Internal Revenue Service, Treasury § 1.168(I)–4

Internal Revenue Service, Treasury § 1.168(i)–4

is public utility property of the trans- § 1.168(i)–4 Changes in use. feree and the taxpayer’s excess tax re- (a) Scope. This section provides the serve with respect to the property rules for determining the depreciation (within the meaning of section 203(e) of allowance for MACRS property (as de- the Tax Reform Act of 1986) is treated fined in § 1.168(b)–1T(a)(2)) for which the as an excess tax reserve of the trans- use changes in the hands of the same feree with respect to the property. taxpayer (change in the use). The al- (b) Amount of reduction. If public util- lowance for depreciation under this ity property of a taxpayer becomes de- section constitutes the amount of deregulated public utility property to preciation allowable under section which this section applies, the reduc- 167(a) for the year of change and any tion in the taxpayer’s excess tax re- subsequent taxable year. For purposes serve permitted under section 203(e) of of this section, the year of change is the Tax Reform Act of 1986 is equal to the taxable year in which a change in the amount by which the reserve could the use occurs. be reduced under that provision if all (b) Conversion to business or income- such property had remained public producing use—(1) Depreciation deduc- utility property of the taxpayer and tion allowable. This paragraph (b) ap- the taxpayer had continued use of its plies to property that is converted normalization method of accounting from personal use to use in a tax- with respect to such property. payer’s trade or business, or for the (c) Cross reference. See § 1.46–6(k) for production of income, during a taxable rules relating to the treatment of accu- year. This conversion includes property mulated deferred investment tax cred- that was previously used by the tax- its when utilities dispose of regulated payer for personal purposes, including public utility property. real property (other than land) that is (d) Effective/applicability dates—(1) In acquired before 1987 and converted general. Except as provided in para- from personal use to business or income-producing use after 1986, and de- graph (d)(2) of this section, this section preciable property that was previously applies to public utility property that used by a tax-exempt entity before the becomes deregulated public utility entity changed to a taxable entity. Ex- property after December 21, 2005. cept as otherwise provided by the In- (2) Property that becomes public utility ternal Revenue Code or regulations property of the transferee. This section under the Internal Revenue Code, upon does not apply to property that be- a conversion to business or income-pro- comes deregulated public utility prop- ducing use, the depreciation allowance erty with respect to a taxpayer on ac- for the year of change and any subse- count of a transfer on or before March quent taxable year is determined as 20, 2008 if after the transfer the prop- though the property is placed in serv- erty is public utility property of the ice by the taxpayer on the date on transferee. which the conversion occurs. Thus, ex- (3) Application of regulation project cept as otherwise provided by the In- (REG–104385–01). A reduction in the tax- ternal Revenue Code or regulations payer’s excess deferred income tax re- under the Internal Revenue Code, the serve will be treated as ratable if it is taxpayer must use any applicable de- consistent with the proposed rules in preciation method, recovery period, regulation project (REG–104385–01) (68 and convention prescribed under sec- FR 10190) March 4, 2003, and occurs dur- tion 168 for the property in the year of ing the period beginning on March 5, change, consistent with any election 2003, and ending on the earlier of— made under section 168 by the taxpayer (i) The last date on which the util- for that year (see, for example, section ity’s rates are determined under the 168(b)(5)). See §§ 1.168(k)–1T(f)(6)(iii) and rate order in effect on December 21, 1.1400L(b)–1T(f)(6) for the additional 2005; or first year depreciation deduction rules applicable to a conversion to business (ii) December 21, 2007. or income-producing use. The depre- [T.D. 9387, 73 FR 14937, Mar. 20, 2008] ciable basis of the property for the year

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of change is the lesser of its fair mar- be placed in service during the year of ket value or its adjusted depreciable change (taking into account the appli- basis (as defined in § 1.168(b)–1T(a)(4)), cable convention) and the denominator as applicable, at the time of the con- of which is 12. No depreciation deduc- version to business or income-pro- tion is allowable for MACRS property ducing use. placed in service and disposed of in the (2) Example. The application of this same taxable year. See §§ 1.168(k)– paragraph (b) is illustrated by the fol- 1T(f)(6)(ii) and 1.1400L(b)–1T(f)(6) for lowing example: the additional first year depreciation Example. A, a calendar-year taxpayer, pur- deduction rules applicable to property chases a house in 1985 that she occupies as placed in service and converted to per- her principal residence. In February 2004, A sonal use in the same taxable year. ceases to occupy the house and converts it to Upon the conversion to personal use, residential rental property. At the time of no gain, loss, or depreciation recapture the conversion to residential rental prop- under section 1245 or section 1250 is rec- erty, the house’s fair market value (exclud- ognized. However, the provisions of sec- ing land) is $130,000 and adjusted depreciable basis attributable to the house (excluding tion 1245 or section 1250 apply to any land) is $150,000. Pursuant to this paragraph disposition of the converted property (b), A is considered to have placed in service by the taxpayer at