Publication 946 Summarized — How To Depreciate Property

IRS Publication 946, titled How To Depreciate Property, is the rulebook for spreading the cost of business and income-producing property across the years you use it instead of writing it all off the day you buy it. The idea behind depreciation is simple once you see it. When you buy something that wears out or gets used up over several years, the tax code wants the deduction to track that useful life rather than land in one lump. So a delivery van you drive for years, a set of office desks, a rental house, a commercial building, the machines on a shop floor, all of these get deducted a piece at a time. If you run a business, manage rental property, or own equipment that produces income, this publication 946 how to depreciate property guidance touches your return whether you realize it or not.

The first thing the publication settles is what you can depreciate and what you cannot. To depreciate an asset, you have to own it, you have to use it in your business or to produce income, and it has to have a useful life that extends beyond one year. Equipment, vehicles, machinery, furniture, and buildings all clear that bar. Plenty of things do not. Land is the big one, because it does not wear out, so you never depreciate the dirt under a building even though you depreciate the building itself. Inventory is out because you sell it rather than use it up over years. Property you place in service and then dispose of in the same tax year is out too, since there is no multi-year life to recover.

People mix up repairs and improvements here, and it matters. A repair that keeps property in ordinary working order is an expense you deduct in full that year. An improvement that adds value or extends the life of the asset gets capitalized and depreciated. Replacing a few shingles is a repair. Putting on a whole new roof is an improvement. The line is not always obvious, and getting it wrong in either direction either overstates this year or understates it.

The publication also walks through basis, which is the starting number you depreciate from. For most purchases, basis is what you paid plus the costs to get the asset ready for use, like freight or installation. That number is the pool of cost you recover over time, and it shrinks every year by the depreciation you take. Basis matters more than people expect, because it does double duty. It sets how much depreciation you can claim while you own the asset, and it sets your gain when you sell. Get the starting number wrong and both ends of the deal come out wrong.

There is also a timing rule worth knowing up front. Depreciation starts when you place an asset in service, not when you buy it. Place in service means the asset is ready and available for its intended use, so a machine sitting in a crate on December 30 that you do not hook up until February starts depreciating in February, not December. That distinction decides which tax year claims the first deduction, and it catches owners who assume the purchase date controls everything. The same logic ends depreciation when you retire or sell the asset, or when you have recovered its full cost, whichever comes first.

If you are a sole proprietor, your depreciation flows onto your business return through Schedule C. If you own rental real estate, it flows through Schedule E instead. Either way the math runs through one central form first, and we cover that in the next question. Most of the business owners and rental owners we work with in our individual tax return work have depreciation somewhere on their return, often without having thought hard about the method behind it. That method is the part worth getting right, because the choice you make in year one follows the asset for its entire life and shows up again when you sell.

MACRS stands for the Modified Accelerated Cost Recovery System, and it is the default depreciation method for almost everything placed in service since 1986. When people talk about depreciating property in the way Publication 946 lays out, they usually mean MACRS. It does two jobs at once. It assigns each type of property a recovery period, meaning the number of years over which you write it off, and it sets a convention that controls how much you deduct in the first and last years.

Start with recovery periods, because they decide the pace. The IRS sorts property into classes, and each class has a fixed life. Cars and computers fall into the 5-year class. Office furniture and fixtures sit in the 7-year class. Residential rental buildings stretch over 27.5 years. Commercial buildings, like an office or a retail storefront, run 39 years. So a 5,000-dollar computer comes off your return across five years, while the rental duplex you bought takes nearly three decades. Those periods are not negotiable, and guessing at them is a common way people get depreciation wrong. The full class tables live in the publication, and when an asset does not obviously fit a category, that is where you check.

MACRS is called accelerated because for shorter-lived property it front-loads the deduction. Under the most common version, you take bigger deductions in the early years and smaller ones later, which matches how a lot of equipment loses value. Real estate is the exception. Buildings depreciate in equal straight-line amounts across their long lives, the same figure each year.

Then come the conventions, which are the rules for partial first and last years. The half-year convention is the default for most equipment, and it treats every asset as if you placed it in service halfway through the year no matter the actual purchase date. You get half a year of depreciation in year one and the other half tacked on at the end. The mid-quarter convention kicks in when you buy a lot of property late in the year, specifically when more than 40 percent of your equipment for the year goes into service in the last quarter, and it adjusts the first-year deduction by quarter instead. The mid-month convention applies to real estate, treating the building as placed in service in the middle of whatever month you bought it.

Why do these conventions exist? They keep people from buying equipment on December 31 and claiming a full year of depreciation for one day of use. The mid-quarter rule in particular catches owners who stack purchases at year end, and it can quietly shrink a deduction someone expected to be larger. The 40 percent test looks only at property placed in service in the final three months of the year, and once you trip it, every asset you bought that year switches to mid-quarter treatment, not just the late ones. So a single big December purchase can drag your whole year of equipment onto the slower convention.

