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Adjusted Gross Income

  • 715. How is adjusted gross income determined?

    • Adjusted gross income is determined by subtracting the following deductions from gross income:1 (a) expenses directly incurred in carrying on a trade, business or profession (not as an employee – see Q 8053); (b) the deduction allowed for contributions made by a self-employed individual to a qualified pension, annuity, profit sharing plan, a simplified employee pension or SIMPLE IRA plan; (c) certain reimbursed expenses of an employee in connection with his employment, provided the reimbursement is included in gross income (if the employee accounts to his employer and reimbursement does not exceed expenses, reporting is not required); (d) deductions related to property held for the production of rents and royalties (within limits); (e) deductions for depreciation and depletion by a life tenant, an income beneficiary of property held in trust, or an heir, legatee or devisee of an estate; (f) deductions for losses from the sale or exchange of property (see Q 702); (g) the deduction allowed for amounts paid in cash by an eligible individual to a traditional individual retirement account (IRA), or individual retirement annuity; (h) the deduction allowed for amounts forfeited as penalties because of premature withdrawal of funds from time savings accounts (see Q 7921); (i) alimony payments made to the taxpayer’s spouse (prior to 2019, see Q 791); (j) certain reforestation expenses; (k) certain jury duty pay remitted to the taxpayer’s employer; (l) moving expenses permitted by IRC Section 217; (m) the deduction for Archer Medical Savings Accounts under IRC Section 220(i); (n) the deduction for interest on education loans; (o) the deduction for qualified tuition and related expenses; (p) the deduction for contributions (within limits) to Health Savings Accounts; (q) the deduction for attorneys’ fees involving discrimination suits; and (r) and the deduction for certain expenses of elementary and secondary school teachers up to $250 (made permanent by the Protecting Americans from Tax Hikes Act of 2015 (PATH)). For tax years beginning after 2015, the $250 amount will be adjusted annually for inflation ($300 in 2022).


      Planning Point: IRS Revenue Procedure 2021-15 clarified that teachers and others who qualify for the educator expense deduction are entitled to deduct expenses paid for protective items to reduce the spread of Covid-19.  Generally, teachers, instructors, counselors and anyone else who is in a school for at least 900 hours during a school year are entitled to deduct up to $300 (in 2022) in qualifying educational expenses each year.  The deduction is often used by teachers who purchase items for the classroom that are not provided by the school.  Unreimbursed expenses paid or incurred after March 12, 2020 for protective items now qualify for the deduction.


      1. The new Section 199A deduction allowed to certain pass-through entities is not treated as a deduction here.

  • 716. What is the deduction for depreciation?

    • Depreciation is a deduction that permits recovery, over a period of time, of capital invested in tangible property used in a trade or business or held for the production of income.1 It is a deduction taken in arriving at adjusted gross income.2 Only property that has a limited useful life may be depreciated. Land does not have a limited life and, therefore, cannot be depreciated. However, the improvements on land can be depreciated. Inventory and stock in trade are not depreciable.3 A taxpayer who purchases a term interest in property cannot amortize or depreciate the cost of the property during any period in which the remainder interest is held by a related person. This rule is effective for interests created or acquired after July 27, 1989, in taxable years ending after such date.4 However, life tenants and beneficiaries of estates and trusts may be allowed the regular depreciation deduction if the property is depreciable property.5

      The method used to determine the rate of depreciation depends on when the property was placed into service. Property is “placed into service” when it is first placed in a condition or state of readiness and availability for a specifically assigned function for use in a trade or business, for the production of income, or in a tax-exempt or personal activity.6


      1 .IRC Secs. 167(a), 168(a), as amended by the CARES Act.

      2 .IRC Secs. 62(a)(1), 62(a)(4).

      3 .Treas. Reg. §1.167(a)-2.

      4 .IRC Sec. 167(e).

      5 .See IRC Sec. 167(d).

      6 .Prop. Treas. Reg. §1.168-2(l)(2).

  • 717. How is depreciation on property placed in service after 1986 calculated?

    • Editor’s Note 1: The 2017 Tax Act generally allows 100 percent bonus depreciation for business owners with respect to property that is placed in service after September 27, 2017 and before January 1, 2023. Further, under the 2017 Tax Act, the requirement that the property be originally placed into service by the taxpayer was removed (i.e., tax reform permits accelerated expensing of used assets, see ).[1]

      Editor’s Note 2: The 2020 CARES Act fixed the so-called “retail glitch” created by the 2017 tax reform legislation. See heading below for information on how to claim the relief.  See Q 720.

      Generally, the Accelerated Cost Recovery System (ACRS) was modified for property placed in service after 1986. An election could be made to apply the post-1986 ACRS to property that was placed in service between July 31, 1986 and January 1, 1987 (unless such property would have been subject to the anti-churning rules if it had been placed in service after 1986).[2] If real property is acquired before 1987 and converted from personal use to a depreciable use after 1986, the post-1986 ACRS is to be used.[3]

      The post-1986 ACRS deduction is calculated by applying to the basis of the property either (1) a declining balance method that switches to the straight line method at a time which maximizes the deduction or (2) a straight line method.[4] The initial basis in the property is the basis of the property upon acquisition (usually the cost of the property, see Q 692), reduced by the amount, if any, elected for amortization or an IRC Section 179 deduction (see ), and further reduced by any basis reduction required in connection with taking the investment tax credit (see Q 7894).[5] The basis of the property is reduced each year by the amount of the depreciation allowable.[6] Optional depreciation tables set out in Revenue Procedure 87-57 may be used in place of the methods above.[7] Because land cannot be depreciated, the cost basis of improved land must be allocated between the land and improvements.[8] The ACRS deduction is limited in the case of certain automobiles and other “listed property” placed in service after June 18, 1984. See “Limitations,” ().

      The classification of property by recovery period and depreciation method is as follows:[9]

      3 years 200% DB* class life of 4 years or less, certain horses, qualified rent-to-own property
      5 years 200% DB* class life of more than 4 but less than 10 (e.g., heavy trucks, buses, offshore drilling equipment, most computer and data handling equipment, cattle, helicopters and non-commercial aircraft, automobiles and light trucks)
      7 years 200% DB* class life of 10 or more but less than 16 (e.g., most office furnishings, most agricultural machinery and equipment, theme park structures, most railroad machinery, equipment and track, commercial aircraft), motorsports entertainment complexes, Alaska neutral gas pipelines, property without a class life and not otherwise classified under TRA ’86
      10 years 200% DB* class life of 16 or more but less than 20 (e.g., vessels, barges and similar water transportation equipment, petroleum refining equipment)
      15 years 150% DB* class life of 20 or more but less than 25 (e.g., industrial steam and electric generation/distribution systems, cement manufacturing equipment, commercial water transportation equipment (freight or passenger), nuclear power production plants)
      20 years 150% DB* class life of 25 or more (e.g., certain farm buildings, railroad structures and improvements, telephone central office buildings, gas utility production plants and distribution facilities), but excluding real property with class life of 27.5 years or more
      27.5 years straight line residential rental property
      39 years straight line nonresidential real property (class life of 27.5 years or more)
      50 years straight line railroad grading or tunnel bore
      * Declining balance method switching to the straight line method at a time to maximize the deduction. Substitute 150 percent DB for 200% DB if 3-, 5-, 7-, or 10-year property is used in a farming business. An election can be made to use the straight line method instead of the declining balance method. Also, with respect to 3-, 5-, 7-, and 10-year property, an election can be made to use 150 percent DB.

      Property is assigned to various class lives in Revenue Procedure 87-56.[10] These class lives can also be found in IRS Publication 946. The Tax Reform Act of 1986 assigned certain property to recovery periods without regard to their class life (e.g., automobiles and light trucks).

