U.S. Tangible Property Regular MACRS Depreciation
Generally, the acquisition of property by a company is a capital expenditure and is not directly deductible in one year for the full cost of acquiring, producing, or improving a property and putting it into use. Instead, you generally must depreciate such property. Depreciation is the recovery of the cost of the property over several years. You deduct a part of the cost every year until you fully recover its cost.
Generally speaking, the way a company depreciates its property varies between accounting and tax requirements. This article focuses on the tax requirements for depreciation, Modified Accelerated Cost Recovery ("MACRS"), which is the method of depreciation required by Section 168 of the IRC for tangible property placed in service after December 31, 1986.
- Application of MACRS Rules
(1)
|
Categorize any recently acquired depreciable assets that have been put into use during the fiscal year according to their respective MACRS classes;
|
(2)
|
Determine MACRS conventions;
|
(3)
|
Calculate "regular" MACRS depreciation (both first-year assets and assets placed in service in prior periods).
|
- Determine Depreciable Lives by Asset Class
IRS Publication 946, How to Depreciate Property, briefly summarize outlines and defines the property classes as follows:
|
Year Type
|
Applicable property range
|
Convention
|
|
3-year
|
Tractor units for over-the-road use; Qualified rent-to-own property, etc.
|
Half-Year and Mid-quarter
|
|
5-year
|
Automobiles, taxis, buses, and trucks; Office machinery (such as typewriters, calculators, and copiers), etc.
|
|
7-year
|
Office furniture and fixtures (such as desks, files, and safes); Railroad track, etc.
|
|
10-year
|
Vessels, barges, tugs, and similar water transportation equipment; Any single-purpose agricultural or horticultural structure, etc.
|
|
15-year
|
Any retail motor fuels outlet, such as a convenience store; Qualified improvement property placed in service after 2017, etc.
|
|
20-year
|
Farm buildings (other than single-purpose agricultural or horticultural structures); Municipal sewers not classified as 25-year property, etc.
|
|
27.5-year
|
Residential rental property. This is any building or structure, such as a rental home (including a mobile home), if 80% or more of its gross rental income for the tax year is from dwelling units.
|
Mid-month
|
|
39-year
|
Nonresidential real property. This is section 1250 property, such as an office building, store, or warehouse, that is neither residential rental property nor property with a class life of less than 27.5 years.
|
|
- Determine Conventions by Asset Class
Once the asset class has been determined, the correct convention must be applied. Conventions are determined based on whether property is real or personal. There are three general categories:
(1)
|
Half-year (HY)
The cost of property in the 3-, 5-, 7-, and 10-year classes is recovered using the 200-percent declining-balance method, switching to the straight-line method in the year when that maximizes the deduction (IRC Section 168(b)(1)).
HY is general rule: The general rule is that all assets are placed in service at the half-year regardless of when they were actually placed in service. Thus, for a calendar-year taxpayer, all assets are treated as placed in service on 7/1.
|
(2)
|
Mid-quarter (MQ)
The cost of 15- year and 20-year property is recovered using the 150% declining balance method, switching to the straight-line method to maximize the deduction (IRC Section 168(b)(2)).
MQ is exception: If more than 40% of assets by value subject to HY/MQ were placed in service in 4Q (10/1?2/31 for calendar year taxpayers), the MQ convention applies (not HY).
|
(3)
|
Mid-month (MM)
The cost of 27.5- year (residential) and 39-year (non-residential) real property is recovered using the straight-line method. Assets are treated as placed in service in the middle of the month in which they were actually placed in service.
|
- Calculate regular MACRS Depreciation
Once assets are classified and conventions determined, MACRS depreciation is calculated for an asset by multiplying original asset basis by the applicable MACRS rate from the MACRS Tables.
Example. Dan starts a new business in Year 1. Dan purchased a computer for $375 on September 15, Year 1. Using the HY convention depreciation, applies to 5-year assets, calculate the annual depreciation for the computer. Assume this is the only asset Dan placed in service during the year. The depreciable basis is $375 Recovery period, multiplied by the applicable exchange rate in the MACRS table (shown) to calculate depreciation. Year 1’s depreciation is $375 times 20% which is $75. Year 2’s depreciation is $375 times 32% which is $120.
But Dan disposes of the computer on February 6, Year 4. Half-year convention assumes all dispositions occur at the mid-point of the tax year. As such, the Year 4 depreciation allowance is reduced by 50% (even though the asset was disposed of well before the mid-point of the year). Year 4’s depreciation is $375 times 11.52% times 50% which is $21.60.
In addition to regular depreciation, there are other special circumstances, such as bonus depreciation and IRC Section 179 related content. Please consult KAIZEN professional consultant for details.
- The difference between book depreciation and tax depreciation
The variance between book and tax depreciation is documented on Schedule M-1 or Schedule M-3 of the tax return, with the latter being utilized when the total assets at the conclusion of the current tax year equal or surpass $10 million. If tax depreciation exceeds book depreciation, the latter must be augmented, whereas if tax depreciation is lower than book depreciation, the book depreciation must be decreased to align with tax depreciation. These disparities between book and tax depreciation are categorized into permanent differences and temporary differences.
SEE ALSO:
https://www.irs.gov/taxtopics/tc704
https://www.irs.gov/forms-pubs/about-publication-946
|