There is one more piece of MACRS worth flagging. The version most people use is called the General Depreciation System, but the rules also include an Alternative Depreciation System with longer recovery periods and straight-line treatment. ADS is required in certain situations and can be elected on purpose when a slower write-off fits your plan. Most small businesses stay on the general system.

The mechanics get detailed fast, which is why the IRS publishes percentage tables you read straight across. You find your property class, your convention, and the recovery year, and the table gives you the percentage of basis to deduct. For rental owners running this through Schedule E, getting the building separated from the land and onto the right 27.5-year line is the part that trips people up most. Clean books make that separation far easier, which is one reason we tie depreciation tracking into our bookkeeping work rather than treating it as a once-a-year scramble. Set the class and convention right the first year and the rest of the schedule mostly runs itself.

MACRS spreads a deduction over years. Publication 946 also explains two tools that pull deductions forward, sometimes all the way into year one. They are Section 179 expensing and bonus depreciation, and business owners ask about them constantly because they want the write-off now rather than later.

Section 179 lets you deduct the full cost of qualifying equipment in the year you place it in service, up to an annual dollar limit, instead of depreciating it slowly. Buy a 20,000-dollar machine, elect Section 179, and the whole 20,000 can come off this year if you qualify. The catch is that Section 179 has guardrails. There is a business-income limit, meaning your Section 179 deduction cannot push your business into a loss. If you do not have enough business income to absorb it, the excess carries forward to a future year rather than disappearing. There is also a phaseout. Once your total equipment purchases for the year cross a threshold, the available Section 179 amount starts shrinking dollar for dollar, which is the law’s way of aiming the break at smaller buyers rather than large operations. The exact dollar limit and phaseout threshold change with inflation and tax law, so check the current figures in the publication and the Form 4562 instructions before you rely on a number.

Bonus depreciation works differently. It lets you deduct a set percentage of an asset’s cost in the first year, on top of or instead of regular depreciation, and it does not carry the business-income limit that Section 179 does, so it can create or deepen a loss. For several years bonus depreciation sat at 100 percent, meaning you could write off the entire cost in year one. Under current law that percentage is phasing down over time. Because the rate has been a moving target and depends on the year an asset is placed in service, I am not going to quote a specific current percentage here. Pull the live figure from the publication or the form instructions for the exact year you are filing, because using last year’s percentage is one of the easier ways to overstate a deduction.

The practical difference between the two comes down to control and limits. Section 179 is elective asset by asset, so you can expense one machine fully and depreciate another normally, but it is capped and cannot create a loss. Bonus depreciation is more automatic, applies broadly to a whole class of property unless you elect out, and can run your income negative. Many returns use both in the same year, Section 179 first and bonus on what remains.

What qualifies matters too. Both tools generally apply to tangible personal property, the equipment, machinery, vehicles, and furniture side of things, rather than to the building itself. Section 179 reaches some real-property improvements like roofs, heating and air systems, and security systems on nonresidential buildings, which surprises owners who assume real estate is always off limits. The structure of a building does not qualify for either tool, though, so the 27.5-year and 39-year assets keep depreciating the slow way regardless. Pin down which bucket each purchase falls into before you assume you can write it off in full.

Here is where people get burned. Writing everything off immediately feels like a win, but it leaves you with zero depreciation in future years when you might be in a higher bracket or actually need the deduction. A deduction is worth more against high-bracket income than low. Front-loading is not automatically the smart move, and we have talked plenty of owners out of expensing everything in a low-income year. That timing call is exactly the kind of question our tax strategy consulting exists to work through before you file, not after. The deduction you skip now might be the one you want most two years from now.

Numbers make this land faster than rules. Say you buy a 7,000-dollar piece of equipment, use it entirely for business, and place it in service this year. It is 5-year property under MACRS. You have two basic paths, and Publication 946 covers both. You can expense the whole thing now under Section 179, or you can depreciate it over five years under MACRS. Watch what happens to the timing of your deduction.

Take Section 179 first. You elect it, you have enough business income to absorb it, and the full 7,000 dollars comes off this year. One clean deduction. Next year and every year after, that asset gives you nothing more, because you already took it all. If you are in a 24 percent bracket, that 7,000 deduction is worth roughly 1,680 dollars in tax this year, and zero in the years that follow.

Now take the MACRS path with the half-year convention, the default for 5-year property. Instead of one big deduction you get a string of smaller ones. The standard 5-year MACRS pattern runs roughly 20 percent in year one, 32 percent in year two, a little over 19 percent in year three, then about 11.5 percent in years four and five, with a small slice left for year six because the half-year convention stretches a 5-year asset across six calendar years. On 7,000 dollars that is about 1,400 in year one, around 2,240 in year two, roughly 1,344 in year three, and so on down to a final sliver. Add it all up and you still deduct the same 7,000 total. Only the timing changed.

