What impact does partial business use have on depreciation recapture reporting on Form 4797?
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Partial business use of property—meaning the property is used for both business (or income-producing) and personal purposes—has several important impacts on depreciation recapture reporting on Form 4797. The key issues are:
1. Depreciation Deductions Are Limited to Business Use
Depreciation (including section 179 and special depreciation allowances) can only be claimed for the portion of the property used in a trade or business or for the production of income. The personal-use portion is not depreciable. For example, if a piece of equipment is used 60% for business and 40% for personal purposes, only 60% of the cost is depreciable, and only 60% of the annual depreciation deductions (including section 179) are allowed.
2. Recapture Is Based on Depreciation Allowed or Allowable
When property is disposed of, the depreciation recapture rules (under sections 1245 and 1250) require that gain up to the amount of depreciation allowed or allowable be reported as ordinary income. For property with partial business use, only the depreciation attributable to the business/investment use is subject to recapture. The personal-use portion is not included in the recapture calculation.
- Section 1245 property: The amount recaptured as ordinary income is the lesser of (a) the depreciation allowed or allowable (for the business/investment use portion) or (b) the gain realized on the disposition.
- Section 1250 property: For real property, recapture applies only to the additional depreciation (i.e., depreciation in excess of straight-line) allowed or allowable for the business/investment use portion.
3. Reporting on Form 4797
- Part III of Form 4797 is used to calculate the recapture amount. Only the business/investment use portion of depreciation is entered on the relevant lines (e.g., line 22 for section 1245 property).
- The gain attributable to the business/investment use is reported and subject to recapture. Any gain attributable to the personal-use portion is generally a capital gain (if the property is a capital asset) and is not subject to depreciation recapture.
4. Change in Use and Recapture
If the business use of property drops to 50% or less during its recovery period, a recapture event occurs. The taxpayer must recapture as ordinary income the excess of the section 179 deduction (and, for listed property, any excess depreciation) over the depreciation that would have been allowable based on the actual business use.
- The recapture amount is reported as ordinary income on Form 4797, Part IV, and the basis of the property is increased by the recapture amount.
5. Allocation of Sales Proceeds
If the property is sold, the amount realized must be allocated between the business/investment and personal-use portions, typically based on relative fair market values. Only the business/investment portion is reported on Form 4797 and subject to recapture; the personal-use portion is reported on Schedule D if it is a capital asset.
6. Example
Suppose a taxpayer purchased equipment for $10,000, used it 60% for business, and claimed $3,000 in depreciation deductions over several years. Upon sale, the taxpayer must:
- Report only 60% of the gain and depreciation on Form 4797.
- The recapture amount is the lesser of $3,000 (depreciation allowed/allowable for business use) or the gain on the business-use portion of the property.
- The remaining gain (if any) on the business-use portion is section 1231 gain or capital gain, depending on the holding period and property type.
- The personal-use portion of the gain is not subject to recapture and is reported on Schedule D if applicable.
7. Recordkeeping
Taxpayers must keep records showing the allocation between business/investment and personal use, as well as the depreciation claimed for the business/investment portion.
Summary: Partial business use limits depreciation deductions and, correspondingly, limits the amount subject to depreciation recapture on Form 4797 to the business/investment use portion. Only the depreciation attributable to business/investment use is recaptured as ordinary income. The personal-use portion is not subject to recapture and is generally reported as a capital gain if applicable. Proper allocation and recordkeeping are essential for accurate reporting.
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