a later date. For residential rental property in February 2004 listed property (as defined in section with a depreciable basis of $130,000. A depre- 280F(d)(4)), see section 280F(b)(2) for ciates the residential rental property under the recapture of excess depreciation the general depreciation system by using the upon the conversion to personal use. straight-line method, a 27.5-year recovery period, and the mid-month convention. Pursu- (d) Change in the use results in a dif- ant to §§ 1.168(k)–1T(f)(6)(iii)(B) or 1.1400L(b)– ferent recovery period and/or depreciation 1T(f)(6), this property is not eligible for the method—(1) In general. This paragraph additional first year depreciation deduction (d) applies to a change in the use of provided by section 168(k) or section MACRS property during a taxable year 1400L(b). Thus, the depreciation allowance subsequent to the placed-in-service for the house for 2004 is $4,137, after taking year, if the property continues to be into account the mid-month convention (($130,000 adjusted depreciable basis multi- MACRS property owned by the same plied by the applicable depreciation rate of taxpayer and, as a result of the change 3.636% (1/27.5)) multiplied by the mid-month in the use, has a different recovery pe- convention fraction of 10.5/12). The amount riod, a different depreciation method, of depreciation computed under section 168, or both. For example, this paragraph however, may be limited under other provi- (d) applies to MACRS property that— sions of the Internal Revenue Code, such as, (i) Begins or ceases to be used pre- section 280A. dominantly outside the United States; (c) Conversion to personal use. The (ii) Results in a reclassification of conversion of MACRS property from the property under section 168(e) due to business or income-producing use to a change in the use of the property; or personal use during a taxable year is (iii) Begins or ceases to be tax-ex- treated as a disposition of the property empt use property (as defined in sec- in that taxable year. The depreciation tion 168(h)). allowance for MACRS property for the (2) Determination of change in the use— year of change in which the property is (i) In general. Except as provided in treated as being disposed of is deter- paragraph (d)(2)(ii) of this section, a mined by first multiplying the adjusted change in the use of MACRS property depreciable basis of the property as of occurs when the primary use of the the first day of the year of change by MACRS property in the taxable year is the applicable depreciation rate for different from its primary use in the that taxable year (for further guidance, immediately preceding taxable year. for example, see section 6 of Rev. Proc. The primary use of MACRS property 87–57 (1987–2 C. B. 687, 692) (see may be determined in any reasonable § 601.601(d)(2)(ii)(b) of this chapter)). manner that is consistently applied to This amount is then multiplied by a the taxpayer’s MACRS property. fraction, the numerator of which is the (ii) Alternative depreciation system number of months (including fractions property—(A) Property used within or of months) the property is deemed to outside the United States. A change in

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the use of MACRS property occurs (B) Computation of depreciation allow- when a taxpayer begins or ceases to use ance. The depreciation allowances for MACRS property predominantly out- the MACRS property for any 12-month side the United States during the tax- taxable year beginning with the year of able year. The determination of wheth- change are determined by multiplying er MACRS property is used predomi- the adjusted depreciable basis of the nantly outside the United States is MACRS property as of the first day of made in accordance with the test in each taxable year by the applicable de- § 1.48–1(g)(1)(i) for determining pre- preciation rate for each taxable year. dominant use. In determining the applicable deprecia- (B) Tax-exempt bond financed property. tion rate for the year of change and A change in the use of MACRS prop- subsequent taxable years, the taxpayer erty occurs when the property changes must use any applicable depreciation to tax-exempt bond financed property, method and recovery period prescribed as described in section 168(g)(1)(C) and under section 168 for the MACRS prop- (g)(5), during the taxable year. For pur- erty in the year of change, consistent poses of this paragraph (d), MACRS with any election made under section property changes to tax-exempt bond 168 by the taxpayer for that year (see, financed property when a tax-exempt for example, section 168(b)(5)). If there bond is first issued after the MACRS is a change in the use of MACRS prop- property is placed in service. MACRS erty, the applicable convention that property continues to be tax-exempt applies to the MACRS property is the bond financed property in the hands of same as the convention that applied the taxpayer even if the tax-exempt before the change in the use of the bond (including any refunding issue) is MACRS property. However, the depre- no longer outstanding or is redeemed. ciation allowance for the year of (C) Other mandatory alternative depre- change for the MACRS property is de- ciation system property. A change in the termined without applying the applica- use of MACRS property occurs when ble convention, unless the MACRS the property changes to, or changes property is disposed of during the year from, property described in section of change. See paragraph (d)(5) of this 168(g)(1)(B) (tax-exempt use property) section for the rules relating to the or (D) (imported property covered by computation of the depreciation allow- an Executive order) during the taxable ance under the optional depreciation year. tables. If the year of change or any (iii) Change in the use deemed to occur subsequent taxable year is less