What Is Tax Code 167? Section 167 Depreciation Rules and Coverage

Tax Code Section 167 is the provision of the Internal Revenue Code that authorizes a deduction for the gradual wear, exhaustion, and obsolescence of property used in a trade or business or held for the production of income. Instead of forcing a business to absorb the full cost of a long-lived asset in the year of purchase, Section 167 spreads that cost across the asset’s productive life. In practice, most tangible business property placed in service after 1986 is depreciated under the specific mechanics of Section 168, the Modified Accelerated Cost Recovery System (MACRS), but Section 167 remains the underlying authority that permits the deduction and still directly governs certain intangibles.¹

What Section 167 Actually Allows

Section 167(a) is narrow about who gets the deduction and for what. It reaches two categories of property: assets used in a trade or business, and assets held for the production of income.¹ A rental duplex fits the second category even if you are not running a storefront business. A personal-use car or a vacation home you never rent out fits neither, and depreciation is unavailable.

The taxpayer claiming the deduction has to be the party bearing the economic loss as the asset declines in value. Possession alone is not enough. When equipment is leased, the lessor holds the ownership interest and takes the depreciation; the lessee deducts lease payments as a current business expense instead.

The property also has to have a determinable useful life extending beyond a single tax year. Items consumed or worn out within twelve months are current expenses, not depreciable assets.² Getting that line wrong matters on audit: the IRS can reclassify an improperly depreciated short-lived item and recompute tax for every affected year.

What Section 167 Covers Today

Section 167 is a general grant of authority. Most of the day-to-day rules for tangible property live in Section 168’s MACRS framework, but a meaningful slice of assets is still handled directly under Section 167.

Intangibles Under Section 167(f)

Section 167(f) specifically addresses certain intangibles that fall outside the Section 197 amortization regime. Computer software that is not a Section 197 asset is depreciated straight-line over 36 months. Mortgage servicing rights are depreciated over 108 months.¹ Other intangibles with a determinable useful life, such as patents and copyrights heading toward expiration, can also qualify under the general Section 167 rule. Intangibles that hold their value indefinitely or appreciate are not depreciable.

Tangible Property (Handled Through MACRS)

For tangible assets like machinery, commercial vehicles, office furniture, and buildings, Section 167 supplies the authorization and Section 168 supplies the method. If you placed property in service after 1986, MACRS almost certainly applies.

MACRS assigns each asset to a class rather than making you estimate a useful life:

5-year property: automobiles, light trucks, computers, and research equipment.³
7-year property: office furniture, railroad track, and assets without a designated class life that are not classified elsewhere.
15-year property: land improvements like fencing and parking lots, plus certain municipal infrastructure.
27.5-year property: residential rental buildings.
39-year property: nonresidential (commercial) real property.

Under the General Depreciation System, property in the 3-, 5-, 7-, and 10-year classes uses the 200% declining balance method, which front-loads deductions in the early years and then switches to straight-line when that produces a larger deduction. The 15- and 20-year classes use 150% declining balance. Residential rental and commercial buildings use straight-line depreciation over their full recovery periods. MACRS also treats salvage value as zero, so the entire basis is depreciated without subtracting a residual figure.

Averaging Conventions

MACRS does not assume you started using the asset on the exact day you bought it. The half-year convention is the default for most personal property: every asset placed in service during the year is treated as though placed in service at the midpoint, producing a half-year of depreciation in year one and again in the final year.² The mid-quarter convention applies when more than 40% of personal property placed in service during the year enters service in the last three months, and it exists to prevent bunching purchases in late December to grab a half-year deduction for a few days of ownership. The mid-month convention applies to real property, treating each asset as placed in service at the midpoint of the month.

What Section 167 Does Not Reach

Land is never depreciable. The IRS treats land as having an unlimited life because it does not wear out.⁴ When you buy real estate that includes land and a building, you must allocate the purchase price between the two and depreciate only the building portion. A common allocation uses the ratio from your local property tax assessment: if the assessor values land at 25% and improvements at 75% of the total, those same percentages apply to your actual purchase price.⁵ On a $200,000 purchase, that is $50,000 to land (not depreciable) and $150,000 to the building (depreciable).

Personal-use property and inventory are also outside Section 167. So is any asset without a determinable useful life.

Figuring the Depreciable Basis

Before any Section 167 deduction can be calculated, you need to know the dollar figure available for depreciation. That starting number is the cost basis.

Under Section 1012, the basis of property is generally its cost.⁶ Cost is more than the sticker price. It includes sales tax, freight, installation and testing fees, excise taxes, and legal or accounting fees that must be capitalized.⁷ Pay $9,000 for a machine plus $400 for delivery and $600 for professional installation, and the depreciable basis is $10,000.

Basis adjusts over time. Permanent improvements that extend the asset’s life or add to its value are capitalized and added to basis, not deducted as current repairs. Rebates or credits at purchase reduce basis. A $500 manufacturer rebate on that $10,000 machine drops the depreciable basis to $9,500.

Property acquired by inheritance generally takes a stepped-up basis equal to fair market value on the date of the original owner’s death.⁸ If a parent bought a rental building for $150,000 and it was worth $400,000 at death, the heir’s depreciable basis starts at $400,000 (less land allocation). Gifted property is different: the recipient generally carries over the donor’s basis, so the depreciation schedule continues rather than resetting.

Listed Property and Mixed Use

Certain assets that commonly straddle personal and business use get extra scrutiny under the “listed property” rules. The category includes passenger vehicles, other transportation equipment that lends itself to personal use, and property used for entertainment or recreation.⁹

Listed property has to be used more than 50% for qualified business purposes to qualify for MACRS accelerated depreciation or Section 179 expensing. If business use falls to 50% or below, the property must be depreciated using the slower straight-line method over a longer Alternative Depreciation System recovery period.⁹ If you initially claimed accelerated depreciation and business use later drops below the threshold, you have to recapture the excess. Contemporaneous records, especially mileage logs for vehicles, are the standard proof.

Reporting the Deduction

Depreciation and amortization are reported on Form 4562, filed as an attachment to your income tax return. The form covers MACRS depreciation, Section 179 expensing, bonus depreciation, amortization of intangibles, and listed-property information.¹⁰ Each asset needs to be classified by its recovery period and method before the form is filled out, because different sections handle different classes of property.

Form 4562 is required in the year property is first placed in service. If you are simply continuing to depreciate property from a prior year and are not claiming Section 179 or reporting listed property, the depreciation may be entered directly on your business schedule (Schedule C, E, or F).

Keep records for as long as the statute of limitations remains open for the tax year in which you dispose of the property.¹¹ For a commercial building depreciated over 39 years, that can mean holding onto purchase contracts, improvement invoices, basis-allocation appraisals, and each year’s depreciation schedule for over four decades. The burden of proof falls on the taxpayer, and missing documentation can cause a deduction to be disallowed outright.

1
Office of the Law Revision Counsel. 26 USC 167 – Depreciation
2
Internal Revenue Service. Publication 946 – How To Depreciate Property
3
Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
4
Internal Revenue Service. Topic No. 704, Depreciation
5
Internal Revenue Service. Depreciation Frequently Asked Questions
6
Office of the Law Revision Counsel. 26 USC 1012 – Basis of Property – Cost
7
Internal Revenue Service. Publication 551 – Basis of Assets
8
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
9
Internal Revenue Service. Instructions for Form 4562
10
Internal Revenue Service. About Form 4562, Depreciation and Amortization
11
Internal Revenue Service. How Long Should I Keep Records?