[Federal Register Volume 69, Number 116 (Thursday, June 17, 2004)]
[Rules and Regulations]
[Pages 33840-33848]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-13723]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9132]
RIN 1545-BB05


Changes in Use Under Section 168(i)(5)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations 
relating to the depreciation of property subject to section 168 of the 
Internal Revenue Code (MACRS property). Specifically, these regulations 
provide guidance on how to depreciate MACRS property for which the use 
changes in the hands of the same taxpayer. The regulations reflect 
changes to the law made by the Tax Reform Act of 1986.

DATES: Effective Date: These regulations are effective June 17, 2004.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.168(i)-1(l)(2) and 1.168(i)-4(g).

FOR FURTHER INFORMATION CONTACT: Sara Logan or Kathleen Reed, (202) 
622-3110 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR part 1. On July 21, 
2003, the IRS and Treasury Department published a notice of proposed 
rulemaking in the Federal Register (REG-138499-02; 68 FR 43047), 
relating to a change in the use of MACRS property in the hands of the 
same taxpayer (change in the use) under section 168(i)(5) of the 
Internal Revenue Code (Code) and relating to a change in the use of 
assets in a general asset account under section 168(i)(4). On March 1, 
2004, Sec. Sec.  1.168(a)-1 and 1.168(b)-1 that were contained in this 
notice of proposed rulemaking were withdrawn (REG-138499-02; 69 FR 
9560). No public hearing was requested or held. Written or electronic 
comments responding to the notice of proposed rulemaking were received. 
After consideration of all the comments, the proposed regulations are 
adopted as amended by this Treasury decision. The revisions are 
discussed below.

Explanation of Provisions

Scope

    The final regulations provide the rules for determining the annual 
depreciation allowance under section 168 for MACRS property as a result 
of a change in the use of such property. Changes in the use include a 
conversion of personal use property to a business or income-producing 
use, a conversion of MACRS property to personal use, or a change in the 
use of MACRS property that results in a different recovery period, 
depreciation method, or both.
I. Conversion to Business Use
    The final regulations retain the rules contained in the proposed 
regulations, providing that personal use property converted to business 
or income-producing use is treated as being placed in service by the 
taxpayer on the date of the conversion. Thus, the property is 
depreciated by using the applicable depreciation method, recovery 
period, and convention prescribed under section 168 for the property 
beginning in the taxable year the change in the use occurs (year of 
change). No comments were received suggesting changes to these rules. 
The final regulations, however, clarify that these rules do not apply 
when another section of the Code (or regulations under that section) 
prescribes the depreciation treatment for a change to business use. For 
example, if listed property (as defined in section 280F(d)(4)) is 
predominantly used by a taxpayer in a qualified business use in a 
taxable year, then in a subsequent taxable year is exclusively used by 
the taxpayer for personal purposes, and then in a later taxable year is 
predominantly used by the taxpayer in a qualified business use, section 
280F(b)(2)(A) requires that the property be depreciated under the 
alternative depreciation system of section 168(g) in the later taxable 
year and subsequent taxable years.
II. Conversion to Personal Use
    The final regulations retain the rule contained in the proposed 
regulations providing that a conversion of MACRS property from business 
or income-producing use to personal use is treated as a disposition of 
the property. Depreciation for the year of change is computed by taking 
into account the applicable convention. No gain, loss, or depreciation 
recapture is recognized upon the conversion. A commentator questioned 
whether recapture of excess depreciation under section 280F(b)(2) 
occurs upon a conversion of listed property from business use to only 
personal use. Upon this conversion, the listed property is not 
predominantly used in a qualified business use for that taxable year 
for purposes of section 280F(b) and, consequently, section 280F(b)(2) 
requires any excess depreciation (as defined in section 280F(b)(2)(B)) 
to be included in gross income for the taxable year in which the listed 
property is converted to personal use. Accordingly, the IRS and 
Treasury Department have included a cross-reference to section 
280F(b)(2) in the final regulations.
III. MACRS Property--Use Changes After Placed-In-Service Year
    The final regulations provide rules for MACRS property if a change 
in the use of the property occurs after the property's placed-in-
service year but the property continues to be MACRS property in the 
hands of the taxpayer.
    A. Determination of a change in the use. The final regulations 
remain unchanged from the proposed regulations. Consequently, a change 
in the use of MACRS property generally occurs when the primary use of 
the MACRS property in the taxable year is different from its primary 
use in the immediately preceding taxable year. However, in determining 
whether a taxpayer begins or ceases to use MACRS property predominantly 
outside the United States, the predominant use, instead of the primary 
use, of the MACRS property governs. A commentator questioned how this 
predominant use test is applied to rolling stock (for example, 
locomotives, freight and passenger train cars) that is not described 
under section 168(g)(4)(B) and that is used within and without the 
United States. This question concerns how to trace the movement of this 
rolling stock to determine its physical location, which the IRS and 
Treasury Department believe is beyond the scope of these regulations.
    B. Change in the use of MACRS property resulting in a different 
recovery period and/or depreciation method. The final regulations 
retain the rules contained in the proposed regulations for determining 
the applicable depreciation method, recovery period, and convention 
used to determine the depreciation allowances for the MACRS

[[Page 33841]]

property for the year of change and subsequent taxable years. 
Consequently, if a change in the use of MACRS property results in a 
shorter recovery period and/or a more accelerated depreciation method 
(for example, MACRS property ceases to be used predominantly outside 
the United States), the adjusted depreciable basis of the MACRS 
property as of the beginning of the year of change is depreciated over 
the shorter recovery period and/or by the more accelerated depreciation 
method beginning with the year of change as though the MACRS property 
is placed in service by the taxpayer in the year of change. If a change 
in the use of MACRS property results in a longer recovery period and/or 
a slower depreciation method (for example, MACRS property begins to be 
used predominantly outside the United States), the adjusted depreciable 
basis of the MACRS property as of the beginning of the year of change 
is depreciated over the longer recovery period and/or by the slower 
depreciation method beginning with the year of change as though the 
taxpayer originally placed the MACRS property in service with the 
longer recovery period and/or slower depreciation method.
    A commentator suggested that the depreciation allowances for all 
changes in the use of MACRS property resulting in a different recovery 
period and/or depreciation method be determined beginning with the year 
of change by treating the new depreciation method and/or recovery 
period as though they applied from the date the MACRS property was 
originally placed in service by the taxpayer. The commentator, in 
effect, is requesting that the rule contained in the proposed 
regulations for a change in the use of MACRS property that results in a 
longer recovery period and/or slower depreciation method also apply to 
a change in the use of MACRS property that results in a shorter 
recovery period and/or a more accelerated depreciation method. The IRS 
and Treasury Department continue to believe that the rules contained in 
the proposed regulations are reasonable because the rules determine the 
depreciation allowance for any taxable year based on the primary use of 
the MACRS property by the taxpayer during that year. Further, for a 
change in the use of MACRS property that results in a shorter recovery 
period and/or a more accelerated depreciation method, the taxpayer 
either may determine the depreciation allowances as though the MACRS 
property is placed-in-service by the taxpayer in the year of change or 
may elect to disregard the change in the use and determine the 
depreciation allowances as though the change in the use had not 
occurred. As a result, the final regulations do not require a recovery 
period that is longer than the recovery period applicable for the MACRS 
property in the taxable year immediately preceding the year of change. 
Accordingly, the commentator's suggestion was not accepted.
    Another commentator requested that Example 4 in Sec.  1.168(i)-
5(d)(6) be clarified by stating which optional depreciation tables the 
transaction coefficient factors are drawn from. The IRS and Treasury 
Department have adopted this suggestion.
IV. Change in the Use During the Placed-in-Service Year
    The final regulations retain the rules contained in the proposed 
regulations if a change in the use of MACRS property occurs during the 
taxable year the property is placed in service and the property 
continues to be MACRS property in the hands of the taxpayer. 
Accordingly, if the use of MACRS property changes during its placed-in-
service year, the depreciation allowance generally is determined by the 
primary use of the property during that taxable year. However, in 
determining whether MACRS property is used within or outside the United 
States during the placed-in-service year, the predominant use, instead 
of the primary use, of the MACRS property governs. Further, in 
determining whether MACRS property is tax-exempt use property or 
imported property covered by an Executive order during the placed-in-
service year, the use of the property at the end of the placed-in-
service year governs. Moreover, MACRS property is tax-exempt bond 
financed property during the placed-in-service year if a tax-exempt 
bond for the MACRS property is issued during the placed-in-service 
year.
V. General Asset Accounts
    Finally, the regulations amend the final regulations under section 
168(i)(4) (TD 8566, 59 FR 51369 (1994) and the temporary regulations 
under section 168(i)(4) (TD 9115, 69 FR 9529 (2004)) for property 
accounted for in a general asset account for which the use of the 
property changes, resulting in a different recovery period and/or 
depreciation method. These amendments are the same rules contained in 
the proposed regulations.

