Limit on the amount of the section 179 deduction.   For 2005, the total amount you can choose to deduct under section 179 generally cannot be more than $105,000.

If the cost of your qualifying section 179 property placed in service in 2005 is over $420,000, you must reduce the $105,000 dollar limit (but not below zero) by the amount of cost over $420,000. If the cost of your section 179 property placed in service during 2005 is $525,000 or more, you cannot take a section 179 deduction.

The total amount you can deduct under section 179 each year after you apply the limits listed above cannot be more than the taxable income from the active conduct of any trade or business during the year.

If you are married and file a joint return, you and your spouse are treated as one taxpayer in determining any reduction to the dollar limit, regardless of which of you purchased the property or placed it in service.

If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit. You must allocate the dollar limit (after any reduction) between you.

For more information on the above section 179 deduction limits, see IRS Publication 946.

Limit for sport utility and certain other vehicles.   For sport utility and certain other vehicles placed in service in 2005, the portion of the vehicle's cost taken into account in figuring your section 179 deduction is limited to $25,000. This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, or highways, that is not subject to any of the passenger automobile limits explained under Depreciation Limits, later, and that is rated at no more than 14,000 pounds gross vehicle weight. However, the $25,000 limit does not apply to any vehicle:

Limit on total section 179 and depreciation deductions.   Generally, the total amount of section 179 and depreciation deductions that you can claim for a qualified car that you placed in service in 2005 is $2,960. The limit is reduced if your business use of the car is less than 100%. See Depreciation Limits, later, for more information.

Cost of car.   For purposes of the section 179 deduction, the cost of the car does not include any amount figured by reference to any other property held by you at any time. For example, if you buy (for cash and a trade-in) a new car to use in your business, your cost for purposes of the section 179 deduction does not include your adjusted basis in the car you trade in for the new car. Your cost includes only the cash you paid.

Basis of car for depreciation.   The amount of the section 179 deduction reduces your basis in your car. If you choose the section 179 deduction, you must subtract the amount of the deduction from the cost of your car. The resulting amount is the basis in your car that you use to figure your depreciation deduction.

When to choose.   If you want to take the section 179 deduction, you must make the choice in the tax year you both purchase the car and place it in service for business or work.

How to choose.    Employees use Form 2106 to make this choice and report the section 179 deduction. All others use Form 4562.

File the appropriate form with either of the following.

Revoking an election.   An election (or any specification made in the election) to take a section 179 deduction for 2005 can be revoked without IRS approval by filing an amended return. The amended return must be filed within the time prescribed by law. The amended return must also include any resulting adjustment to taxable income. Once made, the revocation is irrevocable.

Reduction in business use.   To be eligible to claim the section 179 deduction, you must use your car more than 50% for business or work in the year you acquired it. If your business use of the car is 50% or less in a later tax year during the recovery period, you have to recapture (include in income) in that later year any excess depreciation. Any section 179 deduction claimed on the car is included in calculating the excess depreciation. For information on this calculation, see Excess depreciation under Car Used 50% or Less for Business.

Dispositions.   If you dispose of a car on which you had claimed the section 179 deduction, the amount of that deduction is treated as a depreciation deduction for recapture purposes. You treat any gain on the disposition of the property as ordinary income up to the amount of the section 179 deduction and any allowable depreciation (unless you establish the amount actually allowed). For information on the disposition of a car, see Disposition of a Car.

Generally, you figure depreciation using your basis. However, in some situations (such as use of the straight line method) you will use your adjusted basis (your basis reduced by depreciation allowed or allowable in earlier years). For one of these situations see Exception under Methods of depreciation, later.

If you change the use of a car from personal to business, your basis for depreciation is the lesser of the fair market value or your adjusted basis in the car on the date of conversion. Additional rules concerning basis are discussed later on this page under Unadjusted basis.

Placed in service.   You generally place a car in service when it is available for use in your work or business, in an income-producing activity, or in a personal activity. Depreciation begins when the car is placed in service for use in your work or business or for the production of income.

For purposes of computing depreciation, if you first start using the car only for personal use and later convert it to business use, you place the car in service on the date of conversion.

Car placed in service and disposed of in the same year.   If you place a car in service and dispose of it in the same tax year, you cannot claim any depreciation deduction for that car.

Methods of depreciation.   Generally, you figure depreciation on cars using the Modified Accelerated Cost Recovery System (MACRS). MACRS is discussed later in this chapter.

Exception.   If you used the standard mileage rate in the first year of business use and change to the actual expenses method in a later year, you cannot depreciate your car under the MACRS rules. You must use straight line depreciation over the estimated remaining useful life of the car.

To figure depreciation under the straight line method, you must reduce your basis in the car (but not below zero) by a set rate per mile for all miles for which you used the standard mileage rate. The rate per mile varies depending on the year(s) you used the standard mileage rate. For the rate(s) to use, see Depreciation adjustment when you used the standard mileage rate under Disposition of a Car.

