How To Calculate Depreciation and Determine IRS Limits

There are limits on the amount you can deduct for depreciation of your car. (The section 179 deduction is treated as depreciation for purposes of the limits.) The maximum amount you can deduct each year depends on the year you place the car in service.

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These limits are shown in the following table.

Maximum Depreciation Limits for Cars

Exceptions for clean-fuel cars. There are two exceptions to the depreciation limits for cars. They are effective after August 5, 1997, for cars that run on clean fuel. Clean-fuel cars are discussed in chapter 15 of Publication 535. The exceptions follow.

1.      Amounts you pay for retrofit parts and components to modify a car to run on clean fuel are not subject to the depreciation limit on cars. Only the cost of the car before modification is subject to the limit.

2.      If you place a car in service after August 5, 1997, that was produced to run on electricity, your depreciation limit is increased. The amounts are shown in the following table.

3.      Maximum Depreciation Limits For
Electric Cars Placed in Service
After August 5, 1997

The examples throughout this chapter illustrate gas-fueled cars.

Car used less than full year. The depreciation limits are not reduced if you use a car for less than a full year. This means that you do not reduce the limit when you either place a car in service or dispose of a car during the year. However, the depreciation limits are reduced if you do not use the car exclusively for business and investment purposes. See Reduction for personal use, later.

Example. Marie purchased a car in June 1999 for $16,000 to use exclusively in her business. She does not claim the section 179 deduction and she chooses the 200% DB method of depreciation.

Marie's depreciation (using the rate from Table 3) is $3,200 ($16,000 × 20%). However, the maximum amount she can deduct for depreciation (from the Maximum Depreciation Limits for Cars table) is $3,060. (See Deductions in years after the recovery period, later.)

Reduction for personal use. The depreciation limits are further reduced based on your percentage of personal use. If you use a car less than 100% in your business or work, you must determine the depreciation deduction limit by multiplying the limit amount by the percentage of business and investment use during the tax year.

Example. In June 1999, Karl, an outside dental supply salesman, purchased a car for $25,400 to make sales calls in a territory that extends 200 miles around his home base. He uses his car 85% for his business. Karl does not claim the section 179 deduction and he chooses the 200% DB method to figure his depreciation deduction.

In 1999, Karl computes his MACRS deduction to be $4,318 [($25,400 × 85%) × 20%]. However, Karl's deduction is limited to $2,601. This is the depreciation limit ($3,060) multiplied by the business use percentage (85%).

Karl continues to use his car 85% for business. Depreciation in the next four years continues to be subject to deduction limits. Karl computes his depreciation limits for those years as follows.

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In 2004, Karl's MACRS deduction is $1,244 [($25,400 × 85%) × 5.76%]. Since that amount is less than the depreciation limit of $1,509 ($1,775 × 85%), Karl's depreciation deduction for 2004 is $1,244.

If Karl continues to use his car for business after 2004, he can continue to claim a depreciation deduction for his unrecovered basis. However, he cannot deduct more than $1,775 multiplied by his business use percentage. See Deductions in years after the recovery period, later.

Section 179 deduction. The section 179 deduction is treated as a depreciation deduction. If you place a car in service in 1999, use it only for business, and choose the section 179 deduction, the combined section 179 and depreciation deduction for that car for 1999 is limited to $3,060.

Example. On September 4, 1999, Jack bought a used car for $6,000 and placed it in service. He used it 80% for his business and he chooses to take a section 179 deduction for the car.

Before applying the limit, Jack figures his maximum section 179 deduction to be $4,800. This is the cost of his qualifying property (up to the maximum $19,000 amount) multiplied by his business use ($6,000 × 80%).

Jack then figures that his section 179 deduction for 1999 is limited to $2,448 (80% of $3,060). He then has an unadjusted basis of $2,352 [($6,000 × 80%) - $2,448] for determining his depreciation deduction. Since he has already reached the maximum limit for 1999, Jack will use the unadjusted basis to figure his depreciation deduction for 2000.

Deductions in years after the recovery period. If the depreciation limits apply to your car, you may have unrecovered basis in your car at the end of the recovery period. If you continue to use your car for business, you can deduct that unrecovered basis after the recovery period ends.

Unrecovered basis. This is your cost or other basis in the car reduced by any clean-fuel vehicle deduction, electric vehicle credit, and depreciation and section 179 deductions that would have been allowable if you had used the car 100% for business and investment use.

The recovery period. For cars placed in service after 1986, your recovery period is 6 calendar years. For a 5-year recovery period, a part year's depreciation is allowed in the first calendar year, a full year's depreciation is allowed in each of the next 4 calendar years, and a part year's depreciation is allowed in the 6th calendar year.

Your recovery period is the same whether you use MACRS, declining balance, or straight line depreciation. Under MACRS, you determine your unrecovered basis in the 7th year after you placed the car in service.

How to treat unrecovered basis. If you continue to use your car for business after the recovery period, you can claim a depreciation deduction for that business use in each succeeding tax year until you recover your full basis in the car. The maximum amount you can deduct is determined by the date you placed the car in service and your business-use percentage. For example, no deduction is allowed for a year you use your car 100% for personal purposes.

