Words you may need to know (see Glossary):

• Business/investment use
• Commuting
• Fair market value (FMV)
• Placed in service
• Recovery period
• Straight line method

If you do not use listed property predominantly (more than 50%) in a qualified business use, you cannot take a section 179 deduction for the property and you must depreciate the property using ADS (straight line method) over the ADS recovery period.

Listed property meets the predominant use test for any year if its qualified business use is more than 50% of its total use. You must allocate the use of any item of listed property used for more than one purpose during the year among its various uses. You cannot use the percentage of investment use of listed property as part of the percentage of qualified business use to meet the predominant use test. However, you do use the combined total of business and investment use to figure your depreciation deduction for the property.

Property does not stop being predominantly used in a qualified business use because of a transfer at death.

Example 1. Sarah Bradley uses a home computer 50% of the time to manage her investments. She also uses the computer 40% of the time in her part-time consumer research business. Sarah's home computer is listed property because it is not used at a regular business establishment. Because she does not use the computer more than 50% for business, it does not meet the predominant use test. Because it does not meet the predominant use test, she cannot elect a section 179 deduction for this property. Her combined rate of business/investment use for determining her depreciation deduction using ADS is 90%.

Example 2. If Sarah in Example 1 uses her computer 30% of the time to manage her investments and 60% of the time in her consumer research business, her property meets the predominant use test. She can elect a section 179 deduction. Her combined business/investment use for determining her depreciation deduction using GDS is 90%.

Qualified Business Use

A qualified business use is any use in your trade or business. However, it does not include the following.

• The use of property held merely to produce income (investment use).
• The leasing of property to any 5% owner or related person (to the extent that the property is used by a 5% owner or person related to the owner or lessee of the property).
• The use of property as pay for services of a 5% owner or related person.
• The use of property as pay for services of any person (other than a 5% owner or related person) unless the value of the use is included in that person's gross income and income tax is withheld on that amount where required. See Employees, later.

5% owner. Generally, a 5% owner is any person who owns more than 5% of the capital or profits interest in the business.

A 5% owner of a corporation is any person who owns, or is considered to own either of the following.

• More than 5% of the outstanding stock of the corporation.
• Stock possessing more than 5% of the total combined voting power of all stock in the corporation.

Related person. A related person is anyone related to a taxpayer as discussed in chapter 2 in Related persons under Nonqualifying Property.

Entertainment Use

Treat the use of listed property for entertainment, recreation, or amusement purposes as a qualified business use only to the extent you can deduct expenses (other than interest and property tax expenses) due to its use as an ordinary and necessary business expense.

Leasing or Compensatory Use of Aircraft

If at least 25% of the total use of any aircraft during the year is for a qualified business use, treat the leasing or compensatory use of the aircraft by a 5% owner or related person as a qualified business use.

Commuting

The use of an automobile for commuting is not business use, regardless of whether work is performed during the trip. For example, a business telephone call made on a car telephone while commuting to work does not change the character of the trip from commuting to business. This is also true for a business meeting held in a car while commuting to work. Similarly, a business call made on an otherwise personal trip does not change the character of a trip from personal to business. The fact that an automobile is used to display material that advertises the owner or user's trade or business does not convert an otherwise personal use into business use.

Use of Your Passenger Automobile by Another Person

If someone else uses your automobile, do not treat that use as business use unless one of the following applies.

1. That use is directly connected with your business.
2. You properly report the value of the use as income to the other person and withhold tax on the income where required.
3. You are paid a fair market rent.

Treat any payment to you for the use of the automobile as a rent payment for purposes of item (3).

Examples

The following examples illustrate whether the use of business property is qualified business use.

Example 1. John Maple is the sole proprietor of a plumbing contracting business. John employs his brother, Richard, in the business. As part of Richard's pay, he is allowed to use one of the company automobiles for personal use. The company includes the value of the personal use of the automobile in Richard's gross income and properly withholds tax on it. Because the use of the automobile is pay for the performance of services by a "related person," the use of the company automobile is not a qualified business use. See Qualified Business Use, earlier.

Example 2. John, in Example 1, allows unrelated employees to use company automobiles for personal purposes. He does not include the value of the personal use of the company automobiles as part of their compensation and he does not withhold tax on the value of the use of the automobiles. This use of company automobiles by employees is not a qualified business use.

Example 3. James Company Inc., owns several automobiles which its employees use for business purposes. The employees are also allowed to take the automobiles home at night. The fair market value of the use of an automobile for any personal purpose, such as commuting to and from work, is reported as income to the employees and James Company withholds tax on it. This use of company automobiles by employees, even for personal purposes, is a qualified business use for the company.

Employees

Any use by an employee of his or her own listed property (or listed property rented by an employee) in performing services as an employee is not business use unless both the following apply.

• The use is for the employer's convenience.
• The use is required as a condition of employment.

Employer's convenience. Whether the use of listed property is for the employer's convenience must be determined from all the facts. The use is for the employer's convenience if it is for a substantial business reason of the employer. The use of listed property during the employee's regular working hours to carry on the employer's business is generally for the employer's convenience.

Condition of employment. Whether the use of listed property is a condition of employment depends on all the facts and circumstances. The use of property must be required for the employee to perform duties properly. The employer does not have to explicitly require the employee to use the property. However, a mere statement by the employer that the use of the property is a condition of employment is not sufficient.

Example 1. Virginia Sycamore is employed as a courier with We Deliver, which provides local courier services. She owns and uses a motorcycle to deliver packages to downtown offices. We Deliver explicitly requires all delivery persons to own a car or motorcycle for use in their employment. Virginia's use of the motorcycle is for the convenience of We Deliver and is required as a condition of employment.

