42.1 What Property May Be Depreciated?
Depreciation deductions may be claimed only for property used in your business or other income-producing activity. If the primary purpose of the property is to produce income but it fails to yield any income, the property may still be depreciated.
Depreciation may not be claimed on property held for personal purposes such as a personal residence or pleasure car. If property, such as a car, is used both for business and pleasure, only the business portion may be depreciated.
Caution
Nondepreciable assets.
Not all assets used in your business or for the production of income may be depreciable. Land is not depreciable, but the cost of landscaping business property may be depreciated if the landscaping is so closely associated with a building that it would have to be destroyed if the building were replaced. Qualifying trees and bushes are depreciable over 15 years.
Property held primarily for sale to customers or property includible in inventory is not depreciable, regardless of its useful life.
Amortization for business intangibles.
The cost of goodwill, going concern value, and other intangibles including covenants not to compete, information bases, customer lists, franchises, licenses, and trademarks is amortizable over a 15-year period.
The amortization rule generally applies to property acquired after August 10, 1993 (42.17).
Residences.
For depreciation of rented residences, see 9.5. For depreciation of a home office, see 40.13. For depreciation of a sublet cooperative apartment or one used in business, see 40.17.
Farm property.
Farmland is not depreciable; farm machinery and buildings are. Livestock acquired for work, breeding, or dairy purposes and not included in inventory may also be depreciated. For a detailed explanation of the highly technical rules for depreciating farm property and livestock, see IRS Publication 225, Farmer’s Tax Guide.
Dispute over importance of useful life.
According to the Tax Court, under ACRS (1981–86) and current MACRS law, useful life is irrelevant for claiming depreciation if you can show that an asset is subject to exhaustion, wear and tear, or obsolescence. Thus, in the case of antique musical instruments played by professional musicians, depreciation is allowable because of wear and tear, even though the instruments have an indeterminable useful life. Two federal appeals courts have agreed, allowing professional violinists to deduct ACRS depreciation for their instruments.
In a case involving exotic cars that were not used for transportation but for exhibition, MACRS depreciation was allowed because the owner showed that they were subject to obsolescence. The autos were purchased solely for exhibition. The three state-of-the-art autos were a 1987 Lotus Pantera costing $63,000, a Lotus Espirit costing $48,000, and a Ferrari Testarossa costing $290,453. Over a four-year period, the owner deducted depreciation of over $298,000 while reporting gross income from exhibition fees of $96,630. The IRS disallowed the depreciation because the cars had no determinable useful life. The Tax Court allowed the depreciation because such cars are subject to obsolescence in the car-show business when new models appear with newer designs and high-tech features. One witness testified this could occur in some cases within a year.
The Tax Court warned that such exotic cars should not be confused with museum pieces. If they had been museum pieces, such as antique cars, no depreciation would have been allowed. In the case of art objects and antiques used as business assets, the useful life requirement remains relevant because such assets are not subject to exhaustion, wear or tear, or obsolescence.
The IRS may continue to dispute and litigate cases in which depreciation is claimed on assets with indeterminable useful lives. For example, in a private ruling, the IRS did not allow a developer to depreciate street improvements that had been turned over to a city. The improvements were an intangible asset that improved the developer’s access to its real estate projects, but this asset had an unlimited life. There was no determinable useful life because the city had agreed to maintain and replace the improvements as necessary, and there was no evidence that the city would ever assess the developer for replacement costs.
Basis for depreciation.
Generally, the basis of the property on which you figure depreciation is its adjusted basis, which usually is its cost. To determine basis when property is acquired other than by purchase, see 5.16 through 5.20.
If you convert property from personal to business use, the basis for depreciation purposes is the lower of its adjusted basis or its fair market value at the time of the conversion.