EXAMPLE 1: I. M. Author bought a new car in March 2005 for $21,000. Earlier we calculated that Ms. Author's business use of the car was 1/3 or 33%. Since her car is "listed property" and is used less than 50% of the time for her business, the tax rules require that the "straight line" method of depreciation be used rather than an accelerated method such as MACRS or ACRS. Her "recovery rate" under the straight line method would be divided by the number of years left in the recovery period. Automobiles have a designated recovery period of 5 years. Since this is her first year to recover, her rate is 1/5 or 20%.

However, the "half-year convention" requires that you treat all property purchased during the tax year as purchased in the middle of the year and the rate of the depreciation deduction must be reduced accordingly. Thus I. M. Author is allowed half of her rate or 10% of her basis as a deduction. Her basis in the car is the $21,000 she paid for it, so her depreciation deduction would be $2,100 times her business use [$2,100 x .33 = $700].

The depreciation deduction on passenger cars placed in service in 2005 is limited to her business usage (33%) times $2,960 [.33 x $2960 = $977]. Since this is greater than the $700 we have calculated for her deduction, she can deduct the entire $700. Since her business use was less than 50%, Ms. Author cannot take a Sec. 179 deduction, nor the bonus depreciation. (Diffferent rules apply for depreciation of leased vehicles and hybrid electric vehicles. See Publication 946 for details.)