      Intangible property that is depreciable is subject to special recovery periods. If computer software is depreciable, the deduction is calculated using a straight line method over 36 months.[11] Computer software acquired after August 10, 1993 is generally depreciable if it:

      1. is a program designed to cause a computer to perform a desired function, (but generally not a database); and
      2. either (a) is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially modified, or (b) is not acquired in a transaction involving the acquisition of assets constituting a trade or business.[12]

      Certain mortgage servicing rights may be depreciated over 108 months using the straight line method.[13]

      Certain rights that are not acquired in a transaction involving the acquisition of a trade or business are subject to special rules for depreciation. Depreciation deductions for (1) rights to receive tangible property or services under a contract or a government grant; (2) interests in patents or copyrights; or (3) certain contracts of fixed duration or amount, are to be defined in the regulations.[14]

      Regulations generally require the amortization of the right to receive property under a contract or government grant by multiplying the basis of the right by a fraction. The numerator of the fraction is the amount of property or services received during the taxable year and the denominator is the total amount to be received under the contract or government grant. For a patent or copyright, the deduction is generally equal to the amount paid during a taxable year if the purchase price is paid on an annual basis as either a fixed amount per use or a fixed percentage of revenue from the patent or copyright, otherwise it is depreciated either ratably over its useful life or by using the income forecast method. The basis of a right to an unspecified amount over a fixed duration of less than fifteen years is amortized ratably over the period of the right.[15]

      In the years in which property is acquired or disposed of, depreciation is limited to the portion of the year in which the property is considered to be held under the following conventions: Residential rental property, nonresidential real property, and railroad grading or tunnel bore are treated as placed in service (or disposed of) on the mid-point of the month in which placed in service (or disposed of). Property, other than such real property, is generally treated as placed in service (or disposed of) on the mid-point of the year in which placed in service.

      However, the mid-quarter convention (instead of the mid-year convention) applies to depreciable property placed in service during the taxable year if the aggregate bases of property placed in service during the last three months of the taxable year exceeds 40 percent of the aggregate bases of property placed in service (or disposed of) during the taxable year (“the 40 percent test”). “Aggregate bases” is defined as the sum of the depreciable bases of all items of depreciable property taken into account in applying the 40 percent test.

      For taxable years ending after January 30, 1991, property not taken into account in applying the test include the following: (1) real property subject to the mid-month convention (described above), and (2) property placed in service and disposed of in the same taxable year. Conversely, property that would be taken into account in applying the 40 percent test includes: (1) listed property (discussed in ) placed in service during the taxable year, and (2) property placed in service, disposed of, subsequently reacquired, and again placed in service in the same taxable year (but only the basis of the property on the later of the dates that the property is placed in service is considered).[16] The IRS provided some relief from the mid-quarter convention if a taxpayer’s third or fourth quarter included September 11, 2001.[17]

      Regardless of whether the mid-year convention or the mid-quarter convention applies, no depreciation deduction is available for property placed in service and disposed of in the same year.[18]

      Property subject to the mid-month convention is treated as placed in service (or disposed of) on the mid-point of the month without regard to whether the taxpayer has a short taxable year (i.e., a taxable year that is less than twelve months). The mid-quarter 40 percent test is also made without regard to the length of the taxable year. Thus, if property (with exceptions, as noted in the preceding paragraphs) is placed in service in a taxable year of three months or less, the mid-quarter convention applies regardless of when such property was placed in service (i.e., 100 percent of property has been placed in service in the last three months).[19]

      In the case of a short taxable year and with respect to property to which the mid-year or mid-quarter convention applies, the recovery allowance is determined by multiplying the deduction that would have been allowable if the recovery year were not a short taxable year by a fraction, the numerator of which equals the number of months in the short taxable year and the denominator of which is twelve.[20] Proposed regulations under IRC Section 168(f)(5) (as in effect prior to TRA ’86) provided that a taxable year of a person placing property in service did not include any month prior to the month in which the person began engaging in a trade or business or holding recovery property for the production of income.[21] Presumably, this principle would continue to apply after TRA ’86.

      Unit of Production Method

      Instead of using ACRS, a property owner may elect to use the unit of production method of depreciation (if appropriate) or any other method not expressed in a term of years.[22] For example, under the unit of production method, the depreciation deduction for a machine that, it is estimated, will produce 1,000,000 shoes (units) before wearing out, and that produces 250,000 units in the first year, would be:

      (250,000 ÷ 1,000,000) × basis

      [1].     IRC Sec. 168(k)(2)(A)(ii), 168(k)(2)(E)(ii).

      [2].     TRA ’86, Sec. 203(a)(1)(B), as amended by TAMRA ’88, Sec. 1002(c)(1).

      [3].     TAMRA ’88, Sec. 1002(c)(3).

      [4].     IRC Sec. 168(b).

      [5].     IRC Sec. 50(c)(1); Treas. Reg. §1.179-1(f)(1).

      [6].     IRC Sec. 1016(a)(2).

      [7].     Rev. Proc. 87-57, 1987-2 CB 687.

      [8].     See Treas. Reg. §1.167(a)-5.

      [9].     IRC Secs. 168(c), 168(e), Rev. Proc. 87-57, above.

      [10].   1987-2 CB 674.

      [11].   IRC Sec. 167(f)(1).

      [12].   IRC Secs. 167(f)(1), 197(e)(3)(B).

      [13].   IRC Sec. 167(f)(3).

      [14].   IRC Sec. 167(f)(2).

      [15].   Treas. Reg. §1.167(a)-14(c).

      [16].   IRC Sec. 168(d); Treas. Reg. §1.168(d)-1.

      [17].   Notice 2001-74, 2001-2 CB 551.

      [18].   Treas. Reg. §1.168(d)-1(b)(3)(ii).

      [19].   Rev. Proc. 89-15, 1989-1 CB 816.

      [20].   Rev. Proc. 89-15, 1989-1 CB 816.

      [21].   Prop. Treas. Reg. §1.168-2(f)(4).

      [22].   IRC Sec. 168(f)(1).

  • 718. What is bonus depreciation? How did the 2017 tax reform legislation impact the bonus depreciation rules?

    • Bonus depreciation is a form of depreciation that allows taxpayers to take a larger depreciation deduction in the year property is first placed into service.  In general, for certain property acquired after September 11, 2001, and before January 1, 2005, a depreciation “bonus” of 30 percent could be taken in the year the property was placed in service.[1] For certain property acquired after May 5, 2003, and before January 1, 2005, 50 percent bonus depreciation could be taken.[2]

      The IRS has provided procedures on how to claim bonus depreciation.[3] Bonus first-year depreciation applies only to qualified property and is claimed in the first year that the property is placed in service. For eligible property, taxpayers were entitled to elect 50 percent bonus depreciation, 30 percent bonus depreciation, or no bonus depreciation. For certain qualified property placed in service in 2008 until 2017, bonus depreciation of 50 percent was allowed.[4]

      Under the 2017 tax reform legislation, the bonus depreciation allowable depends upon the year the property is placed in service, and is the following percentage of the unadjusted depreciable basis of qualified property:

      • Property placed in service after September 27, 2017 and before January 1, 2023: 100 percent expensing.
      • Property placed in service after December 31, 2022 and before January 1, 2024: 80 percent expensing.
      • Property placed in service after December 31, 2023 and before January 1, 2025: 60 percent expensing.
      • Property placed in service after December 31, 2024 and before January 1, 2026: 40 percent expensing.
      • Property placed in service after December 31, 2025 and before January 1, 2027: 20 percent expensing.
      • 2027 and thereafter: 0 percent expensing.[5]

      For certain property with longer production periods, the modified schedule that applies under the 2017 tax reform legislation is as follows:

      • Property placed in service after September 27, 2017 and before January 1, 2024: 100 percent expensing.
      • Property placed in service after December 31, 2023 and before January 1, 2025: 80 percent expensing.
      • Property placed in service after December 31, 2024 and before January 1, 2026: 60 percent expensing.
      • Property placed in service after December 31, 2025 and before January 1, 2027: 40 percent expensing.
      • Property placed in service after December 31, 2026 and before January 1, 2028: 20 percent expensing.
      • 2028 and thereafter: 0 percent expensing.[6]

      Under a transition rule, a business was entitled to elect to apply a 50 percent depreciation allowance instead of the 100 percent allowance for the taxpayer’s first tax year ending after September 27, 2017.[7]


      Planning Point: Some taxpayers expressed concern that the tax reform legislation’s changes to the bonus depreciation rules came too late for taxpayers to make the relevant elections on their 2016 or 2017 tax returns. In response, the IRS released guidance permitting taxpayers to revoke an election, or make a late election, for bonus depreciation with respect to certain property acquired by the taxpayer after September 27, 2017 and placed into service (or planted) during the tax year that included September 28, 2017. For taxpayers who filed their 2016 or 2017 returns on time, and claimed additional 100-percent bonus depreciation for property acquired after September 27, 2017 and placed in service during 2016 or 2017 tax years, the taxpayer could (1) file an amended return changing (to revoke or make a late election) the election before the taxpayer files its federal tax return for the first taxable year succeeding the 2016 taxable year or the 2017 taxable year or (2) file a Form 3115 with the taxpayer’s federal tax return for the first, second, or third taxable year succeeding the 2016 taxable year or the 2017 taxable year. Taxpayers who elect to deduct 50-percent, rather than 100-percent, bonus depreciation, could change their election by filing an amended return or Form 3115 within the same time frames.[8]


      For property used both in an individual’s trade or business (or for the production of income) and in a personal or tax-exempt activity during a taxable year, depreciation is allocated to all uses of the property, and only the portion attributable to the trade or business or production of income use is deductible.[9]

      [1].     IRC Sec. 168(k)(1), before amendment by ESA 2008.

      [2].     IRC Sec. 168(k)(4), before amendment by ESA 2008.

      [3].     Rev. Proc. 2003-50, 2003-29 IRB 119.

      [4].     IRC Sec. 168(k), as amended by ESA 2008, ARRA 2009, ATRA and the 2017 Tax Act.

      [5].      IRC Sec. 168(k)(6)(A).

      [6].      IRC Sec. 168(k)(6)(B).

      [7].      IRC Sec. 168(k)(8).

      [8].      Rev. Proc. 2019-33.

      [9].     Prop. Treas. Reg. §1.168-2(d)(2)(ii).

  • 719. How did the 2020 CARES Act fix the “Retail Glitch”?

    • The CARES Act provided retroactive relief for many business owners, including fixing the so-called “retail glitch” to allow businesses to take advantage of 100% bonus depreciation on qualified improvement property through 2022.[1] The CARES Act retroactively reduced the recovery period for qualified improvement property placed in service after 2017 from 39 years to 15 years. Eligible taxpayers may be entitled to a refund. Corporate taxpayers should also examine the interaction between the depreciation relief and the CARES Act NOL carryback relief.

      The IRS has provided guidance on how to make, revoke or withdraw elections relating to the CARES Act bonus depreciation rule changes. Because of the administrative burden of filing amended returns and average accounting returns (AARs), the IRS will treat late or revocable elections for property placed in service by taxpayers during their 2018, 2019, or 2020 taxable years, as a change in method of accounting with a Section 481(a) adjustment for a limited period of time. As a result, taxpayers can generally make, revoke or withdraw elections with respect to bonus depreciation by filing an amended tax return, AAR or Form 3115 (with the taxpayer’s federal income tax return or Form 1065). The action is essentially treated as changing from an impermissible method of determining depreciation to a permissible method. Returns or forms must generally be filed by October 15, 2021. This amended return or AAR must include the adjustment to taxable income for the change in determining depreciation of the qualified improvement property and any collateral adjustments to taxable income or to tax liability.[2]

      These election methods do not apply to certain farming businesses or electing real property businesses, who must make elections under the procedures in Revenue Procedure 2020-22. Partnerships subject to the partnership audit rules use the procedures in Revenue Procedure 2020-23.

      Revenue Procedure 2020-23 provides relief so that partnerships subject to the new partnership audit rules can also now file amended returns, rather than waiting to file current year returns to claim the benefits. Preexisting law may have prevented partnerships from filing amended Forms 1065 and Schedules K-1.[3] Partnerships may file amended returns and issue revised Schedules K-1 for 2018 and 2019 to take advantage of retroactive CARES Act bonus depreciation relief.

      The Revenue Procedure 2020-23 relief applies for 2018 and 2019 as long as the original Forms 1065 and Schedules K-1 were filed/issued before April 13, 2020 (the date Rev. Proc. 2020-23 was released). Partnerships can file amended Form 1065 and Schedule K-1 (electronically or by mail), by checking the Form 1065 “amended return” box and writing “FILED PURSUANT TO REV PROC 2020-23” at the top. The same notation must be included in a statement attached to amended Schedules K-1 sent to partners. The amended returns had to be filed/furnished to partners by September 30, 2020.

      ______________

      [1].      IRC Secs. 168(e)(3)(E)(vii), 168(g), as amended by the 2020 CARES Act.

      [2].      Rev. Proc. 2020-25.

      [3].      The Bipartisan Budget Act of 2015 limited the circumstances under which some partnerships were permitted to amend these documents.  Instead, partnerships would have been required to file an administrative adjustment request under IRC Section 6227, so that partners would not have received relief until filing returns for the current tax year. The deadline for filing an administrative adjustment request is October 15, 2021.

  • 720. How do the bonus depreciation rules apply to used property under the 2017 Tax Act?

    • The bonus depreciation rules (see Q 717) may be applied to used property if the property was not used by the taxpayer (or a predecessor) prior to the acquisition. The property is considered to have been used by the taxpayer or a predecessor prior to the acquisition if the taxpayer or predecessor had a depreciable interest in the property at any time prior to the acquisition, regardless of whether depreciation deductions were actually claimed.1

      Under the 2019 final regulations, “predecessor” is defined to include (i) a transferor of an asset to a transferee in a transaction to which IRC Section 381(a) applies, (ii) a transferor of an asset to a transferee in a transaction in which the transferee’s basis in the asset is determined, in whole or in part, by reference to the basis of the asset in the hands of the transferor, (iii) a partnership that is considered as continuing under IRC Section 708(b)(2), (iv) the decedent in the case of an asset acquired by an estate, or (v) a transferor of an asset to a trust.2

      Further, all of the following must be true:

      (1) the property was not acquired from certain related parties, including: (a) the taxpayer’s spouse, ancestors and descendants, (b) an individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the individual, (c) a grantor and a fiduciary of any trust, (d) a fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts, (e) a fiduciary and a beneficiary of a trust, (f) A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts, (g) a fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust, (h) a person and an organization to which IRC Section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual, (i) a corporation and a partnership if the same person owns more than 50 percent of the outstanding stock in the corporation or capital interest or profits of the partnership, (j) an S corporation and another S corporation if the same person owns more than 50 percent of the outstanding stock of each corporation, (k) an S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation, (l) the executor and beneficiary of an estate, (m) two partnerships in which the same person owns more than 50 percent of the capital interests and profits or (n) a partnership and a person owning more than 50 percent of the capital interests and profits of the partnership.