Effective Dates

    These regulations are applicable for any change in the use of MACRS 
property in a taxable year ending on or after June 17, 2004. For any 
change in the use of MACRS property after December 31, 1986, in a 
taxable year ending before June 17, 2004, the IRS will allow any 
reasonable method of depreciating the property under section 168 in the 
year of change and the subsequent taxable years that is consistently 
applied to the MACRS property for which the use changes in the hands of 
the same taxpayer. However, a taxpayer may choose, on a property-by-
property basis, to apply the final regulations to a change in the use 
of MACRS property after December 31, 1986, in a taxable year ending 
before June 17, 2004. In this case and consistent with Chief Counsel 
Notice 2004-007, Change in Litigating Position--Application of Section 
446(e) to Changes in Computing Depreciation (CC-2004-007, January 28, 
2004, at the IRS Internet site at www.irs.gov/foia), a change to the 
method of accounting for depreciation provided in the final regulations 
due to a change in the use of MACRS property in a taxable year ending 
on or after December 30, 2003, is a change in method of accounting and 
a change to the method of accounting for depreciation provided in the 
final regulations due to a change in the use of MACRS property after 
December 31, 1986, in a taxable year ending before December 30, 2003, 
may be treated by the taxpayer as a change in method of accounting.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations and, because 
these regulations do not impose on small entities a collection of 
information requirement, the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) does not apply to these regulations. Therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Code, the notice of proposed rulemaking was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Drafting Information

    The principal author of these regulations is Sara Logan, Office of 
Associate Chief Counsel (Passthroughs and Special Industries). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

[[Page 33842]]

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.168(i)-4 also issued under 26 U.S.C. 168(i)(5). * * *


0
Par. 2. Section 1.168(i)-0 is amended by revising the entry for Sec.  
1.168(i)-1(h)(2) and adding entries for Sec.  1.168(i)-1(h)(2)(i) 
through (h)(2)(iii) to read as follows:


Sec.  1.168(i)-0  Table of contents for the general asset account 
rules.

* * * * *


Sec.  1.168(i)-1  General asset accounts.

* * * * *
    (h) * * *
    (2) Change in use results in a different recovery period and/or 
depreciation method.
    (i) No effect on general asset account election.
    (ii) Asset is removed from the general asset account.
    (iii) New general asset account is established.
* * * * *


0
Par. 3. Section 1.168(i)-1 is amended by:
0
1. Revising paragraph (b)(1).
0
2. Amending paragraph (c)(2)(ii) by:
0
a. Removing the language ``and'' from the end of paragraph 
(c)(2)(ii)(C).
0
b. Removing the period ``.'' from the end of paragraph (c)(2)(ii)(D) 
and adding ``; and'' in its place.
0
c. Revising paragraph (c)(2)(ii)(E).
0
3. Removing the language ``the change in use occurs and'' from the last 
sentence of paragraph (h)(1) and adding ``the change in use occurs (the 
year of change) and'' in its place.
0
4. Revising paragraph (h)(2).
0
5. Removing the language ``(h)(1)'' from paragraph (k)(1) and adding 
``(h)'' in its place.
0
6. Revising paragraph (l).
    The revisions read as follows:


Sec.  1.168(i)-1  General asset accounts.

