Cost Basis and Business-Use Percentage for Depreciation

To find the depreciable basis of a mixed-use asset, take your full cost in the property and multiply it by the share of use that is business. That single product is the cost basis and business-use percentage for depreciation that flows into the MACRS tables. Both inputs need care: the cost figure is more than the sticker price, and the percentage has to be measured, not estimated.

What Counts as Your Cost

Federal law defines basis as the cost of the property to the taxpayer.¹ Cost, in this context, is everything you spent to acquire the asset and get it ready for its intended use. That includes sales tax, freight, installation, testing, legal fees, and recording fees.² A $48,000 machine with $900 in delivery charges and $600 in professional installation has a cost basis of $49,500, not $48,000.

Rebates and credits from the manufacturer reduce basis. A $1,000 rebate on a $50,000 purchase produces a $49,000 starting figure. If you acquired the property in a like-kind exchange, your basis in the new asset is the adjusted basis of what you gave up plus any cash you added.² Debt you assume in the purchase is part of your cost too.

Go through your closing statement and invoices line by line. Overlooking title insurance, a recording fee, or an installation charge understates basis and quietly shrinks every year’s deduction for the life of the asset.

Land Is Never Depreciable

If the purchase involves real estate, the land portion has to come out. Land is not considered to wear out or become obsolete, so the IRS does not allow depreciation on it.³ Only the building enters your depreciable basis. Most taxpayers allocate the price between land and structure using the property tax assessment ratio or an independent appraisal. On commercial real estate, an inflated land allocation reduces the deduction every year for 39 years, so the split is worth getting right the first time.

Property You Convert From Personal Use

When you start using something you already owned for business, the depreciable basis is the lesser of your adjusted cost basis or the fair market value on the conversion date.² If you paid $35,000 for a car three years ago and it is worth $22,000 the day you begin driving it for work, your depreciable basis is $22,000. You do not get credit for the personal-use years or for depreciation you never claimed.

When Depreciation Actually Starts

The clock on depreciation runs from the placed-in-service date, meaning the date the asset is ready and available for its specific business use.³ A machine sitting in a warehouse waiting for a technician is not in service. A delivery truck parked and ready to run is, even if you have not sent it out yet. The date matters because it fixes the tax year of your first deduction and controls which first-year convention applies.

Measuring Your Business-Use Percentage

Only the business share of an asset is depreciable.³ The measurement method depends on the asset:

Vehicles: business miles divided by total miles driven.⁴
Home offices: office square footage divided by total home square footage.
Equipment: hours of business operation over total hours, or a similar production-based ratio.

Apply the percentage to the cost basis to get the depreciable basis. A $60,000 vehicle driven 15,000 business miles out of 20,000 total miles yields a 75% business-use percentage and a $45,000 depreciable basis. A $100,000 piece of equipment used 80% for business produces an $80,000 depreciable basis, which is the figure that goes into the MACRS calculation.⁵ The percentage is recalculated every year, so your annual deduction moves with your actual usage.

Commuting Miles Are Not Business Miles

The single most common inflation of business-use percentage comes from counting the daily drive between home and a regular workplace. The IRS treats commuting as personal no matter how long the drive is, and taking business calls in the car does not change that.⁶ Putting your company’s advertising on the vehicle does not convert the commute either.

A few situations are genuinely deductible. Trips from home to a temporary work location outside your metropolitan area count. If your home office qualifies as your principal place of business, drives from home to other work sites in the same trade or business count. Travel between two workplaces on the same day counts.⁶ Outside those categories, treating a commute as business use inflates the percentage and creates audit exposure.

Listed Property and the 50% Cliff

Passenger automobiles, other transportation equipment, and property generally used for entertainment or recreation fall into a category called listed property, which the IRS scrutinizes closely because these assets are easy to use personally while claiming business deductions.⁷

For listed property, the business-use percentage carries a hard threshold. Above 50%, you can use standard MACRS and claim bonus depreciation. At or below 50%, you are restricted to the Alternative Depreciation System, which stretches deductions over a longer recovery period.⁷ If you started above 50% and later drop to 50% or below, you have to recapture the excess depreciation as ordinary income on Form 4797 in the year the drop happens.⁸ A percentage that hovers near the threshold deserves attention, not a rough estimate.

Substantiating the Percentage

Federal law requires taxpayers to substantiate the business use of listed property with adequate records showing the amount, time, place, and business purpose of each use.⁹ The records need to be contemporaneous, kept as the use happens rather than reconstructed at year end.

For a vehicle, that means a mileage log with the date, starting and ending odometer readings, destination, and business purpose of each trip.⁶ For equipment, an hours-of-operation log or production schedule serves the same role. Calendars and appointment books can back up the business purpose of specific uses. Keep the original purchase receipts and every invoice that adds to basis for as long as you own the asset, plus three years after filing the return that reports the disposition.

Digital Records Are Fine, If They Work

Apps and electronic logs are acceptable, but the IRS expects the electronic system to maintain the integrity, accuracy, and reliability of the records, index them, reproduce them legibly, and print hard copies on request.¹⁰ A mileage app that syncs to the cloud and exports a report meets the standard. A phone camera roll full of receipts does not.

What Happens If You Cannot Prove It

If you cannot substantiate the business-use percentage in an audit, the IRS can disallow the depreciation deduction entirely for every year at issue. On top of the lost deduction, an accuracy-related penalty of 20% of the resulting underpayment can apply.¹¹ The percentage on your return is only as strong as the log behind it.

1
Office of the Law Revision Counsel. 26 USC 1012 – Basis of Property Cost
2
Internal Revenue Service. Publication 551 – Basis of Assets
3
Internal Revenue Service. Publication 946 – How To Depreciate Property
4
Internal Revenue Service. Topic No. 510, Business Use of Car
5
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
6
Internal Revenue Service. Publication 463 – Travel, Gift, and Car Expenses
7
Office of the Law Revision Counsel. 26 USC 280F – Limitation on Depreciation for Luxury Automobiles; Limitation Where Certain Property Used for Personal Purposes
8
Internal Revenue Service. Instructions for Form 4562
9
Office of the Law Revision Counsel. 26 USC 274 – Disallowance of Certain Entertainment, Etc., Expenses
10
Internal Revenue Service. Revenue Procedure 97-22
11
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments