How to Depreciate Property When Use Changes (Reg. § 1.168(i)-4)
Sometimes, taxpayers decide to use a property for a different purpose over the course of a tax year. A residential space may be converted into a business, for example.
The Modified Accelerated Cost Recovery System (MACRS) provides rules for how the IRS requires people to depreciate property when use changes. Find important information about this tax toptic below.
Personal-Use Property Converted to Business or Income-Producing Use
(e.g., personal residence converted to rental property) would be:
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Treated as placed in service on the conversion date;,
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Subject to the MACRS (Code Sec. 168) depreciation method;,
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Subject to recovery period and placed-in-service convention applicable to the property beginning in the tax year of the conversion.,
The property's depreciable basis in the change year would be the lesser of:
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Its fair market value, or,
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Adjusted depreciable basis when it is converted.,
These rules don’t apply when another section of the Code prescribes a specific depreciation treatment for a change to business use, such as under the rules for listed property.
Business Use Property Converted to Personal or Investment Use
The conversion of MACRS property from business or income-producing use to personal use would be treated as a disposition, with depreciation for the conversion year computed by applying the applicable convention. However, the conversion wouldn't result in gain, loss or depreciation recapture (except for recapture under § 280F(b)(2) of excess depreciation upon conversion of listed property to personal use). (Reg § 1.168(i)-4(c))
Use Changes in MACRS Property After Placed-In-Service Year
e.g., a taxpayer may change commercial rental property to residential rental property or vice versa.
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Generally, MACRS depreciation for the change year would be determined as though the change occurred on the first day of that year. (Reg § 1.168(i)-4(d)(2)(iii))
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Shorter Recovery Period – For changes resulting in a shorter recovery period or a faster depreciation method, the property's adjusted depreciable basis as of the beginning of the change year would be depreciated over the shorter recovery period and/or by the faster depreciation method beginning with the year of change as though the property were first placed in service in that year. (Reg § 1.168(i)-4(d)(3)(i)(A))
Where the change results in a shorter recovery period, this rule would require a taxpayer to depreciate the property over the new shorter recovery period even if the remaining portion of the original longer recovery period is less than the new shorter recovery period. To avoid this adverse effect, taxpayers could elect on timely filed returns (including extensions) to continue to depreciate the property as though the change in use had not occurred. The election is made by claiming the depreciation deduction as though no change of use had occurred. (Reg § 1.168(i)-4(d)(3)(ii))
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Longer Recovery Period – If a longer recovery period and/or slower depreciation results from a use change, the property's adjusted depreciable basis as of the beginning of the change year is depreciated over the remaining portion of the new, longer recovery period as of the beginning of the year of change. (Reg § 1.168(i)-4(d)(4))
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Using Optional MACRS Tables - A taxpayer that had been using the optional MACRS depreciation tables from the time the property was first placed in service would be allowed (but not required) to continue using the tables after the change in use. The regs provide guidance on how to modify the calculations. (Reg § 1.168(i)-4(d)(5))
Use Changes During Placed-In-Service Year
The depreciation allowance will generally be determined by the primary use of the property during that tax year, determined in any reasonable manner that is consistently applied to the taxpayer's MACRS property. (Reg § 1.168(i)-4(e))