* * * * *
    (b) * * *
    (1) Unadjusted depreciable basis is the basis of an asset for 
purposes of section 1011 without regard to any adjustments described in 
section 1016(a)(2) and (3). This basis reflects the reduction in basis 
for the percentage of the taxpayer's use of property for the taxable 
year other than in the taxpayer's trade or business (or for the 
production of income), for any portion of the basis the taxpayer 
properly elects to treat as an expense under section 179, and for any 
adjustments to basis provided by other provisions of the Internal 
Revenue Code and the regulations under the Internal Revenue Code (other 
than section 1016(a)(2) and (3)) (for example, a reduction in basis by 
the amount of the disabled access credit pursuant to section 44(d)(7)). 
For property subject to a lease, see section 167(c)(2).
* * * * *
    (c) * * *
    (2) * * *
    (ii) * * *
    (E) Assets subject to paragraph (h)(2)(iii)(A) of this section 
(change in use results in a shorter recovery period and/or a more 
accelerated depreciation method) for which the depreciation allowance 
for the year of change (as defined in Sec.  1.168(i)-4(a)) is not 
determined by using an optional depreciation table must be grouped into 
a separate general asset account.
* * * * *
    (h) * * *
    (2) Change in use results in a different recovery period and/or 
depreciation method--(i) No effect on general asset account election. A 
change in the use described in Sec.  1.168(i)-4(d) (change in use 
results in a different recovery period and/or depreciation method) of 
an asset in a general asset account shall not cause or permit the 
revocation of the election made under this section.
    (ii) Asset is removed from the general asset account. Upon a change 
in the use described in Sec.  1.168(i)-4(d), the taxpayer must remove 
the asset from the general asset account as of the first day of the 
year of change and must make the adjustments to the general asset 
account described in paragraphs (e)(3)(iii)(C)(2) through (4) of this 
section. If, however, the result of the change in use is described in 
Sec.  1.168(i)-4(d)(3) (change in use results in a shorter recovery 
period and/or a more accelerated depreciation method) and the taxpayer 
elects to treat the asset as though the change in use had not occurred 
pursuant to Sec.  1.168(i)-4(d)(3)(ii), no adjustment is made to the 
general asset account upon the change in use.
    (iii) New general asset account is established--(A) Change in use 
results in a shorter recovery period and/or a more accelerated 
depreciation method. If the result of the change in use is described in 
Sec.  1.168(i)-4(d)(3) (change in use results in a shorter recovery 
period and/or a more accelerated depreciation method) and adjustments 
to the general asset account are made pursuant to paragraph (h)(2)(ii) 
of this section, the taxpayer must establish a new general asset 
account for the asset in the year of change in accordance with the 
rules in paragraph (c) of this section, except that the adjusted 
depreciable basis of the asset as of the first day of the year of 
change is included in the general asset account. For purposes of 
paragraph (c)(2) of this section, the applicable depreciation method, 
recovery period, and convention are determined under Sec.  1.168(i)-
4(d)(3)(i).
    (B) Change in use results in a longer recovery period and/or a 
slower depreciation method. If the result of the change in use is 
described in Sec.  1.168(i)-4(d)(4) (change in use results in a longer 
recovery period and/or a slower depreciation method), the taxpayer must 
establish a separate general asset account for the asset in the year of 
change in accordance with the rules in paragraph (c) of this section, 
except that the unadjusted depreciable basis of the asset, and the 
greater of the depreciation of the asset allowed or allowable in 
accordance with section 1016(a)(2), as of the first day of the year of 
change are included in the newly established general asset account. 
Consequently, this general asset account as of the first day of the 
year of change will have a beginning balance for both the unadjusted 
depreciable basis and the depreciation reserve of the general asset 
account. For purposes of paragraph (c)(2) of this section, the 
applicable depreciation method, recovery period, and convention are 
determined under Sec.  1.168(i)-4(d)(4)(ii).
* * * * *
    (l) Effective dates--(1) [Reserved]. For further guidance, see 
Sec.  1.168(i)-1T(l)(1).
    (2) Exceptions--(i) In general--(A) Paragraph (b)(1) of this 
section applies on or after June 17, 2004. For the applicability of 
Sec.  1.168(i)-1(b)(1) before June 17, 2004, see Sec.  1.168(i)-1(b)(1) 
in effect prior to June 17, 2004 (Sec.  1.168(i)-1(b)(1) as contained 
in 26 CFR part 1 edition revised as of April 1, 2004).
    (B) Paragraphs (c)(2)(ii)(E) and (h)(2) of this section apply to 
any change in the use of depreciable assets pursuant to Sec.  1.168(i)-
4(d) in a taxable year ending on or after June 17, 2004. For any change 
in the use of depreciable assets as described in Sec.  1.168(i)-4(d) 
after December 31, 1986, in a taxable year ending before June 17, 2004, 
the Internal Revenue Service will allow any reasonable method that is 
consistently

[[Page 33843]]

applied to the taxpayer's general asset accounts or the taxpayer may 
choose, on an asset-by-asset basis, to apply paragraphs (c)(2)(ii)(E) 
and (h)(2) of this section.
    (ii) Change in method of accounting--(A) In general. If a taxpayer 
adopted a method of accounting for general asset account treatment due 
to a change in the use of depreciable assets pursuant to Sec.  
1.168(i)-4(d) in a taxable year ending on or after December 30, 2003, 
and the method adopted is not in accordance with the method of 
accounting provided in paragraphs (c)(2)(ii)(E) and (h)(2) of this 
section, a change to the method of accounting provided in paragraphs 
(c)(2)(ii)(E) and (h)(2) of this section is a change in method of 
accounting to which the provisions of section 446(e) and the 
regulations under section 446(e) apply. However, if a taxpayer adopted 
a method of accounting for general asset account treatment due to a 
change in the use of depreciable assets pursuant to Sec.  1.168(i)-4(d) 
after December 31, 1986, in a taxable year ending before December 30, 
2003, and the method adopted is not in accordance with the method of 
accounting provided in paragraphs (c)(2)(ii)(E) and (h)(2) of this 
section, the taxpayer may treat the change to the method of accounting 
provided in paragraphs (c)(2)(ii)(E) and (h)(2) of this section as a 
change in method of accounting to which the provisions of section 
446(e) and the regulations under section 446(e) apply.
    (B) Automatic consent to change method of accounting. A taxpayer 
changing its method of accounting in accordance with this paragraph 
(l)(2)(ii) must follow the applicable administrative procedures issued 
under Sec.  1.446-1(e)(3)(ii) for obtaining the Commissioner's 
automatic consent to a change in method of accounting (for further 
guidance, for example, see Rev. Proc. 2002-9 (2002-1 C.B. 327), as 
modified by Rev. Proc. 2004-11 (2004-3 I.R.B. 311) (see Sec.  
601.601(d)(2)(ii)(b) of this chapter)). Because this change does not 
change the adjusted depreciable basis of the asset, the method change 
is made on a cut-off basis and, therefore, no adjustment under section 
481(a) is required or allowed. For purposes of Form 3115, Application 
for Change in Accounting Method, the designated number for the 
automatic accounting method change authorized by this paragraph 
(l)(2)(ii) is ``87.'' If Form 3115 is revised or renumbered, any 
reference in this section to that form is treated as a reference to the 
revised or renumbered form.
    (3) [Reserved]. For further guidance, see Sec.  1.168(i)-1T(l)(3).

0
Par. 4. Section 1.168(i)-1T is amended by:
0
1. Revising paragraphs (c)(2)(ii)(E) and (l)(2).
0
2. Removing the language ``(h)(1) (conversion to personal use)'' from 
paragraphs (d)(2) and (i) and adding ``(h) (changes in use)'' in its 
place.
0
3. Removing the language ``(h)(1)'' from paragraph (j) and adding 
``(h)'' in its place.
    The revisions read as follows:


Sec.  1.168(i)-1T  General asset accounts (temporary).

* * * * *
    (c) * * *
    (2) * * *
    (ii) * * *
    (E) [Reserved]. For further guidance, see Sec.  1.168(i)-
1(c)(2)(ii)(E).
* * * * *
    (l) * * *
    (2) [Reserved]. For further guidance, see Sec.  1.168(i)-1(l)(2).
* * * * *

