Depreciation, Amortization & Asset Basis (2025)

Asset Basis (Unit 7)

Cost Basis

Initial basis = cost (cash + notes + property + services). Includes: sales/use tax, freight, installation/testing, excise tax, legal/accounting fees, stamp duty/registration, buyer-paid property tax, settlement costs, assumed liabilities.

Self-constructed assets: UNICAP rules apply. Includes: labor, materials, architect fees, permits, inspections, equipment rental, employee wages. Owner's own labor or free labor by friends/family does NOT increase basis.

Demolition costs: Added to land basis (not building). Land clearing costs also added to land basis.

Real property settlement costs added to basis: abstract fees, utility installation, legal fees (title search, deed prep), recording fees, survey fees, transfer taxes, title insurance, amounts paid for seller's back property taxes.

NOT included in basis: casualty insurance premiums (deductible), rent/utilities before closing, loan costs (points, mortgage insurance, appraisal, credit reports — points amortized as interest).

Adjusted Basis

Increases: extension of utility lines, impact fees, legal fees (protecting ownership), zoning costs, restoration costs (minus restoration credits), government assessments increasing property value.

Decreases: rebates, amortization, depreciation, §179 deduction, depletion, tax-exempt corporate distributions, energy conservation subsidies, residential energy credits, vehicle credits (through Sep 30, 2025), investment credits, excluded COD income, easement payments.

Non-Cost Basis

• Property for services: FMV = income to recipient AND becomes basis
• Property in lieu of wages: FMV = employee income; employer recognizes gain/loss on FMV vs adjusted basis
• Bargain purchase: FMV − purchase price = income; basis = FMV (purchase price + income recognized)

Basis in Entity Transfers

• §351 (to corporation): Corporation's basis = transferor's adjusted basis + gain recognized by transferor. Shareholder's stock basis = basis of property − boot + gain recognized − liabilities assumed.
• §721 (to partnership): Partnership's basis = contributing partner's adjusted basis (carryover). Partner's outside basis = cash + adjusted basis of property + gain recognized + share of liabilities.

Tangible Property Regulations (2014)

• Repairs: Keep property in working order → currently deductible
• Improvements: Add value or extend useful life → capitalize and depreciate. Classified as: betterment, restoration, or adaptation to new use. Buildings divided into 9 "building systems" (plumbing, HVAC, electrical, etc.)

Safe harbors:

• De minimis: $5,000/item with AFS (written capitalization policy); $2,500/item without AFS
• Small taxpayer building: Gross receipts ≤$10M, building basis ≤$1M → deduct lesser of 2% of basis or $10,000 as repairs
• Routine maintenance: Deduct costs expected to recur within 10 years (buildings) or class life (other property)
• Materials/supplies: $200 items, <12-month useful life, components, incidental supplies, consumables → deduct when used/consumed

MACRS (Modified Accelerated Cost Recovery System)

Standard depreciation system for most business property placed in service after 1986.

Recovery Periods

MACRS Methods

• 200% declining balance (3, 5, 7, 10-year property) — switch to SL when optimal
• 150% declining balance (15, 20-year property)
• Straight-line (27.5, 39-year real property) — always SL

Conventions

• Half-year: All property treated as placed in service mid-year (used unless >40% placed in Q4)
• Mid-quarter: If >40% of annual additions in Q4, each asset uses mid-quarter convention
• Mid-month: Real property (27.5/39-year) — placed in service mid-month

Non-Depreciable Assets

Land (but land improvements ARE depreciable), property placed in service and disposed of same year, property with useful life ≤1 year, personal-use property, inventory, §197 intangibles (amortized instead).

Form 4562 used to claim depreciation, §179, bonus depreciation, and report listed property.

§179 Expensing

Immediate deduction of qualifying business property cost (new or used).