than 12 on first day of the year of change. If a months, the depreciation allowance de- change in the use of MACRS property termined under this paragraph (d)(3)(i) occurs under this paragraph (d)(2), the must be adjusted for a short taxable depreciation allowance for that year (for further guidance, for example, MACRS property for the year of change see Rev. Proc. 89–15 (1989–1 C.B. 816) is determined as though the use of the (see § 601.601(d)(2)(ii)(b) of this chap- MACRS property changed on the first ter)). day of the year of change. (C) Special rules. MACRS property af- (3) Change in the use results in a short- fected by this paragraph (d)(3)(i) is not er recovery period and/or a more acceler- eligible in the year of change for the ated depreciation method—(i) Treated as election provided under section placed in service in the year of change— 168(f)(1), 179, or 1400L(f), or for the addi- (A) In general. If a change in the use re- tional first year depreciation deduction sults in the MACRS property changing provided in section 168(k) or 1400L(b). to a shorter recovery period and/or a See §§ 1.168(k)–1T(f)(6)(iv) and depreciation method that is more ac- 1.1400L(b)–1T(f)(6) for other additional celerated than the method used for the first year depreciation deduction rules MACRS property before the change in applicable to a change in the use of the use, the depreciation allowances MACRS property subsequent to its beginning in the year of change are de- placed-in-service year. For purposes of termined as though the MACRS prop- determining whether the mid-quarter erty is placed in service by the tax- convention applies to other MACRS payer in the year of change. property placed in service during the

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year of change, the unadjusted depre- use of MACRS property, the applicable ciable basis (as defined in § 1.168(b)– convention that applies to the MACRS 1T(a)(3)) or the adjusted depreciable property is the same as the convention basis of MACRS property affected by that applied before the change in the this paragraph (d)(3)(i) is not taken use of the MACRS property. If the year into account. of change or any subsequent taxable (ii) Option to disregard the change in year is less than 12 months, the depre- the use. In lieu of applying paragraph ciation allowance determined under (d)(3)(i) of this section, the taxpayer this paragraph (d)(4)(ii) must be ad- may elect to determine the deprecia- justed for a short taxable year (for fur- tion allowance as though the change in ther guidance, for example, see Rev. the use had not occurred. The taxpayer Proc. 89–15 (1989–1 C.B. 816) (see elects this option by claiming on the § 601.601(d)(2)(ii)(b) of this chapter)). See taxpayer’s timely filed (including ex- paragraph (d)(5) of this section for the tensions) Federal income tax return for rules relating to the computation of the year of change the depreciation al- the depreciation allowance under the lowance for the property as though the optional depreciation tables. In deter- change in the use had not occurred. See mining the applicable depreciation rate paragraph (g)(2) of this section for the for the year of change and any subse- manner for revoking this election. quent taxable year— (4) Change in the use results in a longer (A) The applicable depreciation recovery period and/or a slower deprecia- method is the depreciation method tion method—(i) Treated as originally that would apply in the year of change placed in service with longer recovery pe- and any subsequent taxable year for riod and/or slower depreciation method. If the MACRS property had the taxpayer a change in the use results in a longer used the longer recovery period and/or recovery period and/or a depreciation the slower depreciation method in the method for the MACRS property that placed-in-service year of the property. is less accelerated than the method If the 200-or 150-percent declining bal- used for the MACRS property before ance method would have applied in the the change in the use, the depreciation placed-in-service year but the method allowances beginning with the year of would have switched to the straight change are determined as though the line method in the year of change or MACRS property had been originally any prior taxable year, the applicable placed in service by the taxpayer with depreciation method beginning with the longer recovery period and/or the the year of change is the straight line slower depreciation method. MACRS method; and property affected by this paragraph (B) The applicable recovery period is (d)(4) is not eligible in the year of either— change for the election provided under (1) The longer recovery period result- section 168(f)(1), 179, or 1400L(f), or for ing from the change in the use if the the additional first year depreciation applicable depreciation method is the deduction provided in section 168(k) or 200-or 150-percent declining balance 1400L(b). See §§ 1.168(k)–1T(f)(6)(iv) and method (as determined under para- 1.1400L(b)–1T(f)(6) for other additional graph (d)(4)(ii)(A) of this section) un- first year depreciation deduction rules less the recovery period did not change applicable to a change in the use of as a result of the change in the use, in MACRS property subsequent to its which case the applicable recovery pe- placed-in-service year. riod is the same recovery period that (ii) Computation of the depreciation al- applied before the change in the use; or lowance. The depreciation allowances (2) The number of years remaining as for the MACRS property for any 12- of the beginning of each taxable year month taxable year beginning with the (taking into account the applicable year of change are determined by mul- convention) had the taxpayer used the tiplying the adjusted depreciable basis longer recovery period in the placed-in- of the MACRS property as of the first service year of the property if the ap- day of each taxable year by the appli- plicable depreciation method is the cable depreciation rate for each tax- straight line method (as determined able year. If there is a change in the under paragraph (d)(4)(ii)(A) of this