0
Par. 5. Section 1.168(i)-4 is added to read as follows: Sec. 1.168(i)-4 
Changes in use.
    (a) Scope. This section provides the rules for determining the 
depreciation allowance for MACRS property (as defined in Sec.  
1.168(b)-1T(a)(2)) for which the use changes in the hands of the same 
taxpayer (change in the use). The allowance for depreciation under this 
section constitutes the amount of depreciation allowable under section 
167(a) for the year of change and any subsequent taxable year. For 
purposes of this section, the year of change is the taxable year in 
which a change in the use occurs.
    (b) Conversion to business or income-producing use--(1) 
Depreciation deduction allowable. This paragraph (b) applies to 
property that is converted from personal use to use in a taxpayer's 
trade or business, or for the production of income, during a taxable 
year. This conversion includes property that was previously used by the 
taxpayer for personal purposes, including real property (other than 
land) that is acquired before 1987 and converted from personal use to 
business or income-producing use after 1986, and depreciable property 
that was previously used by a tax-exempt entity before the entity 
changed to a taxable entity. Except as otherwise provided by the 
Internal Revenue Code or regulations under the Internal Revenue Code, 
upon a conversion to business or income-producing use, the depreciation 
allowance for the year of change and any subsequent taxable year is 
determined as though the property is placed in service by the taxpayer 
on the date on which the conversion occurs. Thus, except as otherwise 
provided by the Internal Revenue Code or regulations under the Internal 
Revenue Code, the taxpayer must use any applicable depreciation method, 
recovery period, and convention prescribed under section 168 for the 
property in the year of change, consistent with any election made under 
section 168 by the taxpayer for that year (see, for example, section 
168(b)(5)). See Sec. Sec.  1.168(k)-1T(f)(6)(iii) and 1.1400L(b)-
1T(f)(6) for the additional first year depreciation deduction rules 
applicable to a conversion to business or income-producing use. The 
depreciable basis of the property for the year of change is the lesser 
of its fair market value or its adjusted depreciable basis (as defined 
in Sec.  1.168(b)-1T(a)(4)), as applicable, at the time of the 
conversion to business or income-producing use.
    (2) Example. The application of this paragraph (b) is illustrated 
by the following example:

    Example. A, a calendar-year taxpayer, purchases a house in 1985 
that she occupies as her principal residence. In February 2004, A 
ceases to occupy the house and converts it to residential rental 
property. At the time of the conversion to residential rental 
property, the house's fair market value (excluding land) is $130,000 
and adjusted depreciable basis attributable to the house (excluding 
land) is $150,000. Pursuant to this paragraph (b), A is considered 
to have placed in service residential rental property in February 
2004 with a depreciable basis of $130,000. A depreciates the 
residential rental property under the general depreciation system by 
using the straight-line method, a 27.5-year recovery period, and the 
mid-month convention. Pursuant to Sec. Sec.  1.168(k)-
1T(f)(6)(iii)(B) or 1.1400L(b)-1T(f)(6), this property is not 
eligible for the additional first year depreciation deduction 
provided by section 168(k) or section 1400L(b). Thus, the 
depreciation allowance for the house for 2004 is $4,137, after 
taking into account the mid-month convention (($130,000 adjusted 
depreciable basis multiplied by the applicable depreciation rate of 
3.636% (1/27.5)) multiplied by the mid-month convention fraction of 
10.5/12). The amount of depreciation computed under section 168, 
however, may be limited under other provisions of the Internal 
Revenue Code, such as, section 280A.

    (c) Conversion to personal use. The conversion of MACRS property 
from business or income-producing use to personal use during a taxable 
year is treated as a disposition of the property in that taxable year. 
The depreciation allowance for MACRS property for the year of change in 
which the property is treated as being disposed of is determined by 
first multiplying the

[[Page 33844]]

adjusted depreciable basis of the property as of the first day of the 
year of change by the applicable depreciation rate for that taxable 
year (for further guidance, for example, see section 6 of Rev. Proc. 
87-57 (1987-2 C. B. 687, 692) (see Sec.  601.601(d)(2)(ii)(b) of this 
chapter)). This amount is then multiplied by a fraction, the numerator 
of which is the number of months (including fractions of months) the 
property is deemed to be placed in service during the year of change 
(taking into account the applicable convention) and the denominator of 
which is 12. No depreciation deduction is allowable for MACRS property 
placed in service and disposed of in the same taxable year. See 
Sec. Sec.  1.168(k)-1T(f)(6)(ii) and 1.1400L(b)-1T(f)(6) for the 
additional first year depreciation deduction rules applicable to 
property placed in service and converted to personal use in the same 
taxable year. Upon the conversion to personal use, no gain, loss, or 
depreciation recapture under section 1245 or section 1250 is 
recognized. However, the provisions of section 1245 or section 1250 
apply to any disposition of the converted property by the taxpayer at a 
later date. For listed property (as defined in section 280F(d)(4)), see 
section 280F(b)(2) for the recapture of excess depreciation upon the 
conversion to personal use.
    (d) Change in the use results in a different recovery period and/or 
depreciation method--(1) In general. This paragraph (d) applies to a 
change in the use of MACRS property during a taxable year subsequent to 
the placed-in-service year, if the property continues to be MACRS 
property owned by the same taxpayer and, as a result of the change in 
the use, has a different recovery period, a different depreciation 
method, or both. For example, this paragraph (d) applies to MACRS 
property that--
    (i) Begins or ceases to be used predominantly outside the United 
States;
    (ii) Results in a reclassification of the property under section 
168(e) due to a change in the use of the property; or
    (iii) Begins or ceases to be tax-exempt use property (as defined in 
section 168(h)).
    (2) Determination of change in the use--(i) In general. Except as 
provided in paragraph (d)(2)(ii) of this section, a change in the use 
of MACRS property occurs when the primary use of the MACRS property in 
the taxable year is different from its primary use in the immediately 
preceding taxable year. The primary use of MACRS property may be 
determined in any reasonable manner that is consistently applied to the 
taxpayer's MACRS property.
    (ii) Alternative depreciation system property--(A) Property used 
within or outside the United States. A change in the use of MACRS 
property occurs when a taxpayer begins or ceases to use MACRS property 
predominantly outside the United States during the taxable year. The 
determination of whether MACRS property is used predominantly outside 
the United States is made in accordance with the test in Sec.  1.48-
1(g)(1)(i) for determining predominant use.
    (B) Tax-exempt bond financed property. A change in the use of MACRS 
property occurs when the property changes to tax-exempt bond financed 
property, as described in section 168(g)(1)(C) and (g)(5), during the 
taxable year. For purposes of this paragraph (d), MACRS property 
changes to tax-exempt bond financed property when a tax-exempt bond is 
first issued after the MACRS property is placed in service. MACRS 
property continues to be tax-exempt bond financed property in the hands 
of the taxpayer even if the tax-exempt bond (including any refunding 
issue) is no longer outstanding or is redeemed.
    (C) Other mandatory alternative depreciation system property. A 
change in the use of MACRS property occurs when the property changes 
to, or changes from, property described in section 168(g)(1)(B) (tax-
exempt use property) or (D) (imported property covered by an Executive 
order) during the taxable year.
    (iii) Change in the use deemed to occur on first day of the year of 
change. If a change in the use of MACRS property occurs under this 
paragraph (d)(2), the depreciation allowance for that MACRS property 
for the year of change is determined as though the use of the MACRS 
property changed on the first day of the year of change.
    (3) Change in the use results in a shorter recovery period and/or a 
more accelerated depreciation method--(i) Treated as placed in service 
in the year of change--(A) In general. If a change in the use results 
in the MACRS property changing to a shorter recovery period and/or a 
depreciation method that is more accelerated than the method used for 
the MACRS property before the change in the use, the depreciation 
allowances beginning in the year of change are determined as though the 
MACRS property is placed in service by the taxpayer in the year of 
change.
    (B) Computation of depreciation allowance. The depreciation 
allowances for the MACRS property for any 12-month taxable year 
beginning with the year of change are determined by multiplying the 
adjusted depreciable basis of the MACRS property as of the first day of 
each taxable year by the applicable depreciation rate for each taxable 
year. In determining the applicable depreciation rate for the year of 
change and subsequent taxable years, the taxpayer must use any 
applicable depreciation method and recovery period prescribed under 
section 168 for the MACRS property in the year of change, consistent 
with any election made under section 168 by the taxpayer for that year 
(see, for example, section 168(b)(5)). If there is a change in the use 
of MACRS property, the applicable convention that applies to the MACRS 
property is the same as the convention that applied before the change 
in the use of the MACRS property. However, the depreciation allowance 
for the year of change for the MACRS property is determined without 
applying the applicable convention, unless the MACRS property is 
disposed of during the year of change. See paragraph (d)(5) of this 
section for the rules relating to the computation of the depreciation 
allowance under the optional depreciation tables. If the year of change 
or any subsequent taxable year is less than 12 months, the depreciation 
allowance determined under this paragraph (d)(3)(i) must be adjusted 
for a short taxable year (for further guidance, for example, see Rev. 
Proc. 89-15 (1989-1 C.B. 816) (see Sec.  601.601(d)(2)(ii)(b) of this 
chapter)).
    (C) Special rules. MACRS property affected by this paragraph 
(d)(3)(i) is not eligible in the year of change for the election 
provided under section 168(f)(1), 179, or 1400L(f), or for the 
additional first year depreciation deduction provided in section 168(k) 
or 1400L(b). See Sec. Sec.  1.168(k)-1T(f)(6)(iv) and 1.1400L(b)-
1T(f)(6) for other additional first year depreciation deduction rules 
applicable to a change in the use of MACRS property subsequent to its 
placed-in-service year. For purposes of determining whether the mid-
quarter convention applies to other MACRS property placed in service 
during the year of change, the unadjusted depreciable basis (as defined 
in Sec.  1.168(b)-1T(a)(3)) or the adjusted depreciable basis of MACRS 
property affected by this paragraph (d)(3)(i) is not taken into 
account.
    (ii) Option to disregard the change in the use. In lieu of applying 
paragraph (d)(3)(i) of this section, the taxpayer may elect to 
determine the depreciation allowance as though the change in the use 
had not occurred. The taxpayer elects this option by claiming on the 
taxpayer's timely filed (including