Eligible: §1245 property (machinery, equipment, vehicles, furniture), off-the-shelf computer software, qualified improvement property (QIP), non-residential building roofs, HVAC, fire/security systems, single-purpose agricultural structures, oil distribution storage facilities. Must be used >50% for business, acquired by purchase (not gift/inheritance), not from related party (spouse, ancestors, lineal descendants only).

Election: Opt-in on Form 4562, asset-by-asset basis. Cannot create or increase business loss.

Bonus Depreciation (Additional First-Year)

• OBBBA (2025): 100% bonus depreciation for qualified property acquired after January 19, 2025 under the written-binding-contract rule, subject to the normal placed-in-service requirement
• Property acquired before Jan 20, 2025: 40% (TCJA phase-down). 2025 is a "split year."
• Transition election: Taxpayers can elect to apply pre-OBBBA percentages (40% standard, 60% long-production-period/aircraft, 40% certain plants)
• Applies to: MACRS property with recovery period ≤20 years, water utility property, off-the-shelf software, qualified film/TV/live theatrical productions, qualified recorded music productions, fruit/nut-bearing trees, land improvements, QIP
• New AND used property qualify (taxpayer must not have used property before acquisition; cannot acquire from related party unless new)
• No dollar limit or spending cap — can create NOL
• Automatic — taxpayer must elect OUT (by class) on timely filed return
• Ordering rule: §179 first (cannot create loss), then bonus depreciation (can create loss), then regular MACRS

Qualified Production Property (QPP) — Separate Special Allowance

OBBBA created a SEPARATE 100% special depreciation for qualified manufacturing/refining facilities:

• Non-residential real property used for qualified production activities (manufacturing, agricultural production, chemical production, tangible personal property refining)
• Must be placed in service in US/US possessions
• Construction must begin after Jan 19, 2025 and before Jan 1, 2029
• Must be placed in service after Jul 4, 2025 and before Jan 1, 2031
• Elective allowance; original use generally must begin with the taxpayer
• Excludes portions used for offices, lodging, parking, sales, research, software development, engineering, and other non-production functions

Listed Property

Property used for both business and personal purposes with stricter substantiation:

• Passenger vehicles (4-wheel, ≤6,000 lbs GVWR, unless exempt/non-personal-use vehicle)
• Entertainment/recreation property (photography/video equipment)
• TCJA removed computers/peripheral equipment from listed property

Predominant use test: Must be >50% business use to use accelerated depreciation/§179/bonus. If ≤50% → straight-line only, must recapture excess depreciation.

Luxury Auto Depreciation Limits (Passenger Autos, 2025)

Heavier vehicles (GVWR >6,000 lbs): may qualify for full §179 and bonus depreciation. SUV §179 limit: $31,300 (2025, for vehicles 6,000-14,000 lbs GVWR; exceptions for 9+ passenger seating, 6+ ft cargo bed, cargo vans).

Amortization

• §197 Intangibles: Amortized over 15 years (180 months, straight-line, mid-month convention). Includes: goodwill, going concern value, workforce in place, patents, copyrights, customer lists, franchises, licenses, covenants not to compete. No amortization in month of acquisition or disposition.
• Start-up costs: $5,000 immediate + 180 months
• §174 R&E: Domestic R&E currently deductible (OBBBA §174A, for tax years after Dec 31, 2024). Foreign R&E amortized over 15 years.
• Cost segregation: Engineering study to identify and reclassify building components into shorter recovery periods (5, 7, 15-year) to accelerate depreciation.

Depletion

• Cost depletion: Basis ÷ total estimated recoverable units × units sold in year
• Percentage depletion: Statutory percentage × gross income from property (limited to 50% of taxable income before depletion, 100% for oil/gas). Timber cannot use percentage depletion. Oil/gas: 15% depletion rate.

Asset Dispositions (Unit 9)

Capital Assets vs. Non-Capital Assets

Capital assets: Personal-use property (residence, vehicles, vacation home) and investment property (stocks, bonds, collectibles, investment real estate — unless dealer). Capital losses deductible only against capital gains + $3,000 (individuals).