      Planning Point: The IRS regulations on the bonus depreciation rules contain a general anti-abuse rule that will apply to determine related party status.  The rules provide that in a series of related transactions, the property is treated as though it was transferred directly from its original owner to its ultimate owner.  The relationship between the original owner and the ultimate owner is tested immediately after the last transfer in the series of transactions. The 2019 final regulations provide for a five-year “lookback” period in making the determination as to whether the property was previously used by a prohibited party.3


      (2) the property was not acquired by one member of a controlled group from another member of that group,

      (3) the basis of the property in the hands of the person acquiring it is not determined in whole or part by reference to the adjusted basis of the property in the hands of the person from whom it was acquired or under IRC Section 1014(a) (basis of property acquired from a decedent),

      (4) the cost of the property does not include the basis of the property as determined by reference to the basis of other property held by the taxpayer.4


      1. Prop. Treas. Reg. §1.168(k)-2(b)(3)(C).

      2. Treas. Reg. §1.168(k)-2(a)(2)(iv).

      3. Prop. Treas. Reg. §1.168(k)-2(b)(3)(iii)(C).

      4. IRC Secs. 168(k)(2)(E)(ii), 267(b), 707(b).

  • 721. Are there any situations where a taxpayer can now claim bonus depreciation with respect to used property in which the taxpayer previously held an interest? How do the bonus depreciation rules apply to leased property?

    • In order to claim bonus depreciation with respect to used property, the property must not be used by the taxpayer or a predecessor at any time before the taxpayer acquired the property (see Q 720).  This requirement raised questions as to whether bonus depreciation could be available with respect to property that the taxpayer previously leased, or in which the taxpayer previously held an interest but did not own entirely. See the heading below for a discussion of the short holding period exception proposed in the 2019 regulations.

      Under the regulations, bonus depreciation may now be available for property that a taxpayer previously leased and later acquired.  In some situations, a taxpayer may make improvements to property that is leased and so obtain a depreciable interest in the property as a result.  If the taxpayer later acquires the property, bonus depreciation is unavailable with respect to the portion of the property in which the taxpayer held a depreciable interest during the lease period.1

      Relatedly, if a taxpayer originally held a depreciable interest in property, and later acquires an additional depreciable interest in an additional portion of the same property, the additional depreciable interest is not treated as though it was used by the taxpayer prior to acquisition (i.e., it is eligible for bonus depreciation under the used property rules if all other requirements are satisfied).  If the taxpayer previously had a depreciable interest in the subsequently acquired additional portion, bonus depreciation is not available.  A different rule applies in situations where a taxpayer sells a partial interest in property and later buys a partial interest in the same property.  If a taxpayer holds a depreciable interest in a portion of the property, sells that portion or a part of that portion, and later acquires a depreciable interest in another portion of the same property, the taxpayer is treated as previously having a depreciable interest in the property up to the amount of the portion for which the taxpayer held a depreciable interest in the property before the sale.2

      Under the 2019 proposed regulations, the mere fact that a business leases property to a disqualified business (i.e., one that does not qualify to use bonus depreciation, such as certain businesses with floor plan financing interest) does not “taint” the property, meaning that such exclusion from the additional first year depreciation deduction does not apply to lessors of property to a trade or business described in IRC Section 168(k)(9) so long as the lessor is not described the section.3

      Short Holding Period Exception

      The 2019 regulations provide an exception to the depreciable interest rule in situations where the taxpayer disposes of the property within a short period of time after placing the property in service.  If the following are true:

      (a) a taxpayer acquires and places in service property,
      (b) the taxpayer or a predecessor did not previously have a depreciable interest in the property,
      (c) the taxpayer disposes of the property to an unrelated party within 90 calendar days after the date the property was originally placed in service by the taxpayer (without taking into account the applicable convention), and
      (d) the taxpayer reacquires and again places in service the property,

      The taxpayer’s depreciable interest in the property during that 90-day period is not taken into account for determining whether the property was used by the taxpayer or a predecessor at any time prior to its reacquisition by the taxpayer.4 The proposed rule does not apply if the taxpayer reacquires and again places in service the property during the same taxable year the taxpayer disposed of the property.


      1. Treas. Reg. §1.168(k)-2(b)(3)(iii)(B)(1).

      2. Treas. Reg. §1.168(k)-2(b)(3)(iii)(B)(2).

      3. Treas. Reg. §1.168(k)- 2(b)(2)(ii)(F).

      4. Prop. Treas. Reg. §1.168(k)-2(b)(3)(iii)(B)(4).

  • 722. Is bonus depreciation available in situations involving a partnership buyout?

    • The proposed bonus depreciation regulations clarify when bonus depreciation will be available in the context of a partnership buyout.  Availability under the regulations depends upon whether the partnership itself buys out the departing partner in a redemption-type buyout, or whether the individual partners buy out the partner in a cross-purchase type buyout.

      If the partnership redeems the departing partner’s interest in partnership assets at a premium, so that the basis in the relevant assets increases, bonus depreciation is not available.  This is because the IRS views a redemption-type buyout as a transaction in which the partnership previously had an interest in the assets in question, rendering the assets ineligible for used asset treatment under Section 168(k).

      If the individual partners buy out the departing partner at a premium, resulting in an increase in basis, the “step up” in basis is eligible for bonus depreciation.  This is because the IRS views each partner as owning a separate and divided interest in the partnership property owned by the partnership, so that one partner does not have a previously existing interest in another partner’s share of partnership assets.1


      1.Prop. Treas. Reg. §1.168(k)-2(b)(3)(iii)(D).  See also IRC Secs. 743, 734.

  • 723. What is the alternative depreciation system that may be used to calculate depreciation on property placed in service after 1986?

    • An alternative depreciation system is provided for (1) tangible property used predominately outside the United States, (2) tax-exempt use property, (3) tax-exempt bond financed property, (4) certain imported property covered by an executive order regarding countries engaging in unfair trade practices, and (5) property for which an election is made. The election may be made with respect to each property in the case of nonresidential real property and residential rental property. For all other property, the election is made with respect to all property placed in service within a recovery class during a taxable year.1

      The alternative depreciation is determined using the straight line method and the applicable convention, above, over the following periods:2

      tax-exempt use property subject to a lease     

      longer of 125 percent of lease term or period below

      residential rental property

           and nonresidential real property

      40 years

      personal property with no class life

      12 years

      railroad grading or tunnel bore

      50 years

      all other property

      the class life

      TRA ’86 assigns certain property to recovery periods without regard to

      their class life, e.g., automobiles and light trucks.


      1 .IRC Sec. 168(g).

      2 .IRC Sec. 168(g)(2)(C).

  • 724. How are depreciable assets grouped into general asset classes?

    • Assets that are subject to either the general depreciation system of IRC Section 168(a) or the alternative depreciation system of IRC Section 168(g) may be grouped in one or more general asset accounts. The assets in a particular general asset account are generally depreciable as a single asset. Such an account must include only assets that have the same depreciation method, recovery period, convention, and that are placed in service in the same tax year. An asset may not be included in a general asset account if the asset is used in a personal activity at any time before the end of the tax year in which it was placed in service.1

      Upon disposition of an asset from a general asset account, the asset is treated as having an adjusted basis of zero, and the total amount realized on the disposition is generally recognized as ordinary income. However, the ordinary income treatment is limited to the unadjusted basis of the account less amounts previously recognized as ordinary income. The character of the amounts in excess of such ordinary income is determined under other applicable provisions of the IRC (other than IRC Sections 1245 and 1250). Because the basis of the property is considered to be zero, no loss is recognized on such a disposition. Generally, the basis in the account is recoverable only through depreciation, unless the taxpayer disposes of all the assets in the account.2


      1 .Treas. Reg. §1.168(i)-1(c), as modified by T.D. 9564.

      2 .Treas. Reg. §1.168(i)-1(e).

