Switch to actual

[jainen]

When you take standard mileage allowance the first year, you can switch to actual expenses later. How exactly do you calculate depreciation? You have elected out of MACRS so you can't do accelerated. What is the useful life at that point? Do you have to adjust the basis so you don't double-dip on depreciation already taken as a component of the standard mileage allowance? What about salvage value, which must be a factor under ordinary accounting rules ?

[Brad Imsdahl]

TheTaxBook, page 10-5, second column has an author’s comment that says: “Straight line depreciation mentioned in IRS Pub 463 in connection with the standard mileage rate is referring to pre-1981 straight line depreciation where the taxpayer estimates a salvage value and deducts the remainder straight line over the remaining useful life. Pre-1981 straight line cannot be elected in the first year an asset is placed in service. So there is no way for a taxpayer to use the actual expense method in the first year and qualify for the standard mileage rate in later years. The pre-1981 straight line method seems to only be sanctioned in IRS Pub. 463 for a taxpayer that chooses the standard mileage rate in the first year and then switches to actual expenses in a later year.”

This author’s comment has some history to back it up. I had some unofficial correspondence with an IRS person on this issue who told me that straight-line in connection with the standard mileage rate means pre-1981 straight line and not MACRS straight line. The reason being MACRS straight line is still a form of MACRS. Rev. Proc. 2005-78 (for 2006) specifically says code section 168 MACRS is not allowed. So it has to be a form of straight line not included in section 168 (or former section 168 for ACRS).

[Unregistered]

depreciation

How exactly do you calculate depreciation?


If you start using your car in 2003 with Standard miles, then in 2005 started using actual expense, the depreciation would start the date your use the car, which is 2003 and continue for 5 years. So for 2003 and 2004 the years you use standard miles, you use the depreciation component of standard mileage rate of .16 cent per miles for each year, then continue the depreciation in 2005 with SL

[jainen]

doesn't agree

That doesn't agree with what Brad posted, which is why I asked the question. First of all, how did you determine a 5-year life--wouldn't that depend on the specific car? Secondly, are you saying that in 2005 you deduct 1/5 of the original cost, or 1/3 (three years remaining), or some percent of the basis remaining after the 16 cent years? And did you start it at mid-month or mid-year or some other convention? And another question about basis: under straight line you aren't allowed full cost recovery, because there is always some salvage value. Just wondering.

[Brad Imsdahl]

Pre-1981 straight line method

Example:

Let’s say you bought a car in 2003 for $15,000 and used the standard mileage rate for 2003 and 2004. During 2003, you used the car 10,000 miles for business and 2,000 miles for personal. During 2004 you used the car 5,000 for business and 7,000 for personal.

Depreciation under the standard mileage rate is calculated as follows:

2003: 10,000 X 16¢ = $1,600
2004: 5,000 X 16¢ = $800

The 16 cents per mile is the depreciation component of the standard mileage rate for both 2003 and 2004.

The car’s adjusted basis is now $12,600 on January 1, 2005 ($15,000 minus $1,600 minus $800).

IRS Pub 463 says you can now switch to the actual expense method using straight line depreciation over the estimated useful life, taking into consideration a salvage value. This straight line depreciation is NOT 5 year MACRS straight line depreciation. It is pre-1981 straight line depreciation.

Prior to 1981, depreciable assets did not have class lives. The class life system was introduced under ACRS and later used by MACRS. Without a class life system, you would estimate the useful life under facts and circumstances that would apply to a particular business.

In our example, the basis of the car on January 1, 2005 is $12,600. Let’s assume the following:

A 2 year old car with 24,000 miles has 10 more years before it hits 150,000 miles. But let’s say that for business purposes, you don’t want to be driving a junk car. So it has another 7 years before it gets too old and rusty to be used for business. At that point, you estimate total mileage on the car to be around 110,000 miles and you could reasonably get $2,000 for it on the used car market. Let’s also assume that during 2005 you used the car 60% for business.

Straight line depreciation for 2005 is calculated as follows:

$12,600 minus $2,000 salvage value = $10,600
$10,600 multiplied by 60% = $6,360
$6,360 divided by 7 years = $909

Under the actual expense method, your 2005 depreciation deduction would be $909.

[jainen]

Thank you

Thank you. I think maybe I will buy your book after all.

[Black Bart]

Dang,

Brad. That was somethin'. This board is better'n a lifetime subscription to CCH.

I agree, jainen. I'd buy the book for an answer like that, if I hadn't already done it. When you want the very last, definitive and authoritative word on a tax topic, this obviously is the place to get it.

[Unregistered]

Another Guest

Thanks Brad, very good example, only correction is instead of using straight-line depreciation over the estimated useful life. Should be depreciation over the estimated remaining useful life. Probably doesn’t make any difference.

[RLymanC]

Salvage Value

Brad:
Your example was copied and saved with MSWord to be handed out as needed.

Great reply.

One thing that I would like to know however, what kind of auto in your example???
Mine is nowhere near that salvage value after like time in service. ;>)

[Brad Imsdahl]

Should be depreciation over the estimated remaining useful life. Probably doesn’t make any difference.