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section) unless the recovery period did of change by the annual depreciation not change as a result of the change in rate for each recovery year (expressed the use, in which case the applicable as a decimal equivalent) specified in recovery period is the number of years the appropriate optional depreciation remaining as of the beginning of each table. The appropriate optional depre- taxable year (taking into account the ciation table for the MACRS property applicable convention) based on the re- is based on the depreciation system, covery period that applied before the depreciation method, recovery period, change in the use. and convention applicable to the (5) Using optional depreciation tables— MACRS property in the year of change (i) Taxpayer not bound by prior use of as determined under paragraph (d)(3)(i) table. If a taxpayer used an optional de- of this section. The depreciation allow- preciation table for the MACRS prop- ance for the year of change for the erty before a change in the use, the MACRS property is determined by tak- taxpayer is not bound to use the appro- ing into account the applicable conven- priate new table for that MACRS prop- tion (which is already factored into the erty beginning in the year of change optional depreciation tables). If the (for further guidance, for example, see year of change or any subsequent tax- section 8 of Rev. Proc. 87–57 (1987–2 C.B. able year is less than 12 months, the 687, 693) (see § 601.601(d)(2)(ii)(b) of this depreciation allowance determined chapter)). If a taxpayer did not use an under this paragraph (d)(5)(ii)(A) must optional depreciation table for MACRS be adjusted for a short taxable year property before a change in the use and (for further guidance, for example, see the change in the use results in a Rev. Proc. 89–15 (1989–1 C.B. 816) (see shorter recovery period and/or a more § 601.601(d)(2)(ii)(b) of this chapter)). accelerated depreciation method (as described in paragraph (d)(3)(i) of this (B) Change in the use results in a section), the taxpayer may use the ap- longer recovery period and/or a slower de- propriate new table for that MACRS preciation method—(1) Determination of property beginning in the year of the appropriate optional depreciation change. If a taxpayer chooses not to table. If a change in the use results in use the optional depreciation table, the a longer recovery period and/or a slow- depreciation allowances for the er depreciation method (as described in MACRS property beginning in the year paragraph (d)(4)(i) of this section), the of change are determined under para- depreciation allowances for the graph (d)(3)(i) or (4) of this section, as MACRS property for any 12-month tax- applicable. able year beginning with the year of (ii) Taxpayer chooses to use optional change are determined by choosing the depreciation table after a change in the optional depreciation table that cor- use. If a taxpayer chooses to use an op- responds to the depreciation system, tional depreciation table for the depreciation method, recovery period, MACRS property after a change in the and convention that would have ap- use, the depreciation allowances for plied to the MACRS property in the the MACRS property for any 12-month placed-in-service year had that prop- taxable year beginning with the year of erty been originally placed in service change are determined as follows: by the taxpayer with the longer recov- (A) Change in the use results in a short- ery period and/or the slower deprecia- er recovery period and/or a more acceler- tion method. If there is a change in the ated depreciation method. If a change in use of MACRS property, the applicable the use results in a shorter recovery convention that applies to the MACRS period and/or a more accelerated depre- property is the same as the convention ciation method (as described in para- that applied before the change in the graph (d)(3)(i) of this section), the de- use of the MACRS property. If the year preciation allowances for the MACRS of change or any subsequent taxable property for any 12-month taxable year year is less than 12 months, the depre- beginning with the year of change are ciation allowance determined under determined by multiplying the ad- this paragraph (d)(5)(ii)(B) must be adjusted depreciable basis of the MACRS justed for a short taxable year (for fur- property as of the first day of the year ther guidance, for example, see Rev.

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Proc. 89–15 (1989–1 C.B. 816) (see tion system changes from 7 years to 5 years. § 601.601(d)(2)(ii)(b) of this chapter)). The depreciation method does not change. (2) Computation of the depreciation al- On January 1, 2004, the adjusted depreciable lowance. The depreciation allowances basis of the equipment is $22,311. X depre- for the MACRS property for any 12- ciates its 5-year recovery property placed in service in 2004 under the general depreciation month taxable year beginning with the system by using the 200-percent declining year of change are computed by first balance method and a 5-year recovery period. determining the appropriate recovery X does not use the optional depreciation ta- year in the table identified under para- bles. graph (d)(5)(ii)(B)(1) of this section. (ii) Under paragraph (d)(3)(i) of this sec- The appropriate recovery year for the tion, X’s allowable depreciation deduction year of change is the year that cor- for the equipment for 2004 and subsequent responds to the year of change. For ex- taxable years is determined as though X ample, if the recovery year