Within our "Accounting for Assets" miniseries, we've examined various textbook definitions of depreciation. We also reviewed the differences between "book value" and "tax value" depreciation.
This week, we begin our summary of MACRS Depreciation for Income Tax purposes. For purposes of clarification, this article is intended to be a discussion of the subject matter. It is not intended to be a definitive guide concerning MACRS Depreciation or to provide any actual tax advice.
For income tax purposes, the Modified Accelerated Cost Recovery System (MACRS) is used to recover the basis of most business and investment property placed in service after 1986. MACRS consists of two depreciation systems: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS).
Generally, these systems provide different methods and recovery periods to use in figuring depreciation deductions.
This article, and our companion piece scheduled for next week, provide an overview of how to determine which MACRS depreciation system applies to specific property.
Throughout this article, we will make references to IRS Publication 946 “How to Depreciate Property.” For questions or clarification, always consult this reference or a qualified tax professional.
This week's article also will discuss other need-to-know information enabling you to compute depreciation under MACRS. This information includes the property's recovery class placed in service date determination and basis for depreciation, as well as the applicable recovery period, partial period averaging conventions and depreciation methods.
The following piece will explain how to use this information to compute depreciation deductions, and how to use a general asset account to depreciate a group of properties. We will use examples from our old "Dongle Maker" in illustrating these computations.
Determining the Applicable Depreciation System
Your use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period you use. The IRS code provides you generally must use the General Depreciation System, unless you're specifically required by law to use the Alternate Depreciation System or you elect to use the Alternate Depreciation System.
For more information concerning the specific circumstances where you are required by law to use the ADS, or circumstances under which you may elect to use ADS, see IRS Publication 946.
MACRS Property Classifications
There are nine property classifications under the General Depreciation System. For detailed information on these property classes and specific examples, refer to Appendix B of IRS Publication 946. The nine property classifications are:
- 3-year Property, including over-the-road tractors, race horses two-plus years of age or placed in service after 12/31/2008 and before 1/1/2017, other horses 12-plus years of age, qualified rent-to-own property (subject to specific provisions set forth in IRS Publication 946).
- 5-year Property, including automobiles, taxis, buses and trucks; computers and peripheral equipment; office machinery; research/experimentation property; breeding and dairy cattle; appliances, carpets, furniture used in residential rental real estate; and certain geothermal, solar and wind energy property.
- 7-year Property, including office furniture/fixtures, agricultural machinery/equipment, railroad track, certain motorsports entertainment complex property placed in service prior to 1/1/2017 property (subject to specific provisions set forth in IRS Publication 946), and any natural gas gathering line placed in service after 4/11/2005.
- 10-year Property, including vessels, tugs, barges and other water transportation equipment; single purpose agricultural/horticultural structures; trees or vines bearing fruit/nuts; qualified small electric meter and smart electric grid systems placed in service on/after 10/3/2008 property (subject to specific provisions set forth in IRS Publication 946).
- 15-year Property, including certain land improvements such as shrubbery, fences, roads, sidewalks and bridges; retail motor fuels outlets (including convenience stores) property (subject to specific provisions set forth in IRS Publication 946); municipal wastewater treatment facilities; qualified leasehold improvement property (subject to specific provisions set forth in IRS Publication 946); qualified restaurant property (subject to specific provisions set forth in IRS Publication 946); initial clearing/grading land improvements for gas utility property; electric transmission property using in transmitting 69-plus kilo-volts of electricity when placed in service after 4/11/2005 (subject to specific provisions set forth in IRS Publication 946); any natural gas distribution line placed in service after 4/11/2005 but prior to 1/1/2011(subject to specific provisions set forth in IRS Publication 946); any qualified retail improvement property; and any telephone distribution plant or comparable equipment used for two-way exchange of voice/data communications.
- 20-year Property, including certain farm buildings, municipal sewers not classified as 25-year property; and initial clearing/grading land improvements for electric utility transmission/distribution plants.
- 25-year Property, including property integral to the gathering, treatment or commercial distribution of water, and that without regarding to this provision would otherwise be classified as 20-year property; municipal sewers other than property placed in service under a contract in effect at all times since 6/9/1996.
- Residential Rental Property, including any building or structure, such as a rental home (including a mobile home), if 80 percent or more of its gross rental income for the tax year is from dwelling units. A dwelling unit is a house or apartment used to provide living accommodations in a building or structure. It does not include a unit in a hotel, motel or other establishment where more than half the units are used on a transient basis. If the owner occupies any part of the building or structure for personal use, its gross rental income must include the fair rental value of the part of the property occupied by the owner.