  • 725. When can a taxpayer elect to treat the cost of property as an expense in the year the property is placed in service under IRC Section 179?

    • A taxpayer may elect to treat the cost of certain qualifying property as an expense in the year the property is placed in service.1 To qualify, property must be eligible for depreciation or certain amortization provisions, it must be personal property (or fall within certain other categories described in IRC Section 1245(a)(3), such as property used for manufacturing or as a storage facility), and must have been acquired by purchase (from an unrelated person) for use in the active conduct of a trade or business. This property does not include any air conditioning or heating units or any ineligible property described in IRC Section 50(b) (certain property used outside the U.S., for lodging, by tax-exempt organizations, or by governments or foreign persons or entities). This election is not available to a trust or estate, nor can it be used for property held for the production of income.2

      For tax years beginning after December 31, 2017, the 2017 Tax Act expanded the definition of qualifying property3 to include certain depreciable tangible property used primarily to provide lodging or in connection with providing lodging, and to include certain improvements to nonresidential real property that is placed in service after the date that the underlying property was first placed in service (roofs, heating, ventilation, air conditioning, fire protection and alarm systems and security systems).4

      Recent legislation has raised the dollar amount that can be expensed for property placed in service in 2008 and beyond (these provisions were made permanent by the Protecting Americans from Tax Hikes Act of 2015 (PATH)). The aggregate cost deductible for 2008 and 2009 cannot exceed $250,000.5 The aggregate cost deductible for 2010 and thereafter is $500,000 (indexed for inflation; the amount for 2017 was $510,000). The annual dollar limitation was reduced by one dollar for each dollar of such investment above $800,000 for 2008 and 2009, above $2 million for 2010 and thereafter (as indexed).6 In 2017, the $2 million amount is indexed to $2,030,000 ($2,010,000 in 2016).7 The 2017 Tax Act increased the maximum amount that can be expensed during the tax year to $1,000,000,8 and increased the phase-out threshold amount from $2,000,000 to $2,500,000.9 These amounts are indexed for inflation for tax years beginning after 2018 ($1,020,000 and $2,550,000 for 2019, $1,040,000 and $2,590,000 for 2020, $1,050,000 and $2,620,000 for 2021, and $1,080,000 and $2,700,000 for 2022.10

      The amount expensed is limited to the aggregate amount of income derived from the active conduct of any trade or business of the taxpayer. An amount that is not deductible because it exceeds the aggregate taxable income from any trade or business may be carried over and taken in a subsequent year. The amount that may be carried over and taken in a subsequent year is the lesser of (1) the amounts disallowed because of the taxable income limitation in all prior taxable years (reduced by any carryover deductions in previous taxable years); or (2) the amount of unused expense allowance for such year. The amount of unused expense allowance is the excess of (1) the maximum cost of property that may be expensed taking into account the dollar and income limitations; over (2) the amount the taxpayer elects to expense.11 Married individuals filing separately are treated as one taxpayer for purposes of determining the amount that may be expensed and the total amount of investment in such property.12 The general business credit is not allowed for any amount expensed under IRC Section 179.13

      Deductions permitted pursuant to a valid election to expense costs are not prorated if the taxpayer has a short tax year.14


      1. IRC Sec. 179.

      2. IRC Secs. 179(d)(1), 179(d)(4).

      3. IRC Sec. 179(d)(1).

      4. IRC Sec. 179(f)(2).

      5. IRC Sec. 179(b)(7), as amended by ESA 2008, ARRA 2009, HIREA and ATRA.

      6. IRC Sec. 179(b)(7), as amended by ESA 2008, ARRA 2009, HIREA and ATRA.

      7. Rev. Proc. 2016-14, Rev. Proc. 2017-58, Rev. Proc. 2018-57.

      8. IRC Sec. 179(b)(1).

      9. IRC Sec. 179(b)(2).

      10. Rev. Proc. 2017-58, Rev. Proc. 2018-57, Rev. Proc. 2020-45, Rev. Proc. 2021-45.

      11. IRC Sec. 179(b)(3); Treas. Reg. §1.179-3.

      12. IRC Sec. 179(b)(4).

      13. IRC Sec. 179(d)(9).

      14. Treas. Reg. §1.179-1(c)(1).

  • 726. What special limitations apply to calculating depreciation on automobiles and other property classified as “listed property”?

    • Editor’s Note: The 2017 Tax Act increased the depreciation limits under Section 280F for passenger automobiles placed into service after December 31, 2017. These rules apply to passenger automobiles for which additional first-year depreciation under IRC Section 168(k) is not claimed.  The limits will be indexed for inflation for passenger automobiles that are placed in service after 2018. Computer and peripheral equipment are removed from the definition of listed property.1 These rules are effective for property placed into service after December 31, 2017 and for tax years ending after December 31, 2017. The IRS has also released safe harbor guidance that can be relied on for passenger automobiles placed into service before 2023 (see below).

      Limitations

      For any passenger automobile placed in service during taxable years after June 18, 1984, the amount of the depreciation deduction, including any amount elected as an expense (see above), cannot exceed the monetary limitations as set forth under the applicable heading in the exhibit, below. Note that once the unadjusted basis of an automobile is recovered, depreciation is no longer deductible. For certain automobiles acquired after September 11, 2001, and before January 1, 2005, the first year depreciation limitation was increased by $4,600. For certain automobiles purchased after May 5, 2003 and before January 1, 2005, the first year depreciation limit was increased by $7,650.2 For certain automobiles purchased after December 31, 2007 and before January 1, 2018, the first year depreciation limit was increased by $8,000.3

      Property

      Placed in Service

      First

      Year

      Second

      Year

      Third

      Year

      Succeeding

      Years

      6-19-84 through 4-2-85 $4,000 $6,000 $6,000 $6,000
      4-3-85 through 1986 $3,200 $4,800 $4,800 $4,800
      1987 and 1988 $2,560 $4,100 $2,450 $1,475
      1989 and 1990 $2,660 $4,200 $2,550 $1,475
      1991 $2,660 $4,300 $2,550 $1,575
      1992 $2,760 $4,400 $2,650 $1,575
      1993 $2,860 $4,600 $2,750 $1,675
      1994 $2,960 $4,700 $2,850 $1,675
      1995 and 1996 $3,060 $4,900 $2,950 $1,775
      1997 $3,160 $5,000 $3,050 $1,775
      1998 $3,160 $5,000 $2,950 $1,775
      1999 $3,060 $5,000 $2,950 $1,775
      2000, 2001, 2002, and 2003 $3,060 $4,900 $2,950 $1,775
      2004 $2,960 $4,800 $2,850 $1,675
      2005 $2,960 $4,700 $2,850 $1,675
      2006 $2,960 $4,800 $2,850 $1,775
      2007 $3,060 $4,900 $2,850 $1,775
      2008 and 2009 $2,960 $4,800 $2,850 $1,775
      2010 $3,060 $4,900 $2,950 $1,775
      2011 $3,060 $4,900 $2,950 $1,775
      2012 $3,160 $5,100 $3,050 $1,875
      2013 $3,160 $5,100 $3,050 $1,875
      2014 $3,160 $5,100 $3,050 $1,875
      2015 $3,160 $5,100 $3,050 $1,875
      2016 $3,160 $5,100 $3,050 $1,875
      2018 (acquired before Sept. 28, 2017) $16,400 $16,000 $9,600 $5,760
      2018 (acquired after Sept. 27, 2017) $18,000 $16,000 $9,600 $5,760[1]
      2019 (acquired before Sept. 28, 2017) $14,900 $16,100 $9,700 $5,760
      2019 (acquired after Sept. 27, 2017) $18,100 $16,100 $9,700 $5,760
      2020 $18,100 $16,100 $9,700 $5,760
      [Rev. Proc. 2020-37; Rev. Proc. 2019-26; Rev. Proc. 2018-25; Rev. Proc. 2017-29; Rev. Proc. 2016-23; Rev. Proc. 2015-19; Rev. Proc. 2014-21; Rev. Proc.2013-21; Rev. Proc. 2012-23; Rev. Proc. 2011-21; Rev. Proc. 2010-18, 2010-9 IRB 427; Rev. Proc. 2009-24, 2009-17 IRB 885; Rev. Proc. 2008-22, 2008-12 IRB 658; Rev. Proc. 2007-30, 2007-18 IRB 1104; Rev. Proc. 2006-18, 2006-12 IRB 645; Rev. Proc. 2005-13, 2005-12 IRB 759; Rev. Proc. 2004-20, 2004-13 IRB 642; Rev. Proc. 2003-75, 2003-2 CB 1018; Rev. Proc. 2002-14, 2002-1 CB 450; Rev. Proc. 2001-19, 2001-1 CB 732; Rev. Proc. 2000-18, 2000-1 CB 722; Rev. Proc. 99-14, 1999-1 CB 413; Rev. Proc. 98-30, 1998-2 CB 930; Rev. Proc. 97-20, 1997-1 CB 647; Rev. Proc. 96-25, 1996-1 CB 681; Rev. Proc. 95-9, 1995-1 CB 498; Rev. Proc. 94-53, 1994-2 CB 712; Rev. Proc. 93-35, 1993-2 CB 472; Rev. Proc. 92-43, 1992-1 CB 873; Rev. Proc. 91-30, 1991-1 CB 563; Rev. Proc. 90-22, 1990-1 CB 504; Rev. Proc. 89-64, 1989-2 CB 783; IRC Sec. 280F(a).]