[[Page 33845]]

extensions) Federal income tax return for the year of change the 
depreciation allowance for the property as though the change in the use 
had not occurred. See paragraph (g)(2) of this section for the manner 
for revoking this election.
    (4) Change in the use results in a longer recovery period and/or a 
slower depreciation method--(i) Treated as originally placed in service 
with longer recovery period and/or slower depreciation method. If a 
change in the use results in a longer recovery period and/or a 
depreciation method for the MACRS property that is less accelerated 
than the method used for the MACRS property before the change in the 
use, the depreciation allowances beginning with the year of change are 
determined as though the MACRS property had been originally placed in 
service by the taxpayer with the longer recovery period and/or the 
slower depreciation method. MACRS property affected by this paragraph 
(d)(4) is not eligible in the year of change for the election provided 
under section 168(f)(1), 179, or 1400L(f), or for the additional first 
year depreciation deduction provided in section 168(k) or 1400L(b). See 
Sec. Sec.  1.168(k)-1T(f)(6)(iv) and 1.1400L(b)-1T(f)(6) for other 
additional first year depreciation deduction rules applicable to a 
change in the use of MACRS property subsequent to its placed-in-service 
year.
    (ii) Computation of the depreciation allowance. The depreciation 
allowances for the MACRS property for any 12-month taxable year 
beginning with the year of change are determined by multiplying the 
adjusted depreciable basis of the MACRS property as of the first day of 
each taxable year by the applicable depreciation rate for each taxable 
year. If there is a change in the use of MACRS property, the applicable 
convention that applies to the MACRS property is the same as the 
convention that applied before the change in the use of the MACRS 
property. If the year of change or any subsequent taxable year is less 
than 12 months, the depreciation allowance determined under this 
paragraph (d)(4)(ii) must be adjusted for a short taxable year (for 
further guidance, for example, see Rev. Proc. 89-15 (1989-1 C.B. 816) 
(see Sec.  601.601(d)(2)(ii)(b) of this chapter)). See paragraph (d)(5) 
of this section for the rules relating to the computation of the 
depreciation allowance under the optional depreciation tables. In 
determining the applicable depreciation rate for the year of change and 
any subsequent taxable year--
    (A) The applicable depreciation method is the depreciation method 
that would apply in the year of change and any subsequent taxable year 
for the MACRS property had the taxpayer used the longer recovery period 
and/or the slower depreciation method in the placed-in-service year of 
the property. If the 200-or 150-percent declining balance method would 
have applied in the placed-in-service year but the method would have 
switched to the straight line method in the year of change or any prior 
taxable year, the applicable depreciation method beginning with the 
year of change is the straight line method; and
    (B) The applicable recovery period is either--
    (1) The longer recovery period resulting from the change in the use 
if the applicable depreciation method is the 200-or 150-percent 
declining balance method (as determined under paragraph (d)(4)(ii)(A) 
of this section) unless the recovery period did not change as a result 
of the change in the use, in which case the applicable recovery period 
is the same recovery period that applied before the change in the use; 
or
    (2) The number of years remaining as of the beginning of each 
taxable year (taking into account the applicable convention) had the 
taxpayer used the longer recovery period in the placed-in-service year 
of the property if the applicable depreciation method is the straight 
line method (as determined under paragraph (d)(4)(ii)(A) of this 
section) unless the recovery period did not change as a result of the 
change in the use, in which case the applicable recovery period is the 
number of years remaining as of the beginning of each taxable year 
(taking into account the applicable convention) based on the recovery 
period that applied before the change in the use.
    (5) Using optional depreciation tables--(i) Taxpayer not bound by 
prior use of table. If a taxpayer used an optional depreciation table 
for the MACRS property before a change in the use, the taxpayer is not 
bound to use the appropriate new table for that MACRS property 
beginning in the year of change (for further guidance, for example, see 
section 8 of Rev. Proc. 87-57 (1987-2 C.B. 687, 693) (see Sec.  
601.601(d)(2)(ii)(b) of this chapter)). If a taxpayer did not use an 
optional depreciation table for MACRS property before a change in the 
use and the change in the use results in a shorter recovery period and/
or a more accelerated depreciation method (as described in paragraph 
(d)(3)(i) of this section), the taxpayer may use the appropriate new 
table for that MACRS property beginning in the year of change. If a 
taxpayer chooses not to use the optional depreciation table, the 
depreciation allowances for the MACRS property beginning in the year of 
change are determined under paragraph (d)(3)(i) or (4) of this section, 
as applicable.
    (ii) Taxpayer chooses to use optional depreciation table after a 
change in the use. If a taxpayer chooses to use an optional 
depreciation table for the MACRS property after a change in the use, 
the depreciation allowances for the MACRS property for any 12-month 
taxable year beginning with the year of change are determined as 
follows:
    (A) Change in the use results in a shorter recovery period and/or a 
more accelerated depreciation method. If a change in the use results in 
a shorter recovery period and/or a more accelerated depreciation method 
(as described in paragraph (d)(3)(i) of this section), the depreciation 
allowances for the MACRS property for any 12-month taxable year 
beginning with the year of change are determined by multiplying the 
adjusted depreciable basis of the MACRS property as of the first day of 
the year of change by the annual depreciation rate for each recovery 
year (expressed as a decimal equivalent) specified in the appropriate 
optional depreciation table. The appropriate optional depreciation 
table for the MACRS property is based on the depreciation system, 
depreciation method, recovery period, and convention applicable to the 
MACRS property in the year of change as determined under paragraph 
(d)(3)(i) of this section. The depreciation allowance for the year of 
change for the MACRS property is determined by taking into account the 
applicable convention (which is already factored into the optional 
depreciation tables). If the year of change or any subsequent taxable 
year is less than 12 months, the depreciation allowance determined 
under this paragraph (d)(5)(ii)(A) must be adjusted for a short taxable 
year (for further guidance, for example, see Rev. Proc. 89-15 (1989-1 
C.B. 816) (see Sec.  601.601(d)(2)(ii)(b) of this chapter)).
    (B) Change in the use results in a longer recovery period and/or a 
slower depreciation method--(1) Determination of the appropriate 
optional depreciation table. If a change in the use results in a longer 
recovery period and/or a slower depreciation method (as described in 
paragraph (d)(4)(i) of this section), the depreciation allowances for 
the MACRS property for any 12-month taxable year beginning with the 
year of change are determined by choosing the optional depreciation 
table that corresponds to the depreciation system, depreciation method, 
recovery period, and convention that would have applied to