- Non-residential Real Property, which is section 1250 property, such as an office building, store or warehouse that is neither residential rental property not property with a class life of less than 27.5 years.
Applicable Placed in Service Dates for MACRS
The above property types maybe claimed for depreciation when the property is placed in service for either use in a trade or business or for the production of income. The placed in service date for such property is the date the property is ready and available for a specific use. Therefore, it is not necessarily the date it is first used. If any such property was converted from property held for personal use to use in a trade or business, or to produce income, such converted property must be treated as being placed in service on the conversion date.
MACRS Depreciation Basis
The basis for depreciation of MACRS property is the property's cost or other basis multiplied by the percentage of business/investment use. The depreciation basis also must be reduced by the amount of any credits and deductions that should be allocated to the property, including any deduction for Section 179, as well as any deductions under Sections 179B, 179C, 179D, 179E, and any special depreciation allowance in addition to multiple other provisions set forth in IRS Publication 946. Please reference that publication with regard to these specific provisions and applicable dates when computing depreciation basis.
MACRS Recovery Periods
The recovery period of property is the number of years over which you recover its cost or other basis. It is determined based on the depreciation system (GDS or ADS) Used. Under GDS, property that is not qualified Indian reservation property is generally depreciated over the same period of time defined under the Property Class, specific provisions and exceptions may apply (see IRS Publication 946 for details). The recovery periods for qualified property placed in service on an Indian reservation after 1993 and prior to 2017 generally are shorter than the periods of time defined under the Property Class. For these specific provisions and exception, see IRS Publication 946. For recovery periods under the Alternate Depreciation System (ADS) see IRS Publication 946.
Additions or Improvements to Property under MACRS
An addition or improvement you make to depreciable property is treated as separate depreciable property. However, its property class and recovery period are the same as those that would apply to the original property if you had placed it in service at the same time you placed the addition or improvement in service. The recovery period begins on the later of the date on which you place the addition or improvement in service, or the date you place in service the property to which you made the addition or improvement.
MACRS Averaging Conventions
Under MACRS, averaging conventions establish when the recovery period begins and ends. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property.
- Mid-month Convention – The mid-month convention is used for nonresidential real property, residential rental property, and any railroad grading or tunnel bore. Under this convention, you treat all property placed in service or disposed of during a month as placed in service or disposed of at the midpoint of the month. This means that a one-half month of depreciation is allowed for the month the property is placed in service or disposed of.
- Mid-quarter Convention – The mid-quarter convention is used if the mid-month convention does not apply and the total depreciable bases of MACRS property you placed in service during the last three months of the tax year (excluding nonresidential real property, residential rental property, any railroad grading or tunnel bore, property placed in service and disposed of in the same year. In addition, property that is being depreciated under a method other than MACRS) are more than 40 percent of the total depreciable bases of all MACRS property you placed in service during the entire year. Under this convention, you treat all property placed in service or disposed of during any quarter of the tax year as placed in service or disposed of at the midpoint of that quarter. This means that 1-1/2 months of depreciation is allowed for the quarter the property is placed in service or disposed of.
- Half-year Convention – The half-year convention is used if neither the mid-quarter convention nor the mid-month convention applies. Under this convention, you treat all property placed in service or disposed of during a tax year as placed in service or disposed of at the midpoint of the year. This means that a one-half year of depreciation is allowed for the year the property is placed in service or disposed of.
Applicable Depreciation Methods
MACRS provides three depreciation methods under the General Depreciation System (GDS) and one depreciation method under the Alternative Depreciation System (ADS).
Remember, you generally must use GDS unless you're specifically required by law to use ADS or you elect to use ADS. The applicable depreciation methods are:
- The 200 percent declining balance method over a GDS recovery period
- The 150 percent declining balance method over a GDS recovery period
- The straight line method over a GDS recovery period
- The straight line method over an ADS recovery period
Special provisions may exist for property placed in service prior to 1999 – in addition to those for Farm Property Depreciation, or the election of a different depreciation method. Refer to IRS Publication 946 for details.
The following table, extracted from IRS Publication 946, lists the types of property you can depreciate under each of the depreciation methods. It also gives a brief explanation of the method, including applicable benefits thereof:
IRS Publication 946 - "How to Depreciate Property"
IRS MACRS Properation Depreciation Methods
Note: Table footnotes shown (in the table above) should be referenced from IRS Publication 946, or the applicable section of the Internal Revenue Code, they do not correspond to references, appendixes or sections of this article.
Next week's Accounting for Assets article will focus on how Depreciation is Computed under MACRS, including applicable examples from our Dongle Manufacturer.