for the year placed the equipment in service in 2004 for of change would have been Year 4 in use primarily in its B business. The depre- the table that applied before the ciable basis of the equipment as of January change in the use of the MACRS prop- 1, 2004, is $22,311 (the adjusted depreciable erty, then the recovery year for the basis at January 1, 2004). Because X does not use the optional depreciation tables, the de- year of change is Year 4 in the table preciation allowance for 2004 (the deemed identified under paragraph placed-in-service year) for this equipment (d)(5)(ii)(B)(1) of this section. Next, the only is computed without taking into ac- annual depreciation rate (expressed as count the half-year convention. Pursuant to a decimal equivalent) for each recovery paragraph (d)(3)(i)(C) of this section, this year is multiplied by a transaction co- equipment is not eligible for the additional efficient. The transaction coefficient is first year depreciation deduction provided by the formula (1 / (1¥x)) where x equals section 168(k) or section 1400L(b). Thus, X’s the sum of the annual depreciation allowable depreciation deduction for the rates from the table identified under equipment for 2004 is $8,924 ($22,311 adjusted paragraph (d)(5)(ii)(B)(1) of this section depreciable basis at January 1, 2004, multiplied by the applicable depreciation rate of (expressed as a decimal equivalent) for 40% (200/5)). X’s allowable depreciation de- the taxable years beginning with the duction for the equipment for 2005 is $5,355 placed-in-service year of the MACRS ($13,387 adjusted depreciable basis at January property through the taxable year im- 1, 2005, multiplied by the applicable deprecia- mediately prior to the year of change. tion rate of 40% (200/5)). The product of the annual depreciation (iii) Alternatively, under paragraph rate and the transaction coefficient is (d)(3)(ii) of this section, X may elect to dis- multiplied by the adjusted depreciable regard the change in the use and, as a result, basis of the MACRS property as of the may continue to treat the equipment as beginning of the year of change. though it is used primarily in its A business. (6) Examples. The application of this If the election is made, X’s allowable depreciation deduction for the equipment for 2004 paragraph (d) is illustrated by the fol- is $8,924 ($22,311 adjusted depreciable basis at lowing examples: January 1, 2004, multiplied by the applicable Example 1. Change in the use results in a depreciation rate of 40% (1/2.5 years remain- shorter recovery period and/or a more acceler- ing at January 1, 2004)). X’s allowable depre- ated depreciation method and optional deprecia- ciation deduction for the equipment for 2005 tion table is not used. (i) X, a calendar-year is $8,925 ($13,387 adjusted depreciable basis at corporation, places in service in 1999 equip- January 1, 2005, multiplied by the applicable ment at a cost of $100,000 and uses this equip- depreciation rate of 66.67% (1/1.5 years re- ment from 1999 through 2003 primarily in its maining at January 1, 2005)). A business. X depreciates the equipment for Example 2. Change in the use results in a 1999 through 2003 under the general deprecia- shorter recovery period and/or a more acceler- tion system as 7-year property by using the ated depreciation method and optional deprecia- 200-percent declining balance method (which tion table is used. (i) Same facts as in Example switched to the straight-line method in 2003), 1, except that X used the optional deprecia- a 7-year recovery period, and a half-year con- tion tables for computing depreciation for vention. Beginning in 2004, X primarily uses 1999 through 2003. Pursuant to paragraph the equipment in its B business. As a result, (d)(5) of this section, X chooses to continue the classification of the equipment under to use the optional depreciation table for the section 168(e) changes from 7-year property equipment. X does not make the election to 5-year property and the recovery period of provided in paragraph (d)(3)(ii) of this sec- the equipment under the general depreciation to disregard the change in use.

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(ii) In accordance with paragraph half-year convention). Thus, the depreciation (d)(5)(ii)(A) of this section, X must first iden- allowance for 2004 is $6,398 ($48,000 adjusted tify the appropriate optional depreciation depreciable basis at January 1, 2004, multi- table for the equipment. This table is table 1 plied by the applicable depreciation rate of in Rev. Proc. 87–57 because the equipment 13.33% (1/7.5 years)). The depreciation allow- will be depreciated in the year of change ance for 2005 is $6,398 ($41,602 adjusted depre- (2004) under the general depreciation system ciable basis at January 1, 2005, multiplied by using the 200-percent declining balance the applicable depreciation rate of 15.38% (1/ method, a 5-year recovery period, and the 6.5 years remaining at January 1, 2005)). half-year convention (which is the conven- Example 4. Change in the use results in a tion that applied to the equipment in 1999). longer recovery period and/or a slower deprecia- Pursuant to paragraph (d)(3)(i)(C) of this section method and optional depreciation table is tion, this equipment is not eligible for the used—(i) Same facts as in Example 3, except additional first year depreciation deduction that Y used the optional depreciation tables provided by section 168(k) or section for computing depreciation in 2002 and 2003. 