This reduction of basis is in addition to those basis adjustments described later under Unadjusted basis. You must use your adjusted basis in your car to figure your depreciation deduction. For additional information on the straight line method of depreciation, see IRS Publication 946.

More-than-50%-use test.   Generally, you must use your car more than 50% for qualified business use (defined next) during the year to use MACRS. You must meet this more-than-50%-use test each year of the recovery period (6 years under MACRS) for your car.

If your business use is 50% or less, you must use the straight line method to depreciate your car. This is explained later under Car Used 50% or Less for Business.

Qualified business use.   A qualified business use is any use in your trade or business. It does not include use for the production of income (investment use). However, you do combine your business and investment use to compute your depreciation deduction for the tax year.

Use of your car by another person.   Do not treat any use of your car by another person as use in your trade or business unless that use meets one of the following conditions.

Business use changes.   If you used your car more than 50% in qualified business use in the year you placed it in service, but 50% or less in a later year (including the year of disposition), you have to change to the straight line method of depreciation. See Qualified business use 50% or less in a later year under Car Used 50% or Less for Business, later.

Use for more than one purpose.   If you use your car for more than one purpose during the tax year, you must allocate the use to the various purposes. You do this on the basis of mileage. Figure the percentage of qualified business use by dividing the number of miles you drive your car for business purposes during the year by the total number of miles you drive the car during the year for any purpose.

Change from personal to business use.   If you change the use of a car from 100% personal use to business use during the tax year, you may not have mileage records for the time before the change to business use. In this case, you figure the percentage of business use for the year as follows.

Limits.   The amount you can claim for section 179 and depreciation deductions may be limited. The maximum amount you can claim depends on the year in which you placed your car in service. You have to reduce the maximum amount if you did not use the car exclusively for business. See Depreciation Limits, later.

Unadjusted basis.   You use your unadjusted basis (often referred to as your basis or your basis for depreciation) to figure your depreciation using the MACRS depreciation chart, explained later under Modified Accelerated Cost Recovery System (MACRS). Your unadjusted basis for figuring depreciation is your original basis increased or decreased by certain amounts.

To figure your unadjusted basis, begin with your car's original basis, which generally is its cost. Cost includes sales taxes, destination charges, and dealer preparation. Increase your basis by any substantial improvements you make to your car, such as adding air conditioning or a new engine. Decrease your basis by any deductible casualty loss, section 179 deduction, special depreciation allowance (claimed in prior years), diesel fuel tax credit, gas guzzler tax, clean-fuel vehicle deduction, and qualified electric vehicle credit. See IRS Publication 535 for more information on the clean-fuel vehicle deduction and the qualified electric vehicle credit.
 

Car trade-in.   If you traded one car (the “old car”) in on another car (the “new car”) in 2005, there are two ways you can treat the transaction.

If you elect to use the method described in (1), you must do so on a timely filed tax return (including extensions). Otherwise, you must use the method described in (2).

Effect of trade-in on basis.   The discussion that follows applies to trade-ins of cars in 2005, where the election was made to treat the transaction as a tax-free disposition of the old car and the purchase of the new car. For information on how to figure depreciation for cars involved in a like-kind exchange (trade-in) in 2005, for which the election was not made, see IRS Publication 946 and Temporary Regulations section 1.168(i)-6T(d)(3).

Traded car used only for business.   If you trade in a car that you used only in your business for another car that will be used only in your business, your original basis in the new car is your adjusted basis in the old car, plus any additional amount you pay for the new car.

To figure the unadjusted basis of your new car for depreciation, first add to your adjusted basis in the old car any additional amount you pay for the new car. Then subtract from that total the excess, if any, of:

Modified Accelerated Cost Recovery System (MACRS).   The Modified Accelerated Cost Recovery System (MACRS) is the name given to the tax rules for getting back (recovering) through depreciation deductions the cost of property used in a trade or business or to produce income.

The maximum amount you can deduct is limited, depending on the year you placed your car in service. See Depreciation Limits.

Recovery period.   Under MACRS, cars are classified as 5-year property. You actually depreciate the cost of a car, truck, or van over a period of 6 calendar years. This is because your car is generally treated as placed in service in the middle of the year and you claim depreciation for one-half of both the first year and the sixth year.

Depreciation deduction for certain Indian reservation property.   Shorter recovery periods are provided under MACRS for qualified Indian reservation property placed in service on Indian reservations after 1993 and before 2006. The recovery period that applies for a business-use car is 3 years instead of 5 years. However, the depreciation limits, discussed later, will still apply.

For more information on the qualifications for this shorter recovery period and the percentages to use in figuring the depreciation deduction, see chapter 4 of IRS Publication 946.

Depreciation methods.   You can use one of the following methods to depreciate your car.

Before choosing a method, you may wish to consider the following facts.