[[Page 33846]]

the MACRS property in the placed-in-service year had that property been 
originally placed in service by the taxpayer with the longer recovery 
period and/or the slower depreciation method. If there is a change in 
the use of MACRS property, the applicable convention that applies to 
the MACRS property is the same as the convention that applied before 
the change in the use of the MACRS property. If the year of change or 
any subsequent taxable year is less than 12 months, the depreciation 
allowance determined under this paragraph (d)(5)(ii)(B) must be 
adjusted for a short taxable year (for further guidance, for example, 
see Rev. Proc. 89-15 (1989-1 C.B. 816) (see Sec.  601.601(d)(2)(ii)(b) 
of this chapter)).
    (2) Computation of the depreciation allowance. The depreciation 
allowances for the MACRS property for any 12-month taxable year 
beginning with the year of change are computed by first determining the 
appropriate recovery year in the table identified under paragraph 
(d)(5)(ii)(B)(1) of this section. The appropriate recovery year for the 
year of change is the year that corresponds to the year of change. For 
example, if the recovery year for the year of change would have been 
Year 4 in the table that applied before the change in the use of the 
MACRS property, then the recovery year for the year of change is Year 4 
in the table identified under paragraph (d)(5)(ii)(B)(1) of this 
section. Next, the annual depreciation rate (expressed as a decimal 
equivalent) for each recovery year is multiplied by a transaction 
coefficient. The transaction coefficient is the formula (1 / (1-x)) 
where x equals the sum of the annual depreciation rates from the table 
identified under paragraph (d)(5)(ii)(B)(1) of this section (expressed 
as a decimal equivalent) for the taxable years beginning with the 
placed-in-service year of the MACRS property through the taxable year 
immediately prior to the year of change. The product of the annual 
depreciation rate and the transaction coefficient is multiplied by the 
adjusted depreciable basis of the MACRS property as of the beginning of 
the year of change.
    (6) Examples. The application of this paragraph (d) is illustrated 
by the following examples:

    Example 1. Change in the use results in a shorter recovery 
period and/or a more accelerated depreciation method and optional 
depreciation table is not used--(i) X, a calendar-year corporation, 
places in service in 1999 equipment at a cost of $100,000 and uses 
this equipment from 1999 through 2003 primarily in its A business. X 
depreciates the equipment for 1999 through 2003 under the general 
depreciation system as 7-year property by using the 200-percent 
declining balance method (which switched to the straight-line method 
in 2003), a 7-year recovery period, and a half-year convention. 
Beginning in 2004, X primarily uses the equipment in its B business. 
As a result, the classification of the equipment under section 
168(e) changes from 7-year property to 5-year property and the 
recovery period of the equipment under the general depreciation 
system changes from 7 years to 5 years. The depreciation method does 
not change. On January 1, 2004, the adjusted depreciable basis of 
the equipment is $22,311. X depreciates its 5-year recovery property 
placed in service in 2004 under the general depreciation system by 
using the 200-percent declining balance method and a 5-year recovery 
period. X does not use the optional depreciation tables.
    (ii) Under paragraph (d)(3)(i) of this section, X's allowable 
depreciation deduction for the equipment for 2004 and subsequent 
taxable years is determined as though X placed the equipment in 
service in 2004 for use primarily in its B business. The depreciable 
basis of the equipment as of January 1, 2004, is $22,311 (the 
adjusted depreciable basis at January 1, 2004). Because X does not 
use the optional depreciation tables, the depreciation allowance for 
2004 (the deemed placed-in-service year) for this equipment only is 
computed without taking into account the half-year convention. 
Pursuant to paragraph (d)(3)(i)(C) of this section, this equipment 
is not eligible for the additional first year depreciation deduction 
provided by section 168(k) or section 1400L(b). Thus, X's allowable 
depreciation deduction for the equipment for 2004 is $8,924 ($22,311 
adjusted depreciable basis at January 1, 2004, multiplied by the 
applicable depreciation rate of 40% (200/5)). X's allowable 
depreciation deduction for the equipment for 2005 is $5,355 ($13,387 
adjusted depreciable basis at January 1, 2005, multiplied by the 
applicable depreciation rate of 40% (200/5)).
    (iii) Alternatively, under paragraph (d)(3)(ii) of this section, 
X may elect to disregard the change in the use and, as a result, may 
continue to treat the equipment as though it is used primarily in 
its A business. If the election is made, X's allowable depreciation 
deduction for the equipment for 2004 is $8,924 ($22,311 adjusted 
depreciable basis at January 1, 2004, multiplied by the applicable 
depreciation rate of 40% (1/2.5 years remaining at January 1, 
2004)). X's allowable depreciation deduction for the equipment for 
2005 is $8,925 ($13,387 adjusted depreciable basis at January 1, 
2005, multiplied by the applicable depreciation rate of 66.67% (1/
1.5 years remaining at January 1, 2005)).
    Example 2. Change in the use results in a shorter recovery 
period and/or a more accelerated depreciation method and optional 
depreciation table is used--(i) Same facts as in Example 1, except 
that X used the optional depreciation tables for computing 
depreciation for 1999 through 2003. Pursuant to paragraph (d)(5) of 
this section, X chooses to continue to use the optional depreciation 
table for the equipment. X does not make the election provided in 
paragraph (d)(3)(ii) of this section to disregard the change in use.
    (ii) In accordance with paragraph (d)(5)(ii)(A) of this section, 
X must first identify the appropriate optional depreciation table 
for the equipment. This table is table 1 in Rev. Proc. 87-57 because 
the equipment will be depreciated in the year of change (2004) under 
the general depreciation system using the 200-percent declining 
balance method, a 5-year recovery period, and the half-year 
convention (which is the convention that applied to the equipment in 
1999). Pursuant to paragraph (d)(3)(i)(C) of this section, this 
equipment is not eligible for the additional first year depreciation 
deduction provided by section 168(k) or section 1400L(b). For 2004, 
X multiplies its adjusted depreciable basis in the equipment as of 
January 1, 2004, of $22,311, by the annual depreciation rate in 
table 1 for recovery year 1 for a 5-year recovery period (.20), to 
determine the depreciation allowance of $4,462. For 2005, X 
multiplies its adjusted depreciable basis in the equipment as of 
January 1, 2004, of $22,311, by the annual depreciation rate in 
table 1 for recovery year 2 for a 5-year recovery period (.32), to 
determine the depreciation allowance of $7,140.
    Example 3. Change in the use results in a longer recovery period 
and/or a slower depreciation method--(i) Y, a calendar-year 
corporation, places in service in January 2002, equipment at a cost 
of $100,000 and uses this equipment in 2002 and 2003 only within the 
United States. Y elects not to deduct the additional first year 
depreciation under section 168(k). Y depreciates the equipment for 
2002 and 2003 under the general depreciation system by using the 
200-percent declining balance method, a 5-year recovery period, and 
a half-year convention. Beginning in 2004, Y uses the equipment 
predominantly outside the United States. As a result of this change 
in the use, the equipment is subject to the alternative depreciation 
system beginning in 2004. Under the alternative depreciation system, 
the equipment is depreciated by using the straight line method and a 
9-year recovery period. The adjusted depreciable basis of the 
equipment at January 1, 2004, is $48,000.
    (ii) Pursuant to paragraph (d)(4) of this section, Y's allowable 
depreciation deduction for 2004 and subsequent taxable years is 
determined as though the equipment had been placed in service in 
January 2002, as property used predominantly outside the United 
States. Further, pursuant to paragraph (d)(4)(i) of this section, 
the equipment is not eligible in 2004 for the additional first year 
depreciation deduction provided by section 168(k) or section 
1400L(b). In determining the applicable depreciation rate for 2004, 
the applicable depreciation method is the straight line method and 
the applicable recovery period is 7.5 years, which is the number of 
years remaining at January 1, 2004, for property placed in service 
in 2002 with a 9-year recovery period (taking into account the half-
year convention). Thus, the depreciation allowance for 2004 is 
$6,398 ($48,000 adjusted depreciable basis at January 1, 2004, 
multiplied by the applicable depreciation rate of 13.33% (1/7.5 
years)).

