26 U.S.C. § 167 — Depreciation

(a) General rule. A taxpayer can deduct a reasonable amount each year for property wearing out, getting used up, or becoming obsolete — but only if the property is used in a trade or business, or held to produce income. (b) Cross reference. If section 168 applies to the property, that section (not this one) sets the actual depreciation amount — this section just points you there. (c) Basis for depreciation. (1) The starting point for figuring wear-and-tear, exhaustion, and obsolescence is the property's "adjusted basis" as defined in section 1011 — the same number used to figure gain when the property is sold. (2) If someone buys property that already has a tenant renting it (a "lease"), none of the price paid can be assigned to the value of that lease; the whole price counts toward figuring depreciation on the property itself. (d) Life tenants and beneficiaries of trusts and estates. If one person owns property for their lifetime and someone else gets it after they die, the depreciation deduction is calculated as if the lifetime owner owned it outright, and that lifetime owner gets the whole deduction. If property is held in a trust, the deduction is split between the trust's income beneficiaries and the trustee, based on the terms of the trust document, or — if the document doesn't say — based on how much trust income goes to each. For an estate, the deduction is split between the estate and its heirs, based on how much of the estate's income goes to each. (e) Certain term interests not depreciable. (1) If someone owns only a temporary interest in property (a "term interest") while a related person owns what's left over after that term ends (the "remainder interest"), the term-interest owner cannot deduct any depreciation or amortization for as long as a related person holds the remainder. (2) This rule doesn't apply to term interests covered by section 273, or to whoever holds dividend rights split off from "stripped" preferred stock under section 305(e)(1). (3) If depreciation would have been allowed except for this rule, the taxpayer's basis in the term interest goes down by the amount disallowed, and the remainder-interest owner's basis goes up by that same amount (adjusted for any deduction the life-tenant rule in subsection (d) did allow). (4) The remainder owner's basis is NOT increased, though, for any disallowed deductions from periods when the term interest was held by a tax-exempt organization, or by a nonresident alien or foreign corporation whose income from it wasn't connected to a U.S. business. And if depreciation would otherwise be allowed to someone under this rule, the life-tenant/trust rules in subsection (d) still apply to them. (5) "Term interest in property" has the meaning given in section 1001(e)(2). A "related person" is anyone related to the taxpayer as described in section 267(b) or (e). (6) The Treasury Secretary must write regulations needed to enforce this subsection, including rules against dodging it through cross-ownership tricks. (f) Treatment of certain property excluded from section 197. (1) Computer software: if a depreciation deduction is allowed for computer software (as defined by reference to section 197(e)(3)(B), but not software that's an amortizable "section 197 intangible"), it must be calculated using the straight-line method over 36 months. If the software would count as "tax-exempt use property" under section 168(h) (assuming that section applied to software), the useful life must be at least 125% of the lease term. (2) For certain interests or rights described in section 197(e)(4)(B), (C), or (D) that are bought separately, the deduction follows Treasury regulations; if the property would be tax-exempt use property, its useful life must likewise be at least 125% of the lease term. (3) For mortgage servicing rights described in section 197(e)(6), the deduction uses the straight-line method over 108 months. (g) Depreciation under income forecast method. (1) Some taxpayers figure depreciation based on how much income the property is expected to earn (the "income forecast method"). For this method: (A) only income earned before the end of the 10th year after the property went into service counts; (B) the property's basis can only include costs that satisfy the "economic performance" rules of section 461(h); (C) by the 10th year, the whole remaining basis must be deducted; and (D) the taxpayer must pay, or can collect, interest — figured under the "look-back method" in paragraph (2) — for certain "recomputation years." (2) The look-back method recalculates what the depreciation deductions should have been in earlier years if the taxpayer had known the property's actual income (through the recomputation year) plus a new estimate of future income, instead of the original guess. It then figures the tax overpayment or underpayment that recalculation would have caused each year, and charges or pays interest on that amount using the "adjusted overpayment rate," compounded daily. Costs paid after the property went into service (that aren't treated as separate property) get discounted back to the in-service date using the mid-term federal interest rate. A taxpayer can choose not to have this discounting rule apply. (3) The interest rule in paragraph (1)(D) doesn't apply to property that cost $100,000 or less. (4) A "recomputation year" is normally the 3rd and 10th year after the property went into service — unless actual income through that year turns out to be within 10% of what was originally estimated, in which case that year isn't a recomputation year. (5) Special rules: costs incurred after the 10-year forecast period, or significant costs during it that meaningfully boost income beyond the original estimate, are treated as separate property. For a TV series, income from syndication doesn't have to be counted until the earlier of the 4th year after the first episode airs or the year the taxpayer first has a syndication deal. For film and TV, forecasted income includes income from exploiting related characters, designs, scripts, scores, and similar items, but only income from unrelated third parties. Any interest owed under this method is treated as additional tax for that year (except for estimated-tax-penalty purposes). Income counted is the taxpayer's gross income from the property. Income calculations under the look-back method follow the same rules as the income forecast method generally, except that income from selling the property is included. Rules similar to those for pass-through entities under section 460(b)(4) apply here too. (6) The income forecast method may only be used for: property described in section 168(f)(3) or (4); copyrights; books; patents; and other property specified by regulation — never for property that's an amortizable section 197 intangible. (7) A taxpayer may include future "participations and residuals" payments (costs that vary by how much the property earns) in the property's basis in the year it's placed in service, but only to the extent they relate to income expected within that 10-year window; special recomputation rules apply if a taxpayer does this. Alternatively, a taxpayer may leave participations and residuals out of the basis and just deduct them as they're actually paid — and either way, these deductions are allowed regardless of certain other timing rules (paragraph (1)(B) and sections 263, 263A, 404, 419, or 461(h)). The Treasury Secretary must set appropriate basis and look-back adjustments for these extra deductions. (8) Special election for musical works: a taxpayer can elect to amortize costs of creating or buying a musical composition or related copyright evenly over 5 years, instead of using the income forecast method — but only for expenses that would otherwise be deductible, and this becomes the only method allowed for those costs once elected. This doesn't apply to property treated under the "qualified creative expenses" or simplified capitalization rules of section 263A, or to amortizable section 197 intangibles. The election is made in the way the Treasury Secretary prescribes and covers all such property placed in service that year. This election was not available for any tax year beginning after December 31, 2010. (h) Amortization of geological and geophysical expenditures. (1) Costs paid to explore for or develop oil or gas within the United States must be deducted evenly over 24 months, starting from the date paid. (2) Payments made during a tax year are treated as paid at the year's midpoint. (3) This 24-month method is the only way to deduct these costs. (4) If the related property is abandoned or retired during that 24-month window, no separate deduction is allowed for the abandonment — the 24-month amortization just keeps going. (5) For a "major integrated oil company" (one that averaged at least 500,000 barrels a day worldwide in the tax year, had over $1 billion in gross receipts for its last 2005 tax year, and doesn't qualify for the small-producer depletion rules under section 613A because it's too large), the amortization period is 7 years instead of 24 months. Related companies under common ownership are combined and treated as one company for these size tests, with a special rule for short tax years. (i) Cross references. (1) For depreciation of improvements to mines, oil and gas wells, other natural deposits, and timber, see section 611. (2) For amortizing goodwill and other intangibles, see section 197.