Partially Depreciable Assets

What if, for a single purchase price, you purchase an asset that is only partly depreciable? Before you can determine the depreciable tax basis of the asset, what you need to do is to allocate the price between the depreciable part and the nondepreciable part.

Example Raymond Anthony buys a property for use in his auto repair business for $100,000. On the lot is a building that was formerly used as a gas station. Considering the size and location of the property, and the size and repair of the building, a fair allocation of the price paid for the property might be $70,000 for the building and $30,000 for the land. In this example, the $70,000 paid for the building could be recovered through depreciation, while the $30,000 paid for the land could not, because land is not depreciable. But wouldn't it be better to allocate as much as possible to the building (say, $90,000), so Ray's depreciation deductions would be larger and his tax bill would be lower? Absolutely, but you can expect the IRS to attack your allocation if it doesn't reflect economic reality.

If an IRS auditor raises objections, you may need to bring in a real estate appraisal to support the allocation you use. In some states, real estate tax bills will show a separate assessment for the buildings and the land on a piece of property, which can be useful evidence in an IRS audit. Ideally, the allocation should have been made as part of the sales contract with which you originally acquired the property, and you should be prepared to prove that the allocation was a part of good faith negotiations between yourself and the seller.

If you acquire a number of assets at the same time (for example, you acquire a number of business assets in the course of buying a business), you need to allocate the purchase price among the various assets you purchased. The IRS provides special rules for doing this — consult your tax advisor for more details.

Mixed-use property. You also need to make an allocation if you have a single asset that is used partly for business and partly for personal purposes; for example, if you have a home office, or a car that you use sometimes for work and sometimes for family driving.

You will need to allocate the cost of the asset according to the percentage of usage that is strictly for business. For example, if 20 percent of the square footage of your home is used as an office, you may be able to depreciate 20 percent of the cost of the home; if 60 percent of the mileage you drive in your car is for business purposes, you may be able to depreciate 60 percent of the cost of the car.

For other business assets, the allocation would ordinarily be based on the amount of time you used the asset for business, compared to the amount of time you used it for personal or family purposes.

Example Although you don't qualify for the home office deduction, you have a computer at home on which you keep a backup copy of your accounting records, and which you use for other business purposes in the evenings. You also use the computer to keep track of your investments, surf the Internet, send and receive social E-mail, etc. Your computer time log shows that you've spent approximately 10 hours per week on the computer for business reasons, and approximately 5 hours per week for other purposes. Therefore, you can depreciate 2/3 of the cost of the computer.