1400L(b). For 2004, X multiplies its adjusted Pursuant to paragraph (d)(5) of this section, depreciable basis in the equipment as of Jan- Y chooses to continue to use the optional de- uary 1, 2004, of $22,311, by the annual depre- preciation table for the equipment. Further, ciation rate in table 1 for recovery year 1 for pursuant to paragraph (d)(4)(i) of this sec- a 5-year recovery period (.20), to determine tion, the equipment is not eligible in 2004 for the depreciation allowance of $4,462. For 2005, the additional first year depreciation deduc- X multiplies its adjusted depreciable basis in tion provided by section 168(k) or section the equipment as of January 1, 2004, of 1400L(b). $22,311, by the annual depreciation rate in (ii) In accordance with paragraph table 1 for recovery year 2 for a 5-year recov- (d)(5)(ii)(B) of this section, Y must first de- ery period (.32), to determine the deprecia- termine the appropriate optional depreciation allowance of $7,140. tion table for the equipment pursuant to Example 3. Change in the use results in a paragraph (d)(5)(ii)(B)(1) of this section. This longer recovery period and/or a slower deprecia- table is table 8 in Rev. Proc. 87–57, which cor- tion method. (i) Y, a calendar-year corpora- responds to the alternative depreciation sys- tion, places in service in January 2002, equip- tem, the straight line method, a 9-year re- ment at a cost of $100,000 and uses this equip- covery period, and the half-year convention ment in 2002 and 2003 only within the United (because Y depreciated 5-year property in States. Y elects not to deduct the additional 2002 using a half-year convention). Next, Y first year depreciation under section 168(k). must determine the appropriate recovery Y depreciates the equipment for 2002 and 2003 year in table 8. Because the year of change is under the general depreciation system by 2004, the depreciation allowance for the using the 200-percent declining balance equipment for 2004 is determined using re- method, a 5-year recovery period, and a half- covery year 3 of table 8. For 2004, Y multi- year convention. Beginning in 2004, Y uses plies its adjusted depreciable basis in the the equipment predominantly outside the equipment as of January 1, 2004, of $48,000, by United States. As a result of this change in the product of the annual depreciation rate the use, the equipment is subject to the al- in table 8 for recovery year 3 for a 9-year re- ternative depreciation system beginning in covery period (.1111) and the transaction co- 2004. Under the alternative depreciation sys- efficient of 1.200 [1/(1¥(.0556 (table 8 for re- tem, the equipment is depreciated by using covery year 1 for a 9-year recovery period) + the straight line method and a 9-year recov- .1111 (table 8 for recovery year 2 for a 9-year ery period. The adjusted depreciable basis of recovery period)))], to determine the depre- the equipment at January 1, 2004, is $48,000. ciation allowance of $6,399. For 2005, Y multi- (ii) Pursuant to paragraph (d)(4) of this plies its adjusted depreciable basis in the section, Y’s allowable depreciation deduction equipment as of January 1, 2004, of $48,000, by for 2004 and subsequent taxable years is de- the product of the annual depreciation rate termined as though the equipment had been in table 8 for recovery year 4 for a 9-year re- placed in service in January 2002, as property covery period (.1111) and the transaction co- used predominantly outside the United efficient (1.200), to determine the deprecia- States. Further, pursuant to paragraph tion allowance of $6,399. (d)(4)(i) of this section, the equipment is not eligible in 2004 for the additional first year (e) Change in the use of MACRS prop- depreciation deduction provided by section erty during the placed-in-service year—(1) 168(k) or section 1400L(b). In determining the In general. Except as provided in para- applicable depreciation rate for 2004, the ap- graph (e)(2) of this section, if a change plicable depreciation method is the straight in the use of MACRS property occurs line method and the applicable recovery period is 7.5 years, which is the number of during the placed-in-service year and years remaining at January 1, 2004, for prop- the property continues to be MACRS erty placed in service in 2002 with a 9-year property owned by the same taxpayer, recovery period (taking into account the the depreciation allowance for that

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property for the placed-in-service year the end of the placed-in-service year; is determined by its primary use dur- or ing that year. The primary use of (B) The general depreciation system MACRS property may be determined in if the MACRS property is not described any reasonable manner that is consist- in section 168(g)(1)(B) or (D) at the end ently applied to the taxpayer’s MACRS of the placed-in-service year, unless property. For purposes of this para- other provisions of the Internal Rev- graph (e), the determination of whether enue Code or regulations under the In- the mid-quarter convention applies to ternal Revenue Code require the depre- any MACRS property placed in service ciation allowance for that MACRS during the year of change is made in property to be determined under the al- accordance with § 1.168(d)–1. ternative depreciation system (for ex- (2) Alternative depreciation system ample, section 168(g)(7)). (3) The application of this property—(i) Property used within and Examples. paragraph (e) is illustrated by the fol- outside the United States. The deprecia- lowing examples: tion allowance for the placed-in-service year for MACRS property that is used Example 1. (i) Z, a utility and calendar-year within and outside the United States is corporation, acquires and places in service determined by its predominant use dur- on January 1, 2004, equipment at a cost of ing that year. The determination of $100,000. Z uses this equipment in its combustion turbine production plant for 4 months whether MACRS property is used pre- and then uses the equipment in its steam dominantly outside the United States production plant for the remainder of 2004. during the placed-in-service year shall Z’s combustion turbine production plant as- be made in accordance with the