from the patent or copyright, otherwise it is depreciated either ratably over its useful life or by using the income forecast method. The basis of a right to an unspecified amount over a fixed duration of less than fifteen years is amortized ratably over the period of the right.<a href="#_ftn14" name="_ftnref14">¹⁴</a><br /> <br /> In the years in which property is acquired or disposed of, depreciation is limited to the portion of the year in which the property is considered to be held under the following <em>conventions</em>: Residential rental property, nonresidential real property, and railroad grading or tunnel bore are treated as placed in service (or disposed of) on the mid-point of the month in which placed in service (or disposed of). Property, other than such real property, is generally treated as placed in service (or disposed of) on the mid-point of the year in which placed in service.<br /> <br /> However, the mid-quarter convention (instead of the mid-year convention) applies to depreciable property placed in service during the taxable year if the aggregate bases of property placed in service during the last three months of the taxable year exceeds 40 percent of the aggregate bases of property placed in service (or disposed of) during the taxable year (&ldquo;the 40&nbsp;percent test&rdquo;). &ldquo;Aggregate bases&rdquo; is defined as the sum of the depreciable bases of all items of depreciable property taken into account in applying the 40 percent test.<br /> <br /> For taxable years ending after January 30, 1991, property not taken into account in applying the test include the following: (1) real property subject to the mid-month convention (described above), and (2) property placed in service and disposed of in the same taxable year. Conversely, property that would be taken into account in applying the 40 percent test includes: (1) listed property (discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="726">726</a>) placed in service during the taxable year, and (2) property placed in service, disposed of, subsequently reacquired, and again placed in service in the same taxable year (but only the basis of the property on the later of the dates that the property is placed in service is considered).<a href="#_ftn15" name="_ftnref15">¹⁵</a> The IRS provided some relief from the mid-quarter convention if a taxpayer&rsquo;s third or fourth quarter included September 11, 2001.<a href="#_ftn16" name="_ftnref16">¹⁶</a><br /> <br /> Regardless of whether the mid-year convention or the mid-quarter convention applies, no depreciation deduction is available for property placed in service and disposed of in the same year.<a href="#_ftn17" name="_ftnref17">¹⁷</a><br /> <br /> Property subject to the mid-month convention is treated as placed in service (or disposed of) on the mid-point of the month without regard to whether the taxpayer has a short taxable year (i.e., a taxable year that is less than 12 months). The mid-quarter 40 percent test is also made without regard to the length of the taxable year. Thus, if property (with exceptions, as noted in the preceding paragraphs) is placed in service in a taxable year of three months or less, the mid-quarter convention applies regardless of when such property was placed in service (i.e., 100 percent of property has been placed in service in the last three months).<a href="#_ftn18" name="_ftnref18">¹⁸</a><br /> <br /> In the case of a short taxable year and with respect to property to which the mid-year or mid-quarter convention applies, the recovery allowance is determined by multiplying the deduction that would have been allowable if the recovery year were not a short taxable year by a fraction, the numerator of which equals the number of months in the short taxable year and the denominator of which is 12.<a href="#_ftn19" name="_ftnref19">¹⁹</a> Proposed regulations under IRC Section 168(f)(5) (as in effect prior to TRA &rsquo;86) provided that a taxable year of a person placing property in service did not include any month prior to the month in which the person began engaging in a trade or business or holding recovery property for the production of income.<a href="#_ftn20" name="_ftnref20">²⁰</a> Presumably, this principle would continue to apply after TRA &rsquo;86.<br /> <p style="text-align: center;"><strong>Unit of Production Method</strong></p><br /> Instead of using ACRS, a property owner may elect to use the unit of production method of depreciation (if appropriate) or any other method not expressed in a term of years.<a href="#_ftn21" name="_ftnref21">²¹</a> For example, under the unit of production method, the depreciation deduction for a machine that, it is estimated, will produce 1,000,000 shoes (units) before wearing out, and that produces 250,000 units in the first year, would be:<br /> <p style="text-align: center;">(250,000 &divide; 1,000,000) &times; basis</p><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp;TRA &rsquo;86, &sect; 203(a)(1)(B), as amended by TAMRA &rsquo;88, &sect; 1002(c)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp;TAMRA &rsquo;88, &sect; 1002(c)(3).