You are correct. It is the estimated remaining useful life.

One thing that I would like to know however, what kind of auto in your example???
Mine is nowhere near that salvage value after like time in service. ;>)

I sold my 1995 Pontiac Grand Am for $2,000 back in 2003. It had about 100,000 miles at the time. I also sold my 1989 GMC cargo van in 2001 for $2,000 when it had about 150,000 miles on it. I seem to be in a $2,000 rut when it comes to selling old vehicles.

[equinecpa]

Question on Adjusted Basis Calc

Brad;

I've got a customer switching to actual from standard.

One question I have is about the calculation of the new adjusted basis. How come the vehicle is not depreciated for the customers personal miles? It would seem to me the personal miles also depreciated the vehicle.

In my case I feel the adjusted basis I'm starting with, is way too high (it exceeds fair market value as at 01/01/05). And actually when I look at your example, don't you think the adjusted basis at 01/01/05 is rather high?

Carolyn

[jainen]

>>personal miles also depreciated the vehicle<<

That's why they changed the term to "cost recovery." You can't take a deduction for the personal use.

[Brad Imsdahl]

Adjusted basis only decreases for depreciation allowed or allowable. Depreciation is only allowed on business use property. Therefore, no depreciation occurs on personal use.

An example of this would be a computer you purchased 10 years ago for $2,000. You used it 100% for personal purposes. It is now worth $50. What is your basis in the computer?

Answer: $2,000.

However, if you convert your computer to business use, for depreciation purposes, the basis for depreciation is the lower of your adjusted basis or fair market value as of the date of conversion. So for depreciation purposes, you would use $50 for its depreciable basis.

Why is a car different?

In the case you described, the car was already being used for business when you claimed the standard mileage rate. So this is not a case where you are converting personal use property to business use. It is a case of simply switching depreciation methods – one that used the standard mileage method to the actual expense method, using straight line depreciation over its remaining estimated useful life.

If the remaining depreciable basis seems high in comparison to the fair market value, it could be because of high personal usage. In this case, that fact would probably not change after using the actual expense method. Depreciation is still going to be limited by the Section 280F limits in place during the year multiplied by the business percentage. So even though the depreciable basis seems high, the actual depreciation expense may still be low.

[KBTS]

What about the next year?

I brought this discussion back to the top of the forum because I had a client switch from standard to actual expenses in 2006. This thread was a great help in figuring out that year's depreciation amount. I followed Brad's example using a $5,000 salvage value and 5 years of life remaining.

Now the question is how do I calculate the depreciation for 2007 to determine if it is better to take actual expenses or mileage? I worked through it using the adjusted basis after subtracting 2006 depreciation with the same salvage value and 4 years of useful life - is that correct? Also, to complicate things, the client traded the vehicle in on May 1 for another vehicle so should I take 1/2 year depreciation for this year or just 4 months since it is Pre-1981 SL?

[Bees Knees]

Now the question is how do I calculate the depreciation for 2007 to determine if it is better to take actual expenses or mileage? I worked through it using the adjusted basis after subtracting 2006 depreciation with the same salvage value and 4 years of useful life - is that correct? Also, to complicate things, the client traded the vehicle in on May 1 for another vehicle so should I take 1/2 year depreciation for this year or just 4 months since it is Pre-1981 SL?

You would continue with the original life, basis, and salvage value in the year you first started using straight line depreciation and multiply that by business use.

For example, to continue with Brad’s example above:

Car purchased in 2003 for $15,000.
Taxpayer used the standard mileage rate for 2003 and 2004.
Business miles for 2003 = 10,000
Business miles for 2004 = 5,000
Depreciation component under the standard mileage rate is:
2003: 10,000 X 16¢ = $1,600
2004: 5,000 X 16¢ = $800
January 1, 2005, the car’s adjusted basis is = $12,600 ($15,000 minus $1,600 minus $800).
2005: Taxpayer switches to the actual expense method.
Assume on January 1, 2005 when the switch is made, the car has an estimated useful life of 7 years with a salvage value of $2,000 at the end of those 7 years.
Assume 60% business use during 2005
Straight line depreciation for 2005 is calculated as follows:
$12,600 minus $2,000 salvage value = $10,600
$10,600 multiplied by 60% = $6,360
$6,360 divided by 7 years = $909
Now you want to compute actual expense depreciation for 2006 assuming 75% business use. You do this by continuing to use the life and salvage value you first used in 2005 when the switch from standard mileage method to actual expense method was made.
$10,600 multiplied by 75% = $7,950
$7,950 divided by 7 years = $1,136
If you only used the vehicle for 4 months in 2006 because it was sold or traded or converted to personal use, you divide $1,136 by 12 months multiplied by 4 months = $380.
You do not figure depreciation as if the vehicle were used 50% during the year in the year sold or traded because the 50% rule is an ACRS or MACRS concept. Pre-1981 depreciation calculated straight line based on the number of months the asset was actually used for business during the year, similar to the way we figure amortization today.