test in sets are classified as 15-year property and are § 1.48–1(g)(1)(i) for determining pre- depreciated by Z under the general deprecia- dominant use. tion system using a 15-year recovery period (ii) Tax-exempt bond financed property. and the 150-percent declining balance method of depreciation. Z’s steam production The depreciation allowance for the plant assets are classified as 20-year property placed-in-service year for MACRS prop- and are depreciated by Z under the general erty that changes to tax-exempt bond depreciation system using a 20-year recovery financed property, as described in sec- period and the 150-percent declining balance tion 168(g)(1)(C) and (g)(5), during that method of depreciation. Z uses the optional taxable year is determined under the depreciation tables. The equipment is 50-per- alternative depreciation system. For cent bonus depreciation property for purposes of section 168(k). purposes of this paragraph (e), MACRS (ii) Pursuant to this paragraph (e), Z must property changes to tax-exempt bond determine depreciation based on the primary financed property when a tax-exempt use of the equipment during the placed-in- bond is first issued after the MACRS service year. Z has consistently determined property is placed in service. MACRS the primary use of all of its MACRS prop- property continues to be tax-exempt erties by comparing the number of full bond financed property in the hands of months in the taxable year during which a MACRS property is used in one manner with the taxpayer even if the tax-exempt the number of full months in that taxable bond (including any refunding issue) is year during which that MACRS property is not outstanding at, or is redeemed by, used in another manner. Applying this ap- the end of the placed-in-service year. proach, Z determines the depreciation allow- (iii) Other mandatory alternative depre- ance for the equipment for 2004 is based on ciation system property. The deprecia- the equipment being classified as 20-year tion allowance for the placed-in-service property because the equipment was used by Z in its steam production plant for 8 months year for MACRS property that changes in 2004. If the half-year convention applies in to, or changes from, property described 2004, the appropriate optional depreciation in section 168(g)(1)(B) (tax-exempt use table is table 1 in Rev. Proc. 87–57, which is property) or (D) (imported property the table for MACRS property subject to the covered by an Executive order) during general depreciation system, the 150-percent that taxable year is determined declining balance method, a 20-year recovery under— period, and the half-year convention. Thus, the depreciation allowance for the equip- (A) The alternative depreciation sys- ment for 2004 is $51,875, which is the total of tem if the MACRS property is de- $50,000 for the 50-percent additional first year scribed in section 168(g)(1)(B) or (D) at depreciation deduction allowable (the

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unadjusted depreciable basis of $100,000 mul- same taxpayer or the taxpayer may tiplied by .50), plus $1,875 for the 2004 depre- choose, on a property-by-property ciation allowance on the remaining adjusted basis, to apply the provisions of this depreciable basis of $50,000 [(the unadjusted depreciable basis of $100,000 less the addi- section. tional first year depreciation deduction of (2) Change in method of accounting—(i) $50,000) multiplied by the annual deprecia- In general. If a taxpayer adopted a tion rate of .0375 in table 1 for recovery year method of accounting for depreciation 1 for a 20-year recovery period]. due to a change in the use of MACRS Example 2. T, a calendar year corporation, property in a taxable year ending on or places in service on January 1, 2004, several after December 30, 2003, and the meth- computers at a total cost of $100,000. T uses od adopted is not in accordance with these computers within the United States for 3 months in 2004 and then moves and uses the the method of accounting for deprecia- computers outside the United States for the tion provided in this section, a change remainder of 2004. Pursuant to § 1.48– to the method of accounting for depre- 1(g)(1)(i), the computers are considered as ciation provided in this section is a used predominantly outside the United change in the method of accounting to States in 2004. As a result, for 2004, the com- which the provisions of sections 446(e) puters are required to be depreciated under and 481 and the regulations under sec- the alternative depreciation system of section 168(g) with a recovery period of 5 years tions 446(e) and 481 apply. Also, a rev- pursuant to section 168(g)(3)(C). T uses the ocation of the election provided in optional depreciation tables. If the half-year paragraph (d)(3)(ii) of this section to convention applies in 2004, the appropriate disregard a change in the use is a optional depreciation table is table 8 in Rev. change in method of accounting to Proc. 87–57, which is the table for MACRS which the provisions of sections 446(e) property subject to the alternative deprecia- and 481 and the regulations under section system, the straight line method, a 5- year recovery period, and the half-year con- tions 446(e) and 481 apply. However, if a vention. Thus, the depreciation allowance taxpayer adopted a method of account- for the computers for 2004 is $10,000, which is ing for depreciation due to a change in equal to the unadjusted depreciable basis of the use of MACRS property after De- $100,000 multiplied by the annual deprecia- cember 31, 1986, in a taxable year end- tion rate of .10 in table 8 for recovery year 1 ing before December 30, 2003, and the for a 5-year recovery period. Because the method adopted is not in accordance computers are required to be depreciated under the alternative depreciation system in with the method of