Depreciating post-1986 MACRS property on a change in use.

• Author: Reilly, Kevin F.

In July 2003, the IRS issued Sec. 168(i)(5) proposed regulations on computing depreciation on post-1986 modified accelerated cost recovery system (MACRS) property when there is a change in use.These changes include conversion to business or personal use and changes in the MACRS recovery period.

These types of situations are not new; taxpayers may have already developed a way to handle them. The proposed regulations provide additional guidance.Taxpayers facing this issue for the first tame may wish to adopt these rules. Taxpayers who have already developed a method to handle these situations can either continue to use their old method (as long as it is "reasonable" and consistently applied) or shift to the proposed method.When final regulations are issued, they will control the tax treatment.

Conversion from or to Personal Use

Conversion to business use: Under Prop. Regs. Sec. 1.168(i)-4(b), personal-use property converted to business or income-producing use is deemed MACRS property placed in service on the date of conversion. The converted property is subject to the MACRS depreciation methods, recovery periods and placed-in-service conventions applicable in the change year. Prop. Regs. Sec. 1.168(i)-4(b)(1) states that the depreciable basis in the change year is the lesser of the fair market value (FMV) or the adjusted depreciable basis at the time of conversion.

Example 1:

A personal residence is converted to mural property. If its original cost were $70,000 and its FMV at the time of conversion were $120,000, the MACRS depreciable basis would be $70,000.

Conversion to personal use: Under Prop. Regs. Sec. 1.168(i)-4(c), business or income-producing property converted to personal use is treated as a disposition; however, the taxpayer recognizes no gain, loss or depreciation recapture on the conversion. Depreciation in the change year hinges on the particular property's MACRS rules. There may also be depreciation recapture if the property is subsequently sold.

Example 2: The facts are the same as in Example 1; in addition, the former residence had been depreciated. Its adjusted basis at the time of the conversion back to business or income-producing use was $60,000. The $10,000 depreciation is not recaptured on conversion. However, the $10,000 depreciation might be subject to recapture if the property were subsequently sold; see Hey. Rul. 69-487.

Change in Use

Prop. Regs. Sec. 1.168(i)-4(d) discusses changes in the use of MACRS property that...