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp;IRC &sect; 168(b).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp;IRC &sect; 50(c)(1); Treas. Reg. &sect; 1.179-1(f)(1).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp;&nbsp;&nbsp;IRC &sect; 1016(a)(2).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp;&nbsp;&nbsp;Rev. Proc. 87-57, 1987-2 CB 687.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp;&nbsp;&nbsp;Treas. Reg. &sect; 1.167(a)-5.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;&nbsp;&nbsp;&nbsp;IRC &sect;&sect; 168(c), 168(e), Rev. Proc. 87-57, above.<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp;&nbsp;&nbsp;&nbsp;1987-2 CB 674.<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp;&nbsp;IRC &sect; 167(f)(1).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp;&nbsp;IRC &sect;&sect; 167(f)(1), 197(e)(3)(B).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.&nbsp;&nbsp;IRC &sect; 167(f)(3).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.&nbsp;&nbsp;IRC &sect; 167(f)(2).<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>.&nbsp;&nbsp;Treas. Reg. &sect; 1.167(a)-14(c).<br /> <br /> <a href="#_ftnref15" name="_ftn15">15</a>.&nbsp;&nbsp;IRC &sect; 168(d); Treas. Reg. &sect; 1.168(d)-1.<br /> <br /> <a href="#_ftnref16" name="_ftn16">16</a>.&nbsp;&nbsp;Notice 2001-74, 2001-2 CB 551.<br /> <br /> <a href="#_ftnref17" name="_ftn17">17</a>.&nbsp;&nbsp;Treas. Reg. &sect; 1.168(d)-1(b)(3)(ii).<br /> <br /> <a href="#_ftnref18" name="_ftn18">18</a>.&nbsp;&nbsp;Rev. Proc. 89-15, 1989-1 CB 816.<br /> <br /> <a href="#_ftnref19" name="_ftn19">19</a>.&nbsp;&nbsp;Rev. Proc. 89-15, 1989-1 CB 816.<br /> <br /> <a href="#_ftnref20" name="_ftn20">20</a>.&nbsp;&nbsp;Prop. Treas. Reg. &sect; 1.168-2(f)(4).<br /> <br /> <a href="#_ftnref21" name="_ftn21">21</a>.&nbsp; IRC &sect; 168(f)(1).<br /> <br /> </div></div><br />

<div class="Section1">The CARES Act provided retroactive relief for many business owners, including fixing the so-called “retail glitch” to allow businesses to take advantage of 100 percent bonus depreciation on qualified improvement property.<a href="#_ftn1" name="_ftnref1">¹</a> The CARES Act retroactively reduced the recovery period for qualified improvement property placed in service after 2017 from 39 years to 15 years. Eligible taxpayers could seek a refund. Corporate taxpayers should also examine the interaction between the depreciation relief and the CARES Act NOL carryback relief.</div><br /> <div class="Section1"><br /> <br /> The IRS has provided guidance on how to make, revoke or withdraw elections relating to the CARES Act bonus depreciation rule changes. Because of the administrative burden of filing amended returns and average accounting returns (AARs), the IRS treated late or revocable elections for property placed in service by taxpayers during their 2018, 2019, or 2020 taxable years, as a change in method of accounting with a Section 481(a) adjustment for a limited period of time. As a result, taxpayers could generally make, revoke or withdraw elections with respect to bonus depreciation by filing an amended tax return, AAR or Form 3115 (with the taxpayer’s federal income tax return or Form 1065). The action was treated as changing from an impermissible method of determining depreciation to a permissible method. Returns or forms generally had to be filed by October 15, 2021. This amended return or AAR was required to include the adjustment to taxable income for the change in determining depreciation of the qualified improvement property and any collateral adjustments to taxable income or to tax liability.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> These election methods did not apply to certain farming businesses or electing real property businesses, who were required to make elections under the procedures in Revenue Procedure 2020-22. Partnerships subject to the partnership audit rules used the procedures in Revenue Procedure 2020-23.<br /> <br /> Revenue Procedure 2020-23 provided relief so that partnerships subject to the new partnership audit rules could also file amended returns, rather than waiting to file current year returns to claim the benefits. Preexisting law might have prevented partnerships from filing amended Forms 1065 and Schedules K-1.<a href="#_ftn3" name="_ftnref3">³</a> Partnerships could file amended returns and issue revised Schedules K-1 for 2018 and 2019 to take advantage of retroactive CARES Act bonus depreciation relief.