[[Page 33847]]

The depreciation allowance for 2005 is $6,398 ($41,602 adjusted 
depreciable basis at January 1, 2005, multiplied by the applicable 
depreciation rate of 15.38% (1/6.5 years remaining at January 1, 
2005)).
    Example 4. Change in the use results in a longer recovery period 
and/or a slower depreciation method and optional depreciation table 
is used--(i) Same facts as in Example 3, except that Y used the 
optional depreciation tables for computing depreciation in 2002 and 
2003. Pursuant to paragraph (d)(5) of this section, Y chooses to 
continue to use the optional depreciation table for the equipment. 
Further, pursuant to paragraph (d)(4)(i) of this section, the 
equipment is not eligible in 2004 for the additional first year 
depreciation deduction provided by section 168(k) or section 
1400L(b).
    (ii) In accordance with paragraph (d)(5)(ii)(B) of this section, 
Y must first determine the appropriate optional depreciation table 
for the equipment pursuant to paragraph (d)(5)(ii)(B)(1) of this 
section. This table is table 8 in Rev. Proc. 87-57, which 
corresponds to the alternative depreciation system, the straight 
line method, a 9-year recovery period, and the half-year convention 
(because Y depreciated 5-year property in 2002 using a half-year 
convention). Next, Y must determine the appropriate recovery year in 
table 8. Because the year of change is 2004, the depreciation 
allowance for the equipment for 2004 is determined using recovery 
year 3 of table 8. For 2004, Y multiplies its adjusted depreciable 
basis in the equipment as of January 1, 2004, of $48,000, by the 
product of the annual depreciation rate in table 8 for recovery year 
3 for a 9-year recovery period (.1111) and the transaction 
coefficient of 1.200 [1/(1-(.0556 (table 8 for recovery year 1 for a 
9-year recovery period) + .1111 (table 8 for recovery year 2 for a 
9-year recovery period)))], to determine the depreciation allowance 
of $6,399. For 2005, Y multiplies its adjusted depreciable basis in 
the equipment as of January 1, 2004, of $48,000, by the product of 
the annual depreciation rate in table 8 for recovery year 4 for a 9-
year recovery period (.1111) and the transaction coefficient 
(1.200), to determine the depreciation allowance of $6,399.

    (e) Change in the use of MACRS property during the placed-in-
service year--(1) In general. Except as provided in paragraph (e)(2) of 
this section, if a change in the use of MACRS property occurs during 
the placed-in-service year and the property continues to be MACRS 
property owned by the same taxpayer, the depreciation allowance for 
that property for the placed-in-service year is determined by its 
primary use during that year. The primary use of MACRS property may be 
determined in any reasonable manner that is consistently applied to the 
taxpayer's MACRS property. For purposes of this paragraph (e), the 
determination of whether the mid-quarter convention applies to any 
MACRS property placed in service during the year of change is made in 
accordance with Sec.  1.168(d)-1.
    (2) Alternative depreciation system property--(i) Property used 
within and outside the United States. The depreciation allowance for 
the placed-in-service year for MACRS property that is used within and 
outside the United States is determined by its predominant use during 
that year. The determination of whether MACRS property is used 
predominantly outside the United States during the placed-in-service 
year shall be made in accordance with the test in Sec.  1.48-1(g)(1)(i) 
for determining predominant use.
    (ii) Tax-exempt bond financed property. The depreciation allowance 
for the placed-in-service year for MACRS property that changes to tax-
exempt bond financed property, as described in section 168(g)(1)(C) and 
(g)(5), during that taxable year is determined under the alternative 
depreciation system. For purposes of this paragraph (e), MACRS property 
changes to tax-exempt bond financed property when a tax-exempt bond is 
first issued after the MACRS property is placed in service. MACRS 
property continues to be tax-exempt bond financed property in the hands 
of the taxpayer even if the tax-exempt bond (including any refunding 
issue) is not outstanding at, or is redeemed by, the end of the placed-
in-service year.
    (iii) Other mandatory alternative depreciation system property. The 
depreciation allowance for the placed-in-service year for MACRS 
property that changes to, or changes from, property described in 
section 168(g)(1)(B) (tax-exempt use property) or (D) (imported 
property covered by an Executive order) during that taxable year is 
determined under--
    (A) The alternative depreciation system if the MACRS property is 
described in section 168(g)(1)(B) or (D) at the end of the placed-in-
service year; or
    (B) The general depreciation system if the MACRS property is not 
described in section 168(g)(1)(B) or (D) at the end of the placed-in-
service year, unless other provisions of the Internal Revenue Code or 
regulations under the Internal Revenue Code require the depreciation 
allowance for that MACRS property to be determined under the 
alternative depreciation system (for example, section 168(g)(7)).
    (3) Examples. The application of this paragraph (e) is illustrated 
by the following examples:

