When an investor buys an investment property or asset, the IRS allows the investor to take an annual depreciation expense. The investor needs to let the IRS know that depreciation is being taken on the property or properties each year. We'll describe the form to use and when investors should use it.
What Is Form 4562?
Form 4562 is titled Depreciation and Amortization. This form is used for annual depreciation or amortization of property or assets.
A depreciable asset is a larger purchase with a life spanning more than one year. Printer paper and pens don't fall into this category and neither does inventory. We're talking about larger purchases such as property, vehicles, or machinery.
For example, if you own a business vehicle, the IRS says it has a useful life of five years. So you depreciate this 5-year property each year for five years.
The IRS defines the amount of annual depreciation that can be expensed over the useful life of an asset. The following shows the number of years that different assets can be depreciated.
- Residential rental property — 27.5 years
- Non-residential real property (i.e., commercial property) — 39 years
- Office furniture — 7 years
- Autos and trucks — 5 years
By dividing the asset's price by its useful life, you get the annual depreciation. For example, an investment property that was purchased for $400,000 has annual depreciation of:
400,000 / 27.5 = $14,545.45
Or you can divide one by the number of years to get the annual depreciation rate:
1 / 27.5 = 3.636% x 400,000 = $14,544
Form 4562 is required for the first year that a depreciable asset is placed into service. If no new assets have been placed into service in subsequent years, Form 4562 is not required unless you filed form 1120 (corporate tax return). Form 4562 must also be filed for each asset.
There are six parts to Form 4562, which we’ll cover next.
Part I: Section 179 deductions
Section 179 is used for assets where you can take full depreciation. If there is a depreciation overflow of an item because you couldn't deduct it all in the first year, Form 4562 must be used for each year that the depreciation is taken. Section 179 allows you to make a full depreciation in one year up to $1,050,000.
Part II: Special depreciation allowance
This section is only used for qualified properties such as a farm or if green technology was purchased for a business. This section can get complex and should be filled out with the assistance of an accountant.
Part III: MACRS depreciation
Unlike Section 179, this section is used with Modified Accelerated Cost Recovery System (MACRS) guidance if you are depreciating property over multiple years. Like Part II, it can get complicated. So it's best to utilize your accountant for this section.
Part IV: Form summary
Some IRS forms have you summarize what's in the form at the beginning. Form 4562 puts it basically in the middle.
Part V: Listed property
This is a property that is used for personal and business use.
Part VI: Amortization
For those who are choosing to amortize their assets, list them here.
Who Should Use Form 4562?
If you depreciate an asset or property in one year (Section 179) or over many years, Form 4562 should be used.
Form 4562 is not required if you used the mileage deduction for a vehicle rather than depreciation. Instead, use Section 4 of Schedule C.
Depreciation is a complex topic that can afford investors sizable tax benefits. Unlike other expenses, depreciation is a paper expense. Meaning it doesn't impact cash flow. Because of the complexity involved with depreciating assets, it's best to work with an accountant when filling out Form 4562.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. Examples shown are hypothetical and for illustrative purposes only.