Non-capital assets: Inventory, business depreciable property, business real property, self-created copyrights/manuscripts/art, receivable notes, dealer-held collectibles, business supplies.

§1231 Assets (Business Property Held >1 Year)

• Net gain: Treated as long-term capital gain
• Net loss: Treated as ordinary loss (favorable — fully deductible against ordinary income)
• Includes: business real property, business personal property, §197 intangibles (not self-created), livestock (draft/breeding/dairy/sport — cattle/horses held ≥24 months, other livestock ≥12 months), unharvested crops

5-Year Lookback Rule

If net §1231 gain in current year AND had net §1231 losses in prior 5 years (unrecaptured) → prior losses recharacterize current gain as ordinary income. For C-corps: §1231 gain as LTCG benefit = can offset with capital losses; recharacterized ordinary income cannot.

§1245 Recapture (Personal Property)

All depreciation (and amortization) recaptured as ordinary income on sale of depreciable/amelitable personal property (machinery, equipment, vehicles, furniture). OBBBA: QPP and qualified recorded music productions placed in service after Jul 4, 2025 are §1245 property. Gain = lesser of (depreciation taken) or (total gain). Excess gain = §1231 LTCG.

§1250 Recapture (Real Property)

Only depreciation in EXCESS of straight-line is recaptured as ordinary income. Since buildings generally use straight-line → §1250 recapture rare. Key concept: unrecaptured §1250 gain = depreciation taken on real property, taxed at max 25% rate. Remainder = §1231 LTCG.

§291 Recapture (C Corporations)

C-corps selling §1250 property: additional 20% of depreciation recaptured as ordinary income (on top of any §1250 excess depreciation recapture). This reduces the amount eligible for 25% unrecaptured §1250 rate treatment.

Related Party Dispositions

• Loss disallowed: Sales/exchanges between related parties (family members, controlled entities >50%) → loss NOT deductible, even if bona fide and at FMV
• Gain/loss cannot offset: Gain is taxable; disallowed loss cannot offset it (including other related-party gains)
• Related parties: Siblings, spouses, ancestors, lineal descendants; corporations >50% owned by same person; partnerships/corps under common control
• Buyer's basis: Reduced by disallowed loss. If buyer later sells to non-related party at a gain, seller's disallowed loss can offset that gain (but cannot create/increase loss)

Installment Sales

Gain recognized proportionally as payments received. Gross profit % × payment (excluding interest). Depreciation recapture ALL recognized in year of sale. Form 6252. Does NOT apply to: inventory sales, loss sales, publicly traded securities. Related party: if buyer disposes within 2 years, seller must report all remaining gain.

Like-Kind Exchange (§1031)

Only real property qualifies (post-TCJA). Both properties held for business/investment. Must be actual property exchange (not cash purchase). Qualified intermediary (QI) typically required for deferred exchanges.

• 45-day identification: Must identify replacement property in writing within 45 days of relinquishing property
• 180-day closing: Must receive replacement property within 180 days or tax return deadline (with extension), whichever is earlier
• Boot received: Taxable up to gain recognized
• Related party: 2-year holding period required (if either party disposes within 2 years, deferred gain recognized — exceptions: death, involuntary conversion, non-tax-avoidance purpose)

Involuntary Conversion (§1033)

Gain deferred if proceeds reinvested in similar replacement property.

• Replacement periods: Generally 2 years from end of year gain realized; 3 years for investment/business real property; 4 years for weather-related livestock; 4 years after the close of the first gain year for a principal residence or contents in a federally declared disaster, with reasonable-cause extensions available
• Drought livestock: Farmer can defer for 4 years; IRS can extend if drought continues
• Basis of replacement property: Cost − unrecognized gain (or old basis − unused proceeds + additional costs + recognized gain)
• Condemnation: Type of involuntary conversion (eminent domain). If replacement property purchased within period → §1033 non-taxable exchange. Business/investment real property: 3-year replacement period.