      The dollar limitations are determined in the year the automobile is placed in service and are subject to an inflation adjustment (rounded to the nearest multiple of $100) for the calendar year in which the automobile is placed in service.The dollar amounts in the table above apply in situations where additional first year depreciation applies. If no additional first year depreciation applies, the respective amounts are $11,200, $18,000, $10,200 and $6,460 in 2022.

      Leased Passenger Automobiles

      Taxpayers who lease passenger automobiles and are allowed a deduction for the lease are required to reduce the deduction if the fair market value of the automobile is greater than a certain amount. For lease terms beginning in 2012, the amount was $18,500 and for lease terms beginning in 2013, the amount was $19,000. In 2014, the amount was reduced to $18,500, but Revenue Procedure 2015-19 modified Revenue Procedure 2014-21 and increased the amount to $19,000 for 2014.6 For lease terms beginning in 2015, the amount is reduced to $18,500, and for 2016-2017, the amount is once again $19,000.7 For 2018, and later years, the amount is increased significantly to $50,000 ($56,000 in 2022, as indexed for inflation).8

      This reduction is accomplished by including in gross income an amount determined from tables promulgated by the IRS. The amount to be added to income is dependent on the fair market value of the automobile at the time the lease term begins. The higher the value of the automobile, the more that is added to income.9 “Passenger automobiles” do not include ambulances, hearses, trucks, vans or other vehicles used by a taxpayer in a trade or business of transporting persons or property for compensation or hire.10

      The amount of the depreciation deduction is also limited for “listed property” placed in service (or leased) after June 18, 1984 (generally) if the business use of the property does not exceed 50 percent of its total use during the taxable year.11 “Listed property” includes any passenger automobile or other property used for transportation (generally, unless used in the transportation business); any property of a type used for entertainment, recreation or amusement; any computer (except computers used exclusively at a regular business establishment or at a dwelling unit that meets the home office requirement); any cellular telephone or similar equipment (but only for tax years that begin before January 1, 2010); or other property specified by the regulations.12 In the case of passenger automobiles, this personal use limitation is applied after the passenger automobile limitation, above.13

      If the business use of the listed property does not exceed 50 percent, depreciation under the regular pre-1987 ACRS and post-1986 ACRS is not allowed. For such property placed in service after 1986, the amount of the depreciation deduction is limited to that amount determined using the alternative depreciation system (see Q 717).14 For such property placed in service after June 18, 1984 and before 1987, the amount of the recovery is generally limited to that amount determined using the straight line method over the following earnings and profit lives:15

      In the case of:

         The applicable recovery period is:

      3-year property

      5 years

      5-year property

      12 years

      10-year property

      25 years

      15-year public utility property

      35 years

      19-year real prop. and low income housing

      40 years

      The more-than-50 percent business use requirement must be met solely by use of the listed property in a trade or business, without regard to the percentage of any use in another income producing activity. However, the percentage of use in any other income producing activity is added to the business use when determining the unadjusted basis of the property subject to depreciation (the unadjusted basis is the same as the initial basis, described above). If the listed property meets the more-than-50 percent business use requirement in the year it is placed in service and ceases to do so in a subsequent year, then any “excess depreciation” will be recaptured and included in gross income in the year it ceases to meet the requirement. “Excess depreciation” is the excess, if any, of the depreciation allowable while the property met the business use requirement over the depreciation that would have been allowable if the property had not met the requirement for the taxable year it was placed in service.16 This excess depreciation recapture is distinct from the depreciation recapture that occurs on early disposition; see Q 727.

      Safe Harbor

      The IRS has released safe harbor guidance that taxpayers can rely upon in depreciating passenger automobiles under the provisions of the 2017 tax reform legislation.  Assuming the depreciable basis of the passenger automobile is less than the first year limitation, the additional amount is generally deductible in the first tax year after the end of the recovery period.  Under the safe harbor, however, the taxpayer can take the depreciation deductible for the excess amounts during the recovery period up to the limits applicable to passenger autos during this time frame.  The IRS will publish a depreciation table in Appendix A of Publication 946, which taxpayers must use to apply the safe harbor.  The safe harbor only applies to passenger autos placed into service before 2023, and does not apply if (1) the taxpayer elected out of 100 percent first year depreciation or (2) elected to expense the automobile under Section 179.17


      1. IRC Sec. 280F(d)(4)(A), as amended by the 2017 Tax Act.

      2. See IRC Secs. 168(k)(2)(F), IRC Sec. 168(k)(4)(D), prior to amendment by ESA 2008.

      3. IRC Sec. 168(k)(2)(F), as amended by ESA 2008 and ARRA 2009.

      4. IRC Sec. 280F(a)(1)(A), as amended by the 2017 Tax Act.

      5. IRC Sec. 280F(d)(7).

      6. Rev. Proc. 2014-21, 2014-11 IRB 1.

      7. Rev. Proc. 2015-19; Rev. Proc. 2016-23; Rev. Proc. 2017-29.

      8. Rev. Proc. 2022-25, Table 3, Notice 2020-05.

      9. See Treas. Reg. §1.280F-7; Rev. Proc. 2012-23.

      10. IRC Sec. 280F(d)(5)(B).

      11. IRC Sec. 280F(b).

      12. IRC Sec. 280F(d)(4).

      13. IRC Sec. 280F(a)(2).

      14. IRC Sec. 280F(b)(1).

      15. IRC Secs. 280F(b)(2), 312(k), both as in effect prior to amendment by TRA ’86).

      16. IRC Sec. 280F(b)(2).

      17. Rev. Proc. 2019-13.

  • 727. How does the depreciation deduction impact an individual’s basis in the property? Must depreciation ever be “recaptured”?

