When you buy real property (or personal property that lasts more than one year) to use in your business, you may have up to three options for deducting the cost:
- Regular depreciation
- Bonus depreciation
- IRC Section 179 expensing (technically, depreciation in advance)
Regular depreciation takes several years.
Bonus depreciation allows you, through 2022, to deduct 100 percent of the cost of personal property in one year.
IRC Section 179 expensing allows you to deduct up to $1,050,000 of the cost of personal property.
As we explain in this article, various rules govern what year your deduction begins—and if you use regular depreciation, what month it begins.
Rule 1: You Must Be in Business to Claim Depreciation
To claim depreciation, you must place the property in service in an active trade or business.1
If you purchase property with the intent of beginning a new business, no depreciation is allowed until the year the business actually begins.
For example, a taxpayer who purchases equipment for a restaurant cannot claim depreciation until the following year when the restaurant opens for business.2
A business begins for tax purposes when it starts to function as a going concern and performs the activities for which it was organized.3 Earning revenue isn’t necessarily required for a business to begin.
- You begin a service business such as accounting, consulting, financial planning, law, medicine, or dentistry when you first offer your services to the public.4
- You begin a retail business that sells tangible products to customers when your business is ready to offer its product for sale to the public.5
- You begin a manufacturing or other production-related business when it starts using its assets to produce saleable products. The products don’t have to be completed, nor do sales have to be solicited or made.6
- You begin a rental property business when you have the rental ready for occupancy.7
If you buy an existing business, depreciation begins for tax purposes when the purchase is completed—that is, when you take ownership.8
Rule 2: Depreciation Begins When Property Is Placed in Service
Depreciation doesn’t necessarily begin the year you purchase property for your business. Rather, it begins the year the property you purchase is placed in service in your active business.9 You place property in service when it is ready and available for a specific use in your business.10
But you don’t have to actually use the property to place it in service. It just has to be ready and available for its specific use. Here are some examples from the IRS.
Machinery is placed in service when it is delivered and ready for use in your business. You don’t have to actually use it.
Example. Donald Steep bought a machine for his business. The machine was delivered last year. But it was not installed and operational until this year.
Tax rules consider the machine to be placed in service this year. If the machine had been ready and available for use when it was delivered, the IRS would consider the machine placed in service last year even though it was not actually used until this year.11
A rental property is placed in service the day it is ready for occupancy and listed for rent. It doesn’t have to be rented.
Example. On April 6, Sue Thorn bought a house to use as residential rental property. She made several repairs and had it ready for rent on July 5. At that time, she began to advertise it for rent in the local newspaper.
The house is considered placed in service in July when it was ready and available for rent. She can begin to depreciate it in July.12
A car or other vehicle is placed in service the moment it is ready for use in your business. You don’t have to actually drive the car a single mile. (That said, we always recommend that you drive a vehicle at lease one business mile to help prove that you placed it in service.)
Example. James Elm is a building contractor who specializes in constructing office buildings. He bought a truck last year that had to be modified to lift materials to second-story levels. The installation of the lifting equipment was completed, and James accepted delivery of the modified truck on January 10 of this year.
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.13
What Month of the Year Does Depreciation Begin?
If you use bonus depreciation or Section 179 expensing, you get a full deduction for the year you place the property in service, regardless of the month of the year it was placed in service.
This is not the case with regular depreciation, which can take from three to 39 years, depending on the type of property involved.
When personal property is involved, regular depreciation generally doesn’t begin the month you place the property in service in your business. Instead, you must apply a series of rules called conventions to determine the month in which regular depreciation begins.
The default rule is that no matter what month and day of the year you buy personal business property, you treat it as being placed in service on July 1—the midpoint of the year.14
This means that you get one half-year of depreciation for the first year that you own the property. This is a favorable rule because it enables you to claim six months of depreciation for property you place in service as late as December.
You may not use the half-year convention if more than 40 percent of the depreciable basis of all the personal property placed in service during the tax year was placed in service during the final quarter of the year. In this event, you must use the mid-quarter convention.15
When you add up the depreciable basis (cost) of all personal property placed in service during the year, you must include property deducted with bonus depreciation, but you don’t include property deducted with Section 179 expensing.16
Under the mid-quarter convention, you treat all property placed in service during any quarter of the tax year as placed in service at the midpoint of that quarter. For example, property purchased during October through December is treated as being placed in service November15.
Example. Sally purchased and placed in service $120,000 worth of equipment for her home construction business. She placed $20,000 of equipment in service during each of the first, second, and third quarters of the year and $60,000 during the fourth quarter. Because 50 percent (more than 40 percent) of the depreciable basis of all the personal property was placed in service during the fourth quarter, Sally must use the mid-quarter convention.
Planning point. You want to avoid the mid-quarter convention whenever possible, since property you place in service after the midpoint of the tax year is entitled to less depreciation in the first year than under the half-year convention.
- You can avoid the mid-quarter convention by timing your asset purchases so that at least 60 percent of the assets you purchase and place in service during the year are placed in service during the first nine months of the year.
- Another way to avoid the mid-quarter convention is to claim a Section 179 deduction on assets placed in service in the fourth quarter to the extent necessary to reduce fourth-quarter asset purchases below the 40 percent threshold.
You start depreciating residential real property and non-residential real property the month it is placed in service. The start date during the month is determined using the mid-month convention. With the mid-month convention, half a month of depreciation is allowed for the month the asset is placed in service, regardless of the day it is placed in service.17
For example, if you place a rental property in service on March 1, you begin depreciating it on March 15.
Here are five takeaways from this article:
- Depreciation, including bonus depreciation, can’t begin until your business begins.
- A business begins when it is functioning as a going concern—sales and revenue are not required.
- Depreciation for business property purchased for an active business begins only when the property is placed in service in the business—in other words, it is available for use in the business.
- First-year regular depreciation for personal property begins either on July 1 (half-year convention) or at the midpoint of the quarter in which it is placed in service (mid-quarter convention).
- First-year depreciation for real property depreciation begins at the middle of the month during which the property is placed in service (mid-month convention).
Client Letter on This Article for Use by Tax Pros. Click Here.
1 IRC Section 167(a).
2 Walsh v Commr, 884 F.2d 1393 (6th Cir. 1989).
3 Richmond Television Corp. v U.S., 345 F.2d 901 (4th Cir. 1965).
4 Feerick v Commr., T.C. Memo 1991-330.
5 Kennedy v Commr., T.C. Memo 1973-15.
6 McManus v Commr, T.C. Memo 1987-457, aff’d without opin., 865 F.2d 255 (4th Cir. 1988).
7 Aboussie v U.S., 779 F.2d 424 (8th Cir. 1985).
8 IRC Section 195(c)(2)(A).
9 Reg. Section 1.167(a)-10(b).
10 Reg. Section 1.167(a)-11(e)(1)(i).
11 IRS Pub. 946, How to Depreciate Property (2020), dated Mar.17, 2021, p. 7.
14 IRC Section 168(d); Reg. Section 1.168(d)-1(a).
15 IRC Section 168(d); Reg. Section 1.168(d)-1(a).
16 IRC Section 168(d)(3)(B); Reg. Section 1.168(d)-1(b).
17 IRC Section 168(d)(2).