Example. In May 1993, Bob bought and placed in service a car that he used exclusively in his business. The car cost $28,600. Bob did not claim a section 179 deduction for the car. He continued to use the car 100% in his business throughout the recovery period (1993 through 1998). For those years, Bob used the appropriate MACRS Depreciation Chart and Maximum Depreciation Limits for Cars table (as explained earlier) to compute his depreciation deductions as shown in the following table.

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At the end of 1998, Bob had an unrecovered basis in the car of $13,393. This was the $28,600 original basis of his car less the $15,207 depreciation deductions allowed during the recovery period.

Bob continued to use the car 100% for business in 1999. He can claim a depreciation deduction of $1,675 for the year. If he continues to use the car 100% for business in 2000 and later years, Bob can deduct the lesser of $1,675 or his remaining unrecovered basis in each of those years until his deductions total the $11,718 unrecovered basis ($13,393 - $1,675 claimed in 1999).

If Bob's business use of the car was less than 100% during any year, his depreciation deduction would be less than the maximum amount allowable for that year. However, in determining his unrecovered basis in the car, he would still reduce his original basis by the maximum amount allowable. Bob's unrecovered basis at the beginning of 1999 would be $13,365 ($28,600 - $15,235) in this example. This is true even if his actual depreciation deduction for any year was less than the maximum amount shown.

Car Used 50% or Less for Business

If you use your car 50% or less in qualified business use (defined earlier under Depreciation Deduction), the following two special rules apply. (For this purpose, "car" was defined earlier under Actual Car Expenses.)

1.      You cannot take the section 179 deduction.

2.      You must figure depreciation using the straight line method over a 5-year period. You must continue to use the straight line method even if your percentage of business use increases to more than 50% in a later year.

Instead of making the computation yourself, you can use column (c) of Table 3 to find the percentage to use.

Example. On May 21, 1999, Dan bought a car for $15,000. He used it 40% for his consulting business. Because he did not use the car more than 50% for business, Dan cannot take any section 179 deduction, and he must use the straight line method over a 5-year period to recover the cost of his car.

Dan deducts $600 in 1999. This is the lesser of:

1.      $600 [($15,000 cost × 40% business use) × 10% recovery percentage (from column (c), Table 3)], or

2.      $1,224 ($3,060 maximum limit × 40% business use).

Business use drops to 50% or less in a later year. If you use your car more than 50% in qualified business use in the tax year it is placed in service but the business use drops to 50% or less in a later year, you can no longer use an accelerated depreciation method for that car. For the year the business use drops to 50% or less and all later years in the recovery period, you must use the straight line depreciation method over a 5-year recovery period. In addition, for the year your business use drops to 50% or less, you must determine and include in your gross income any excess depreciation (discussed later).

Example. In June 1996, you purchased a car for exclusive use in your business. You met the more-than-50%-use test for the first 3 years of the recovery period (1996 through 1998) but failed to meet it in the fourth year (1999). You determine your depreciation for 1999 using 20% (from column (c) of Table 3). You also will have to determine and include in your gross income any excess depreciation, discussed next.

Excess depreciation. You must include any excess depreciation in your gross income and add it to your car's adjusted basis for the first tax year in which you do not use the car more than 50% in qualified business use. Use Form 4797, Sales of Business Property, to report the excess depreciation in your gross income.

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Excess depreciation is:

1.      The amount of the depreciation deductions allowable for the car (including any section 179 deduction claimed) for tax years in which you did not use the car more than 50% in qualified business use, minus

2.      The amount of the depreciation deductions that would have been allowable for those years if you had used the car more than 50% in qualified business use for the year you placed it in service.

Example. On June 25, 1996, you bought a car for $11,000 and placed it in service. You did not claim the section 179 deduction. You used the car exclusively in qualified business use for 1996, 1997, and 1998. For those years, you used the appropriate MACRS Depreciation Chart to figure depreciation deductions totaling $7,832 ($2,200 for 1996, $3,520 for 1997, and $2,112 for 1998) under the 200% DB method.

During 1999, you used the car 50% for business and 50% for personal purposes. Since you did not meet the more-than-50%-use test, you must include in gross income for 1999 your excess depreciation determined as follows.

In 1999, you must include $2,332 in your gross income using Form 4797. Your adjusted basis in the car is also increased by $2,332. Your 1999 depreciation deduction is $1,100 [$11,000 (unadjusted basis) × 50% (business use percentage) × 20% (from column (c) of Table 3 on the line for Jan. 1-- Sept. 30, 1996)].

The Vehicle Mileage & Maintenance Record Book is designed for busy professionals like you who are tired of cheap tax information recording tools that fall apart and don't provide adequate room on forms for writing. Order one of our auto mileage logs today and start making this essential task simple and quick. Each book comes with a MONEY BACK GUARANTEE!  Click here to order by using our online shopping cart, downloadable order form, or through Amazon.com.