<br /> <br /> The Revenue Procedure 2020-23 relief applied for 2018 and 2019 as long as the original Forms 1065 and Schedules K-1 were filed/issued before April 13, 2020 (the date Rev. Proc. 2020-23 was released). Partnerships could file amended Form 1065 and Schedule K-1 (electronically or by mail), by checking the Form 1065 “amended return” box and writing “FILED PURSUANT TO REV PROC 2020-23” at the top. The same notation was required to be included in a statement attached to amended Schedules K-1 sent to partners. The amended returns had to be filed/furnished to partners by September 30, 2020.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC §§ 168(e)(3)(E)(vii), 168(g), as amended by the 2020 CARES Act.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. Rev. Proc. 2020-25.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. The Bipartisan Budget Act of 2015 limited the circumstances under which some partnerships were permitted to amend these documents. Instead, partnerships would have been required to file an administrative adjustment request under IRC Section 6227, so that partners would not have received relief until filing returns for the current tax year. The deadline for filing an administrative adjustment request was October 15, 2021.<br /> <br /> </div>

<div class="Section1"><br /> <br /> Depreciation is a deduction that permits recovery, over a period of time, of capital invested in tangible property used in a trade or business or held for the production of income.<a href="#_ftn1" name="_ftnref1">¹</a> It is a deduction taken in arriving at adjusted gross income.<a href="#_ftn2" name="_ftnref2">²</a> Only property that has a limited useful life may be depreciated. Land does not have a limited life and, therefore, cannot be depreciated. However, the improvements on land can be depreciated. Inventory and stock in trade are not depreciable.<a href="#_ftn3" name="_ftnref3">³</a> A taxpayer who purchases a term interest in property cannot amortize or depreciate the cost of the property during any period in which the remainder interest is held by a related person. This rule is effective for interests created or acquired after July 27, 1989, in taxable years ending after such date.<a href="#_ftn4" name="_ftnref4">⁴</a> However, life tenants and beneficiaries of estates and trusts may be allowed the regular depreciation deduction if the property is depreciable property.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> The method used to determine the rate of depreciation depends on when the property was placed into service. Property is “placed into service” when it is first placed in a condition or state of readiness and availability for a specifically assigned function for use in a trade or business, for the production of income, or in a tax-exempt or personal activity.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC §§ 167(a), 168(a), as amended by the CARES Act.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC §§ 62(a)(1), 62(a)(4).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.167(a)-2.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 167(e).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 167(d).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. Prop. Treas. Reg. § 1.168-2(l)(2).<br /> <br /> </div>

<div class="Section1">The proposed bonus depreciation regulations clarify when bonus depreciation will be available in the context of a partnership buyout. Availability under the regulations depends upon whether the partnership itself buys out the departing partner in a redemption-type buyout, or whether the individual partners buy out the partner in a cross-purchase type buyout.</div><br /> <div class="Section1"><br /> <br /> If the partnership redeems the departing partner’s interest in partnership assets at a premium, so that the basis in the relevant assets increases, bonus depreciation is not available. This is because the IRS views a redemption-type buyout as a transaction in which the partnership previously had an interest in the assets in question, rendering the assets ineligible for used asset treatment under Section 168(k).<br /> <br /> If the individual partners buy out the departing partner at a premium, resulting in an increase in basis, the “step up” in basis is eligible for bonus depreciation. This is because the IRS views each partner as owning a separate and divided interest in the partnership property owned by the partnership, so that one partner does not have a previously existing interest in another partner’s share of partnership assets.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Prop. Treas. Reg. § 1.168(k)-2(b)(3)(iii)(D). <em><em>See also</em></em> IRC §§ 743, 734.<br /> <br /> </div>