MACRS depreciation chart.   A 2005 MACRS Depreciation Chart and instructions are included in this chapter as Table 4-1. Using this table will make it easy for you to figure the 2005 depreciation deduction for your car. A similar chart appears in the Instructions for Form 2106.

You must use the Depreciation Tables in Publication 946 rather than the 2005 MACRS Depreciation Chart in this publication if any one of the following three conditions applies to you.

Depreciation in future years.   If you use the percentages from the chart, you generally must continue to use them for the entire recovery period of your car. However, you cannot continue to use the chart if your basis in your car is adjusted because of a casualty. In that case, for the year of the adjustment and the remaining recovery period, figure the depreciation without the chart using your adjusted basis in the car at the end of the year of the adjustment and over the remaining recovery period. See Figuring the Deduction Without Using the Tables in chapter 4 of IRS Publication 946.

Disposition of car during recovery period.   If you dispose of the car before the end of the recovery period, you are generally allowed a half year of depreciation in the year of disposition unless you purchased the car during the last quarter of a year. See Depreciation deduction for the year of disposition under Disposition of a Car for information on how to figure the depreciation allowed in the year of disposition.

How to use the 2005 chart.   To figure your depreciation deduction for 2005, find the percentage in the column of the chart based on the date that you first placed the car in service and the depreciation method that you are using. Multiply the unadjusted basis of your car (defined earlier) by that percentage to determine the amount of your depreciation deduction. If you prefer to figure your depreciation deduction without the help of the chart, see IRS Publication 946.

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 12 of IRS Publication 535. The exceptions follow.

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 2005 for $20,000 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 MACRS depreciation (using the rate from Table 4-1) is $4,000 ($20,000 × 20%). However, the maximum amount she can deduct for depreciation is $2,960. (See the Maximum Depreciation Deduction for Cars table earlier.)

Reduction for personal use.   The depreciation limits are 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.

Section 179 deduction.   The section 179 deduction is treated as a depreciation deduction. If you place a car that is not a truck, van, or electric vehicle in service in 2005, use it only for business, and choose the section 179 deduction, the combined section 179 and depreciation deduction for that car for 2005 is limited to $2,960.

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 5-year property, your recovery period is 6 calendar years. 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.

Under MACRS, your recovery period is the same whether you use declining balance or straight line depreciation. 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 in each succeeding tax year until you recover your full basis in the car. The maximum amount you can deduct each year 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.

Instead of making the computation yourself, you can use column (c) of Table 4-1 to find the percentage to use.

Qualified business use 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 recapture (include in your gross income) any excess depreciation (discussed later). You also increase the adjusted basis of your car by the same amount.

Example.

In June 2002, 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 (2002 through 2004) but failed to meet it in the fourth year (2005). You determine your depreciation for 2005 using 20% (from column (c) of Table 4-1). 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 figure and report the excess depreciation in your gross income.

   Excess depreciation is:

Figure the fair market value on the first day of the lease term. If the capitalized cost of a car is specified in the lease agreement, use that amount as the fair market value.

Figuring the inclusion amount.   Inclusion amounts are listed in Appendix A for cars, in Appendix B for trucks and vans, and in Appendix C for electric cars leased after August 5, 1997. If the fair market value of the car is $100,000 or less, use the appropriate appendix (depending on the year you first placed the car in service) to determine the inclusion amount. If the fair market value is more than $100,000, see the Revenue Procedure(s) identified in the footnote of the appendices for the inclusion amount. Revenue Procedures are available at most IRS offices and many local libraries. You can also find them on the Internet at www.irs.gov.

For each tax year during which you lease the car for business, determine your inclusion amount by following these three steps.

Example.

On August 16, 2004, Will leased an electric car with a fair market value of $58,600 for 3 years. He used the car exclusively in his own data processing business. On November 5, 2005, Will closed his business and went to work for a company where he is not required to use a car for business. Using Appendix C-5, Will computed his inclusion amount for 2004 and 2005 as shown in the following table and reduced his deductions for lease payments by those amounts.

Leased car changed from personal to business use.   If you lease a car for personal use and, in a later year, change it to business use, you must determine the car's fair market value on the date of conversion. Then figure the inclusion amount using the rules explained earlier under Figuring the inclusion amount. Use the fair market value on the date of conversion.

Example.

In March 2003, Janice leased a car for 4 years for personal use. On June 1, 2005, she started working as a self-employed advertising consultant and started using the leased car for business purposes. Her records show that her business use for June 1 through December 31 was 60%. To figure her inclusion amount for 2005, Janice obtained an appraisal from an independent car leasing company that showed the fair market value of her 2003 car on June 1, 2005, was $21,650. Using Appendix A-6, Janice computed her inclusion amount for 2005 as shown in the following table.

Reporting inclusion amounts.    For information on reporting inclusion amounts, employees should see Car rentals under Completing Forms 2106 and 2106-EZ. Sole proprietors should see the instructions for Schedule C (Form 1040) and farmers should see the instructions for Schedule F (Form 1040).