    • Each year, an individual’s basis is reduced by the amount of the depreciation deduction taken so that his adjusted basis in the property reflects accumulated depreciation deductions. If depreciation is not deducted, his basis must nonetheless be reduced by the amount of depreciation allowable, but the deduction may not be taken in a subsequent year.1

      Recapture

      Upon disposition of property, the seller often realizes more than return of basis after it has been reduced for depreciation. Legislative policy is that on certain dispositions of depreciated property the seller realizes a gain that is, at least in part, attributable to depreciation. To prevent a double benefit, the IRC requires that some of the gain that would otherwise generally be capital gain must be treated as ordinary income. In effect, it requires the seller to “recapture” some of the ordinary income earlier offset by the depreciation.2 In addition, if depreciated property ceases to be used predominantly in a trade or business before the end of its recovery period, the owner must recapture in the tax year of cessation any benefit derived from expensing such property.3 This provision is effective for property placed in service in tax years ending after January 25, 1993.4


      1 .IRC Sec. 1016(a)(2).

      2 .IRC Secs. 1245, 1250.

      3 .Treas. Reg. §1.179-1(e)(1).

      4 .Treas. Reg. §1.179-6.

  • 728. What personal exemptions is an individual entitled to deduct in calculating taxable income?

    • Editor’s Note: The 2017 Tax Act suspended the personal exemption for tax years beginning after December 31, 2017 and before December 31, 2025. Qualified disability trusts will continue to be permitted a personal exemption amount equal to $4,150 for 2018, $4,200 for 2019, $4,300 for 2020-2021, and $4,400 for 2022.1

      For tax years beginning before 2018 (and after 2025), taxpayers generally were permitted to deduct the following personal exemption amounts: (1) For taxable years beginning in 2017, $4,050 for each of two spouses on a joint return ($8,100 combined); (2) $4,050 for a taxpayer filing a single or separate return; (3) $4,050 for the spouse of a taxpayer filing a separate return, provided the spouse has no gross income and is not claimed as the dependent of another taxpayer.2 The basic amount for 2016 was $4,050, in 2015 was $4,000, and in 2014 was $3,950. The personal exemption amount is adjusted annually for inflation.3 Generally, the exemption will not be allowed unless the Social Security number of the individual for whom the personal exemption is being claimed is provided.4


      Planning Point: When the personal exemption was in effect, it was used to help employers determine correct tax withholding for employees.  In the wake of tax reform,  IRS released a draft Form W-4 designed to reflect the new changes to the tax code, including the elimination of the personal exemption.  The new form is more complex and detailed than previously existing forms, because employers can no longer use the personal exemption to calculate withholding.  The form requests information regarding the employee’s credits and deductions, as well as any spouse’s income and income from other employment.  However, much of this information will be optional, although providing detailed income information will allow the employer to more accurately calculate the employee’s withholding.



      Planning Point: For purposes of the definition of “dependent” for other provisions in the IRC, the IRS has released guidance stating that the exemption amount (which was otherwise reduced to zero for 2018-2025) will be treated as though it remained at the pre-reform $4,150 amount in 2018. In other words, for purposes of determining whether a deduction is allowed for the personal exemption, the relevant amount is $0.  For provisions that reference the personal exemption for all other purposes, the relevant amount is $4,150 in 2018, $4,200 in 2019, $4,300 in 2020-2021, and $4,400 in 2022.5


      There was no phaseout of the personal exemptions based on adjusted gross income (AGI) in 2010-2012. The phaseout, including reductions of the phaseout in 2006 through 2009 and repeal of the phaseout for 2010, as well as its reinstatement for tax years beginning after 2012 and before 2018, is discussed below. Under the American Taxpayer Relief Act of 2012 (“ATRA”), the phaseout resumed for tax years beginning in 2013, but was suspended by the 2017 Tax Act.

      When in effect, the personal exemptions of certain upper income taxpayers are phased out over defined income levels. The dollar amount of personal and dependency exemptions of taxpayers with adjusted gross income above certain levels is reduced by an “applicable percentage” in the amount of two percentage points for every $2,500 (or fraction thereof; $1,250 in the case of a married individual filing separately) by which the taxpayer’s adjusted gross income exceeds the following threshold amounts in 2017: Married filing jointly (and surviving spouses); $313,800; Head of household: $287,650; Single: $261,500; Married filing separately: $156,900.

      The phaseout for 2017 was completed at the following income levels: Married filing jointly (and surviving spouses): $436,300; Head of household: $410,150; Single: $384,000; Married filing separately: $218,150.6 These amounts are adjusted annually for inflation.7

      In 2016, the amounts were: Married filing jointly (and surviving spouses); $311,300; Head of household: $285,350; Single: $259,400; Married filing separately: $155,650. The phaseout for 2016 was completed at the following income levels: Married filing jointly (and surviving spouses): $433,800; Head of household: $407,850; Single: $381,900; Married filing separately: $216,900.8

      In 2006 through 2010, the phaseout was gradually reduced each year until it was completely repealed. During this time, the amended phaseout amount was calculated by multiplying the otherwise applicable phaseout amount by the “applicable fraction.” The applicable fraction for each year was as follows: 66.6 percent (2/3) in 2006 and 2007; 33.3 percent (1/3) in 2008 and 2009; and 0 percent in 2010, 2011, and 2012.9

      A child or other dependent (i.e., an individual who may be claimed as a dependent by another taxpayer) who files his own return was not entitled to claim a personal exemption for himself.10

      See Q 760 for a discussion of the expanded child and family tax credits, which are designed to mitigate the impact of the elimination of the personal exemption.


      1. IRC Sec. 642(b)(2)(C)(iii); Re. Proc. 2017-58, Rev. Proc. 2019-44, Rev. Proc. 2020-45, Rev. Proc. 2021-45.

      2. Rev. Proc. 2014-61, Rev. Proc. 2015-53, Rev. Proc. 2016-55.

      3. IRC Sec. 151.

      4. IRC Sec. 151(e).

      5. Rev. Proc. 2017-58, Rev. Proc. 2019-44, Rev. Proc. 2020-45, Rev. Proc. 2021-45.

      6. Rev. Proc. 2014-61, Rev. Proc. 2015-53, Rev. Proc. 2016-55.

      7. IRC Secs. 151(d)(3), 151(d)(4); Rev. Proc. 2014-61.

      8. Rev. Proc. 2014-61, above.

      9. IRC Secs. 151(d)(3)(E), 151(d)(3)(F).

      10. IRC Sec. 151(d)(2).

  • 729. What conditions must be met to entitle the taxpayer to a dependency exemption?

    • Editor’s Note: The 2017 Tax Act suspended the personal exemption and dependency exemption for tax years beginning after December 31, 2017 and before December 31, 2025.  Qualified disability trusts will continue to be permitted a personal exemption amount equal to the “deemed personal exemption amount”, which is $4,400 in 2022, $4,300 in 2020-2021, $4,200 in 2019 and $4,150 in 2018 (as indexed for inflation).The same amounts apply for all other relevant IRC provisions.