<div class="Section1"><em>Editor’s Note:</em> The 2017 tax reform legislation suspended the personal exemption and dependency exemption for tax years beginning after December 31, 2017 and the 2025 OBBB made this change permanent.  For qualified disability trusts and all other relevant IRC provisions, the “deemed personal exemption amount” for $5,100 for 2025, $5,000 for 2024, $4,700 in 2023, $4,400 in 2022, $4,300 in 2020-2021, $4,200 in 2019 and $4,150 in 2018.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> In tax years beginning prior to 2018, the following rules applied: In the case of divorced parents who between them provide more than one-half of a child’s support for the calendar year, and have custody of the child for more than one-half of the calendar year, the custodial parent (i.e., the one having custody for the greater portion of the year) is generally allowed the dependency exemption. However, the noncustodial parent can claim the exemption if the custodial parent signs a written declaration (i.e., Form 8332, or a statement conforming to the substance of Form 8332) agreeing not to claim the child as a dependent, <em>and</em> the noncustodial parent attaches the declaration to the tax return for the calendar year. The noncustodial parent can also claim the exemption if a divorce decree or separation agreement executed before 1985 expressly provides such and he provides at least $600 for the support of the child during the calendar year.<a href="#_ftn2" name="_ftnref2">²</a> The Tax Court held that the special support rule under IRC Section 152(e) applies to parents who have never been married as well as divorced parents.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> The Service has clarified that a custodial parent may revoke the release of the dependency exemption and, therefore, claim the dependency exemption himself, but only if the noncustodial parent agrees and does not claim the child.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> In <em>Miller v. Comm.</em>,<a href="#_ftn5" name="_ftnref5">⁵</a> the Tax Court denied the dependency exemption to the noncustodial parent where the custodial parent had not signed a release of the claim to the exemption. The court order, which gave the noncustodial parent the right to claim the exemption, was held not to be a valid substitute.<br /> <br /> In <em>Boltinghouse v. Comm.</em>,<a href="#_ftn6" name="_ftnref6">⁶</a> the Tax Court held that there is no requirement in IRC Section 152(e) or the regulations that a spouse’s waiver of his claim to a dependency exemption deduction be incorporated into a divorce decree to be effective. The court stated that such a requirement would make Form 8332 itself ineffective on its own. The court also recognized that under the applicable state law (Delaware), the separation agreement created binding contractual obligations that did not cease upon the entry of a divorce decree (regardless of whether the agreement was merged or incorporated into the decree).<br /> <br /> In <em>Omans v. Comm.</em>,<a href="#_ftn7" name="_ftnref7">⁷</a> the Tax Court determined that the custodial parent’s certified signature on the settlement agreement signified her sworn agreement to the settlement agreement’s contents, including her former spouse’s entitlement to the dependency exemption.<br /> <br /> A state appeals court held that federal law does not preempt a state family law court in its discretion from alternating the dependency exemption between the parents, even though one parent may have custody during the calendar year for less than half the year.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> The IRS has provided interim guidance under IRC Section 152(c)(4), which is the rule for determining which taxpayer may claim a qualifying child when two or more taxpayers claim the same child. It clarifies that unless the special rule in IRC Section 152(e) applies (see above), the tie-breaking rule in IRC Section 152(c)(4) applies to the head of household filing status, the child and dependent care credit, the child tax credit, the earned income credit, the exclusion for dependent care assistance, and the dependency deduction as a group, rather than on a section-by-section basis.<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 642(b)(2)(C)(iii), Rev. Proc. 2018-57, Rev. Proc. 2019-44, Rev. Proc. 2020-45, Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34, Rev. Proc. 2024-40.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC §§ 152(e)(1), 152(e)(2); Treas. Reg. § 1.152-4.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. <em>King v. Commissioner</em>, 121 TC 245 (2003). <em><em>See also</em></em> Preamble, REG-149856-03, 72 Fed. Reg. 24192, 24194 (May 2, 2007).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRS CCA 200007031.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. 114 TC 184 (2000).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. TC Memo 2003-134.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>. TC Summary Opinion 2005-110.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>. <em>Rios v. Pulido</em>, 2002 Cal. App. LEXIS 4412 (2d Dist. 2002).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>. Notice 2006-86, 2006-51 IRB 680.<br /> <br /> </div>