Example 2. Bill Nelson is an inspector for Uplift, a construction company with many sites in the local area. He must travel to these sites on a regular basis. Uplift does not furnish an automobile or explicitly require him to use his own automobile. However, it pays him for any costs he incurs in traveling to the various sites. The use of his own automobile or a rental automobile is for the convenience of Uplift and is required as a condition of employment.

Example 3. Assume the same facts as in Example 2 except that Uplift furnishes a car to Bill, who chooses to use his own car and receive payment for using it. The use of his own car is neither for the convenience of Uplift nor required as a condition of employment.

Example 4. Marilyn Lee is a pilot for Y Company, a small charter airline. Y requires pilots to obtain 80 hours of flight time annually in addition to flight time spent with the airline. Pilots can usually obtain these hours by flying with the Air Force Reserve or by flying part-time with another airline. Marilyn owns her own airplane. The use of her airplane to obtain the required flight hours is neither for the convenience of the employer nor required as a condition of employment.

Example 5. David Rule is employed as an engineer with Zip, an engineering contracting firm. He occasionally takes work home at night rather than work late in the office. He owns and uses a home computer which is virtually identical to the office model. His use of the computer is neither for the convenience of his employer nor a required condition of employment.

Employee deductions. Employees who meet the requirements for the use of listed property for both the employer's convenience and as a condition of employment can deduct depreciation, or rental expenses, for the business use of that property. Employees should report their expenses on Form 2106 or Form 2106-EZ and attach it to their individual income tax returns.

Method of Allocating Use

For passenger automobiles and other means of transportation, allocate the property's use on the basis of mileage. You determine the percentage of qualified business use by dividing the number of miles you drove the vehicle for business purposes during the year by the total number of miles you drove the vehicle for all purposes (including business miles) during the year.

For other items of listed property, allocate the property's use on the basis of the most appropriate unit of time. For example, you can determine the percentage of business use of a computer by dividing the number of hours you used the computer for business purposes during the year by the total number of hours you used the computer for all purposes (including business use) during the year.

Applying the Predominant Use Test

You must apply the predominant use test for an item of listed property each year of the recovery period. For example, if you place an item of listed property in service this year, you must apply the predominant use test for that property each year of the recovery period.

First Recovery Year

If you do not use an item of listed property predominantly in a qualified business use in the year you place it in service, the following rules apply.

• You cannot claim a section 179 deduction for the property.
• You must use ADS to figure depreciation on the property.

As discussed earlier in chapter 3 under When To Use ADS, using ADS means that you must figure your depreciation deduction using the straight line method over the ADS recovery period.

The required use of the straight line method for an item of listed property that does not meet the predominant use test is not the same as electing the straight line method. It does not mean that you have to use the straight line method for other property in the same class as the item of listed property.

Example. On July 1, James Wand bought and placed in service a computer, which is 5-year property, costing $4,000. During the year, he uses the computer 40% for qualified business use, 30% for investment purposes (to produce income), and 30% for personal use. James's computer is listed property because it is not used at a regular business establishment. Because the qualified business use is only 40%, he cannot elect any section 179 deduction and must use ADS to figure depreciation. Under ADS, he figures his depreciation deduction for the year using the straight line method over the ADS 5-year recovery period. To determine his deduction, he must first determine the business/investment portion of his property cost. He does this by multiplying the total cost by the combined business/investment use percentage ($4,000 x 70%). He then figures his depreciation deduction for the year. He refers to Table A-8 and obtains the first-year rate of 10% using the half-year convention. He then multiplies the combined business/investment portion of the cost by the first-year straight line rate ($2,800 x 10%). The result is his depreciation deduction for the year, $280.

Years After the First Recovery Year

If, in a year after you place an item of listed property in service, you fail to meet the predominant use test for that item of property, you may be required to recapture part of the section 179 and depreciation deductions claimed. You will also be required to figure your depreciation using the straight line method over the ADS recovery period.

Recapture of excess depreciation. For the first tax year you no longer use the property predominantly in a qualified business use, you must include any excess depreciation in both of the following.

• Your gross income.
• The adjusted basis of your property.

Excess depreciation is the result of the following.

• The depreciation allowable for the property (including any section 179 deduction claimed) for years before the first year you did not use the property predominantly in a qualified business use, minus
• The depreciation that would have been allowable for those years if you had not used the property predominantly in a qualified business use for the year you placed it in service. This means you figure your depreciation using the straight line method over the ADS recovery period.

For information on investment credit recapture, see the instructions for Form 4255.

Example. On June 25, 1996, Ellen Rye purchased and placed in service a pickup truck that cost $18,000. The pickup truck had a gross vehicle weight of 7,000 pounds. She used it only in a qualified business use for 1996 through 1999. Because the pickup truck weighed over 6,000 pounds, it was not subject to the limits that apply to passenger automobiles as discussed later under Special Rule for Passenger Automobiles. Ellen claimed a section 179 deduction of $10,000 based on the purchase of the truck. She began depreciating it using 200% DB over a 5-year GDS recovery period. If, during 2000, she had used the truck 50% for business and 50% for personal purposes, she would include $4,018 excess depreciation in her gross income. The excess depreciation would be determined as follows.

Total section 179 deduction ($10,000) and depreciation claimed ($6,618). Depreciation is from Table A-1.			$16,618
Depreciation allowable (Table A-8):
1996 - 10% of $18,000		$1,800
1997 - 20% of $18,000		3,600
1998 - 20% of $18,000		3,600
1999 - 20% of $18,000		3,600	12,600
Excess depreciation			$4,018

If her use of the truck did not change to 50% for business and 50% for personal purposes until 2002, she would not have to include any excess depreciation in income. This is because there would be no excess depreciation. The total depreciation allowable using Table A-8 through 2002 would be $18,000 which equals the total depreciation plus the section 179 deduction she claimed.

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