      Prior to 2018, a taxpayer was entitled to claim the dependency exemption for each dependent with respect to whom the following tests were met.2 The term “dependent” means a “qualifying child” (see below) or a “qualifying relative” (see below).3

      Dependents were not entitled to claim a personal exemption for themselves in addition to the exemption claimed by the taxpayer who supports them.4 The dependent, if married, could not file a joint return with his or her spouse.5 In addition, the term “dependent” does not include an individual who is not a citizen or resident of the United States (or a resident of Canada or Mexico). However, a legally adopted child who does not satisfy the residency or citizenship requirements may nevertheless qualify as a dependent if certain requirements are met.6

      The taxpayer could claim the exemption even though the dependent files a return. The taxpayer was required to include the Social Security number of any dependent claimed on his return.7

      Qualifying child. The term “qualifying child” means an individual who:

      (1) is the taxpayer’s “child” (see below) or a descendant of such a child, or the taxpayer’s brother, sister, half-brother, half-sister, stepbrother, stepsister or a descendant of any such relative;

      (2) has the same principal place of abode as the taxpayer for more than one-half of the taxable year;

      (3) is younger than the taxpayer claiming the exemption and (i) has not attained the age of nineteen as of the close of the calendar year in which the taxable year begins, or (ii) is a student who has not attained the age of twenty-four as of the close of the calendar year;

      (4) has not provided over one-half of the individual’s own support for the calendar year in which the taxpayer’s taxable year begins; and

      (5) has not filed a joint tax return (other than for a refund) for the taxable year.8

      The term “child” means an individual who is: (1) a son, daughter, stepson, or stepdaughter of the taxpayer; or (2) an “eligible foster child” of the taxpayer.9 An “eligible foster child” means an individual who is placed with the taxpayer by an authorized placement agency or by judgment decree, or other order of any court of competent jurisdiction.10 Any adopted children of the taxpayer are treated the same as natural born children.11

      Qualifying relative. The term “qualifying relative” means an individual:

      (1) who is the taxpayer’s:

      (i) child or a descendant of a child,

      (ii) brother, sister, stepbrother, or stepsister,

      (iii) father or mother or an ancestor of either, or stepfather or stepmother,

      (iv) son or daughter of a brother or sister of the taxpayer,

      (v) brother or sister of the father or mother of the taxpayer,

      (vi) son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law, or

      (vii) an individual (other than a spouse) who, for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer’s household;

      (2) whose gross income for the calendar year in which the taxable year begins is less than the exemption amount (prior to 2018, see editor’s note, above);

      (3) for whom the taxpayer provides over one-half of the individual’s support for the calendar year in which the taxable year begins; and

      (4) who is not a qualifying child of the taxpayer or of any other taxpayer for any taxable year beginning in the calendar year in which the taxable year begins.

      The Service has provided guidance for determining whether an individual is a qualifying relative for whom the taxpayer could claim a dependency exemption deduction under IRC Section 151(c). The guidance clarifies that an individual is not a qualifying child of “any other taxpayer” if the individual’s parent (or other person with respect to whom the individual is defined as a qualifying child) is not required (by IRC Section 6012) to file an income tax return and either (1) does not file an income tax return, or (2) files an income tax return solely to obtain a refund of withheld income taxes.12

      Prior to 2018, the amount of the personal exemption ($4,050 in 2016 and 2017) is adjusted annually for inflation.13 The exemption was subject to phaseout for certain high-income taxpayers (but not in 2010-2012). For details, see Q 728.

      Life insurance premiums on a child’s life are not included in determining the cost of the child’s support.14

      The Tax Court held that a dependent’s self-employment loss did not reduce her earned income for purposes of determining her standard deduction under IRC Section 63(c)(5)(B).15


      1. IRC Sec. 642(b)(2)(C)(iii), Rev. Proc. 2018-57, Rev. Proc. 2019-44, Rev. Proc. 2020-45, Rev. Proc. 2021-45.

      2. IRC Secs. 151, 152.

      3. IRC Sec. 152(a).

      4. IRC Sec. 152(b)(1).

      5. IRC Sec. 152(b)(2).

      6. IRC Sec. 152(b)(3).

      7. See, e.g., Miller v. Comm., 114 TC 184 (2000).

      8. IRC Sec. 152(c), as amended by FCSIAA 2008. See also FS-2205-7 (Jan. 2005).

      9. IRC Sec. 152(f)(1).

      10. IRC Sec. 152(f)(1)(C).

      11. IRC Sec. 152(f)(1)(B).

      12. Notice 2008-5, 2008-2 IRB 256.

      13. Rev. Proc. 2015-53, Rev. Proc. 2016-55, Rev. Proc. 2017-58.

      14Kittle v. Comm., TC Memo 1975-150; Vance v. Comm., 36 TC 547 (1961).

      15Briggs v. Comm., TC Summary Opinion 2004-22.

  • 730. Who is entitled to claim a dependency exemption for a child in the case of divorced parents?

    • Editor’s Note: The 2017 Tax Act suspended the personal exemption and dependency exemption for tax years beginning after December 31, 2017 and before December 31, 2025.  For qualified disability trusts and all other relevant IRC provisions, the “deemed personal exemption amount” for 2022 is $4,400, 2020-2021 is $4,300, $4,200 in 2019 and $4,150 in 2018. [1]

      In tax years beginning prior to 2018, the following rules applied: In the case of divorced parents who between them provide more than one-half of a child’s support for the calendar year, and have custody of the child for more than one-half of the calendar year, the custodial parent (i.e., the one having custody for the greater portion of the year) is generally allowed the dependency exemption. However, the noncustodial parent can claim the exemption if the custodial parent signs a written declaration (i.e., Form 8332, or a statement conforming to the substance of Form 8332) agreeing not to claim the child as a dependent, and the noncustodial parent attaches the declaration to the tax return for the calendar year. The noncustodial parent can also claim the exemption if a divorce decree or separation agreement executed before 1985 expressly provides such and he provides at least $600 for the support of the child during the calendar year.[2] The Tax Court held that the special support rule under IRC Section 152(e) applies to parents who have never been married as well as divorced parents.[3]

      The Service has clarified that a custodial parent may revoke the release of the dependency exemption and, therefore, claim the dependency exemption himself, but only if the noncustodial parent agrees and does not claim the child.[4]

      In Miller v. Comm.,[5] the Tax Court denied the dependency exemption to the noncustodial parent where the custodial parent had not signed a release of the claim to the exemption.  The court order, which gave the noncustodial parent the right to claim the exemption, was held not to be a valid substitute.

      In Boltinghouse v. Comm.,[6] the Tax Court held that there is no requirement in IRC Section 152(e) or the regulations that a spouse’s waiver of his claim to a dependency exemption deduction be incorporated into a divorce decree to be effective. The court stated that such a requirement would make Form 8332 itself ineffective on its own. The court also recognized that under the applicable state law (Delaware), the separation agreement created binding contractual obligations that did not cease upon the entry of a divorce decree (regardless of whether the agreement was merged or incorporated into the decree).

      In Omans v. Comm.,[7] the Tax Court determined that the custodial parent’s certified signature on the settlement agreement signified her sworn agreement to the settlement agreement’s contents, including her former spouse’s entitlement to the dependency exemption.

      A state appeals court held that federal law does not preempt a state family law court in its discretion from alternating the dependency exemption between the parents, even though one parent may have custody during the calendar year for less than half the year.[8]

      The IRS has provided interim guidance under IRC Section 152(c)(4), which is the rule for determining which taxpayer may claim a qualifying child when two or more taxpayers claim the same child. It clarifies that unless the special rule in IRC Section 152(e) applies (see above), the tie-breaking rule in IRC Section 152(c)(4) applies to the head of household filing status, the child and dependent care credit, the child tax credit, the earned income credit, the exclusion for dependent care assistance, and the dependency deduction as a group, rather than on a section-by-section basis.[9]

       

      [1].      IRC Sec. 642(b)(2)(C)(iii), Rev. Proc. 2018-57, Rev. Proc. 2019-44, Rev. Proc. 2020-45, Rev. Proc. 2021-45.

      [2].     IRC Secs. 152(e)(1), 152(e)(2); Treas. Reg. §1.152-4.

      [3].     King v. Comm., 121 TC 245 (2003). See also Preamble, REG-149856-03, 72 Fed. Reg. 24192, 24194 (5-2-2007).

      [4].     IRS CCA 200007031.

      [5].     114 TC 184 (2000).

      [6].     TC Memo 2003-134.

      [7].     TC Summary Opinion 2005-110.

      [8].     Rios v. Pulido, 2002 Cal. App. LEXIS 4412 (2nd App. Dist. 2002).

      [9].     Notice 2006-86, 2006-51 IRB 680.