accounting for de- their placed-in-service year, pursuant to sec- preciation provided in this section, the tion 168(k)(2)(C)(i) and § 1.168(k)–1T(b)(2)(ii), taxpayer may treat the change to the the computers are not eligible for the addi- method of accounting for depreciation tional first year depreciation deduction pro- provided in this section as a change in vided by section 168(k). method of accounting to which the pro- (f) No change in accounting method. A visions of sections 446(e) and 481 and change in computing the depreciation the regulations under sections 446(e) allowance in the year of change for and 481 apply. property subject to this section is not (ii) Automatic consent to change meth- a change in method of accounting od of accounting. A taxpayer changing under section 446(e). See § 1.446– its method of accounting in accordance 1(e)(2)(ii)(d)(3)(ii). with this paragraph (g)(2) must follow (g) Effective dates—(1) In general. This the applicable administrative proce- section applies to any change in the dures issued under § 1.446–1(e)(3)(ii) for use of MACRS property in a taxable obtaining the Commissioner’s auto- year ending on or after June 17, 2004. matic consent to a change in method of For any change in the use of MACRS accounting (for further guidance, for property after December 31, 1986, in a example, see Rev. Proc. 2002–9 (2002–1 taxable year ending before June 17, C.B. 327), (see § 601.601(d)(2)(ii)(b) of this 2004, the Internal Revenue Service will chapter)). Any change in method of ac- allow any reasonable method of depre- counting made under this paragraph ciating the property under section 168 (g)(2) must be made using an adjust- in the year of change and the subse- ment under section 481(a). For purposes quent taxable years that is consist- of Form 3115, Application for Change in ently applied to any property for which Accounting Method, the designated the use changes in the hands of the number for the automatic accounting

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method change authorized by this (i) Relinquished MACRS property. paragraph (g)(2) is ‘‘88.’’ If Form 3115 is (A) General rule. revised or renumbered, any reference in (B) Special rule. this section to that form is treated as (ii) Replacement MACRS property. (A) Remaining recovery period of the re- a reference to the revised or renum- placement MACRS property. bered form. (B) Year of replacement is 12 months. [T.D. 9132, 69 FR 33843, June 17, 2004, as (iii) Year of disposition or year of replace- amended by T.D. 9307, 71 FR 78068, Dec. 28, ment is less than 12 months. 2006] (iv) Deferred transactions. (A) In general. § 1.168(i)–5 Table of contents. (B) Allowable depreciation for a qualified intermediary. This section lists the major para- (v) Remaining recovery period. graphs contained in § 1.168(i)–6. (6) Examples. (d) Special rules for determining deprecia- § 1.168(i)–6 Like-kind exchanges and tion allowances. involuntary conversions. (1) Excess basis. (a) Scope. (i) In general. (b) Definitions. (ii) Example. (1) Replacement MACRS property. (2) Depreciable and nondepreciable prop- (2) Relinquished MACRS property. erty. (3) Time of disposition. (3) Depreciation limitations for auto- (4) Time of replacement. mobiles. (5) Year of disposition. (i) In general. (6) Year of replacement. (ii) Order in which limitations on deprecia- (7) Exchanged basis. tion under section 280F(a) are applied. (8) Excess basis. (iii) Examples. (9) Depreciable exchanged basis. (4) Involuntary conversion for which the (10) Depreciable excess basis. replacement MACRS property is acquired (11) Like-kind exchange. and placed in service before disposition (12) Involuntary conversion. of relinquished MACRS property. (c) Determination of depreciation allow- (e) Use of optional depreciation tables. ance. (1) Taxpayer not bound by prior use of (1) Computation of the depreciation allow- table. ance for depreciable exchanged basis be- (2) Determination of the depreciation de- ginning in the year of replacement. (i) In general. duction. (ii) Applicable recovery period, deprecia- (i) Relinquished MACRS property. tion method, and convention. (ii) Replacement MACRS property. (2) Effect of depreciation treatment of the (A) Determination of the appropriate op- replacement MACRS property by pre- tional depreciation table. vious owners of the acquired property. (B) Calculating the depreciation deduction (3) Recovery period and/or depreciation for the replacement MACRS property. method of the properties are the same, or (iii) Unrecovered basis. both are not the same. (3) Excess basis. (i) In general. (4) Examples. (ii) Both the recovery period and the depre- (f) Mid-quarter convention. ciation method are the same. (1) Exchanged basis. (iii) Either the recovery period or the de- (2) Excess basis. preciation method is the same, or both (3) Depreciable property acquired for non- are not the same. depreciable property. (4) Recovery period or depreciation method (g) Section 179 election. of the properties is not the same. (h) Additional first year depreciation de- (i) Longer recovery period. duction. (ii) Shorter recovery period. (i) Elections. (iii) Less accelerated depreciation method. (1) Election not to apply this section. (iv) More accelerated depreciation method. (2) Election to treat certain replacement (v) Convention. property as MACRS property. (A) Either the relinquished MACRS prop- (j) Time and manner of making election erty or the replacement MACRS property under paragraph (i)(1) of this section. is mid-month property. (1) In general. (B) Neither the relinquished MACRS prop- (2) Time for making election. erty nor the replacement MACRS prop- (3) Manner of making election. erty is mid-month property. (4) Revocation. (5) Year of disposition and year of replace- (k) Effective date. ment. (1) In general.

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