So which is better? It depends entirely on your income picture, and that is the whole point. If this is a strong income year and you expect leaner ones ahead, Section 179 pulls the full deduction into the year it helps most. If you expect your income and your tax bracket to climb, spreading it under MACRS saves deductions for years when each one offsets more highly taxed income. A 7,000 deduction against 12 percent income is worth 840 dollars. The same deduction against 32 percent income is worth 2,240. Same write-off, very different value, decided purely by when you take it.

There is also a cash-flow angle people forget. The full Section 179 deduction lowers this year’s tax bill, which can matter if you stretched to buy the equipment in the first place. A new business hungry for cash often wants the deduction now even if a spreadsheet says waiting is slightly better on paper. That is a real consideration, not a mistake.

The self-employment tax wrinkle is another reason to look past the income-tax number alone. For a sole proprietor, business deductions reduce self-employment tax as well as income tax, so a deduction taken in a year with strong net earnings does more work than the income-tax bracket alone suggests. That can tilt the call toward taking more depreciation in a high-earnings year. It cuts the other way too, since a year you are already near a loss gets little benefit from piling on more deduction.

One detail trips people up on the comparison itself. The MACRS percentages I used assume the half-year convention. If your equipment purchases bunch into the fourth quarter and cross that 40 percent line, the mid-quarter convention applies instead, and the first-year MACRS figure changes. So the exact MACRS schedule for your 7,000-dollar asset depends partly on what else you bought that year, not just the asset in front of you. That is one more reason to run the real numbers rather than trust a rule of thumb.

Whichever path you pick, the deduction reports on Form 4562 and then carries to your Schedule C if you are a sole proprietor. The choice is not just this year’s tax. It is a multi-year decision, and once you make the Section 179 election on a given asset you generally live with it. Run the comparison before you file, with your actual brackets in front of you, instead of defaulting to the biggest first-year number because it feels good.

The most expensive depreciation mistakes do not show up the year you make them. They surface years later when you sell the property, and by then they are hard to fix. Publication 946 flags the trap directly, but it is buried in the language, so most owners miss it. Depreciation is allowed or allowable. That phrase means the tax code reduces your basis by the depreciation you were entitled to take, whether or not you actually claimed it.

Read that twice, because it is the single most misunderstood rule in this area. If you own a rental house and you simply forget to claim depreciation for a few years, you do not get to skip it and keep your full basis. When you sell, the IRS treats your basis as if you had taken that depreciation all along. So you lose the deductions during ownership and you still get hit with the lower basis at sale. It is the worst of both worlds, and we see it most often with rental owners who never set up depreciation in the first year and let it ride.

This connects to depreciation recapture, the part that surprises people at closing. Every dollar of depreciation you take lowers your basis. A lower basis means a larger gain when you sell, because gain is roughly your sale price minus your adjusted basis. On top of that, the portion of your gain that comes from depreciation gets taxed under recapture rules, which can be taxed at rates different from the long-term capital gains rate you might have expected. Buy a rental for 300,000, depreciate 60,000 of the building over the years, and your basis drops to 240,000. Sell for 350,000 and your gain is 110,000, not 50,000, with that 60,000 of prior depreciation facing recapture treatment. The depreciation was not free money. It was a deferral, and the bill comes due at sale.

The other common mistake is depreciating something you should not, and land is the repeat offender. When you buy real estate, the purchase price covers both the building and the land under it. Only the building depreciates. Land does not wear out, so it never gets depreciated. People who fail to split the purchase price between land and building, and instead depreciate the whole amount, are overstating their deductions every single year and inviting an adjustment. Use the property tax assessment or an appraisal to allocate, and document how you did it.

A few more that cost real money. Putting an asset in the wrong class and using the wrong recovery period. Missing the mid-quarter convention when year-end purchases tip past the 40 percent line. Expensing an improvement that should have been depreciated, or capitalizing a repair that could have been deducted now. Forgetting that listed property like a vehicle with personal use only gets depreciated on the business-use percentage, and that the personal miles do not count. Listed property carries its own trap: if business use of a vehicle or similar asset drops to 50 percent or less in a later year, you can be forced to recapture some depreciation and switch to a slower method, so sloppy mileage logs cause real damage here.

If you have already missed depreciation in prior years, the fix usually is not a simple amended return. There is a specific accounting-method change process for catching up missed depreciation, and the mechanics matter, so check the current Form 4562 instructions and the publication before you touch it. The smarter move is setting depreciation up correctly the first year an asset goes into service. Get the basis split, the class, and the method right at the start, and you avoid both the lost deductions and the ugly surprise at sale. If you are buying property this year, decide the depreciation approach before you file the first return, not after the closing statement forces the question.