    Example 1.  (i) Z, a utility and calendar-year corporation, 
acquires and places in service on January 1, 2004, equipment at a 
cost of $100,000. Z uses this equipment in its combustion turbine 
production plant for 4 months and then uses the equipment in its 
steam production plant for the remainder of 2004. Z's combustion 
turbine production plant assets are classified as 15-year property 
and are depreciated by Z under the general depreciation system using 
a 15-year recovery period and the 150-percent declining balance 
method of depreciation. Z's steam production plant assets are 
classified as 20-year property and are depreciated by Z under the 
general depreciation system using a 20-year recovery period and the 
150-percent declining balance method of depreciation. Z uses the 
optional depreciation tables. The equipment is 50-percent bonus 
depreciation property for purposes of section 168(k).
    (ii) Pursuant to this paragraph (e), Z must determine 
depreciation based on the primary use of the equipment during the 
placed-in-service year. Z has consistently determined the primary 
use of all of its MACRS properties by comparing the number of full 
months in the taxable year during which a MACRS property is used in 
one manner with the number of full months in that taxable year 
during which that MACRS property is used in another manner. Applying 
this approach, Z determines the depreciation allowance for the 
equipment for 2004 is based on the equipment being classified as 20-
year property because the equipment was used by Z in its steam 
production plant for 8 months in 2004. If the half-year convention 
applies in 2004, the appropriate optional depreciation table is 
table 1 in Rev. Proc. 87-57, which is the table for MACRS property 
subject to the general depreciation system, the 150-percent 
declining balance method, a 20-year recovery period, and the half-
year convention. Thus, the depreciation allowance for the equipment 
for 2004 is $51,875, which is the total of $50,000 for the 50-
percent additional first year depreciation deduction allowable (the 
unadjusted depreciable basis of $100,000 multiplied by .50), plus 
$1,875 for the 2004 depreciation allowance on the remaining adjusted 
depreciable basis of $50,000 [(the unadjusted depreciable basis of 
$100,000 less the additional first year depreciation deduction of 
$50,000) multiplied by the annual depreciation rate of .0375 in 
table 1 for recovery year 1 for a 20-year recovery period].
    Example 2. T, a calendar year corporation, places in service on 
January 1, 2004, several computers at a total cost of $100,000. T 
uses these computers within the United States for 3 months in 2004 
and then moves and uses the computers outside the United States for 
the remainder of 2004. Pursuant to Sec.  1.48-1(g)(1)(i), the 
computers are considered as used predominantly outside the United 
States in 2004. As a result, for 2004, the computers are required to 
be depreciated under the alternative depreciation system of section 
168(g) with a recovery period of 5 years pursuant to section 
168(g)(3)(C). T uses the optional depreciation tables. If the half-
year convention applies in 2004, the appropriate optional 
depreciation table is table 8 in Rev. Proc. 87-57, which is the 
table for MACRS property subject to the alternative depreciation 
system, the straight line method, a 5-year recovery period, and the

[[Page 33848]]

half-year convention. Thus, the depreciation allowance for the 
computers for 2004 is $10,000, which is equal to the unadjusted 
depreciable basis of $100,000 multiplied by the annual depreciation 
rate of .10 in table 8 for recovery year 1 for a 5-year recovery 
period. Because the computers are required to be depreciated under 
the alternative depreciation system in their placed-in-service year, 
pursuant to section 168(k)(2)(C)(i) and Sec.  1.168(k)-1T(b)(2)(ii), 
the computers are not eligible for the additional first year 
depreciation deduction provided by section 168(k).

    (f) No change in accounting method. A change in computing the 
depreciation allowance in the year of change for property subject to 
this section is not a change in method of accounting under section 
446(e). See Sec.  1.446-1T(e)(2)(ii)(d)(3)(ii).
    (g) Effective dates--(1) In general. This section applies to any 
change in the use of MACRS property in a taxable year ending on or 
after June 17, 2004. For any change in the use of MACRS property after 
December 31, 1986, in a taxable year ending before June 17, 2004, the 
Internal Revenue Service will allow any reasonable method of 
depreciating the property under section 168 in the year of change and 
the subsequent taxable years that is consistently applied to any 
property for which the use changes in the hands of the same taxpayer or 
the taxpayer may choose, on a property-by-property basis, to apply the 
provisions of this section.
    (2) Change in method of accounting--(i) In general. If a taxpayer 
adopted a method of accounting for depreciation due to a change in the 
use of MACRS property in a taxable year ending on or after December 30, 
2003, and the method adopted is not in accordance with the method of 
accounting for depreciation provided in this section, a change to the 
method of accounting for depreciation provided in this section is a 
change in the method of accounting to which the provisions of sections 
446(e) and 481 and the regulations under sections 446(e) and 481 apply. 
Also, a revocation of the election provided in paragraph (d)(3)(ii) of 
this section to disregard a change in the use is a change in method of 
accounting to which the provisions of sections 446(e) and 481 and the 
regulations under sections 446(e) and 481 apply. However, if a taxpayer 
adopted a method of accounting for depreciation due to a change in the 
use of MACRS property after December 31, 1986, in a taxable year ending 
before December 30, 2003, and the method adopted is not in accordance 
with the method of accounting for depreciation provided in this 
section, the taxpayer may treat the change to the method of accounting 
for depreciation provided in this section as a change in method of 
accounting to which the provisions of sections 446(e) and 481 and the 
regulations under sections 446(e) and 481 apply.
    (ii) Automatic consent to change method of accounting. A taxpayer 
changing its method of accounting in accordance with this paragraph 
(g)(2) must follow the applicable administrative procedures issued 
under Sec.  1.446-1(e)(3)(ii) for obtaining the Commissioner's 
automatic consent to a change in method of accounting (for further 
guidance, for example, see Rev. Proc. 2002-9 (2002-1 C.B. 327), as 
modified by Rev. Proc. 2004-11 (2004-3 I.R.B. 311) (see Sec.  
601.601(d)(2)(ii)(b) of this chapter)). Any change in method of 
accounting made under this paragraph (g)(2) must be made using an 
adjustment under section 481(a). For purposes of Form 3115, Application 
for Change in Accounting Method, the designated number for the 
automatic accounting method change authorized by this paragraph (g)(2) 
is ``88.'' If Form 3115 is revised or renumbered, any reference in this 
section to that form is treated as a reference to the revised or 
renumbered form.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: June 7, 2004.
Gregory F. Jenner,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 04-13723 Filed 6-16-04; 8:45 am]
BILLING CODE 4830-01-P