updated September 1, 2023 · 4min read
Depreciation allows businesses to allocate the cost of assets—such as buildings, equipment and machinery, vehicles, and furniture—over the years the assets will be used. For internal accounting purposes, most businesses depreciate assets using the straight-line method.
But when it comes to claiming depreciation on the company's tax return, the IRS requires most businesses to use the modified accelerated cost recovery system, also known as MACRS.
MACRS depreciation was introduced in 1986 to encourage businesses to invest in depreciable assets by allowing larger depreciation deductions in the initial years of the asset's useful life. This contrasts with straight-line depreciation, where the business gets the same deduction each year until the asset is fully depreciated.
Taxpayers can use MACRS depreciation for vehicles, office furniture, machinery, land improvement, computer equipment, and many other assets.
To calculate MACRS depreciation:
Typically, the depreciation basis of an asset is what you paid for it. However, it can include other expenses of acquiring the asset and getting it ready to use.
For example, if you buy a piece of manufacturing equipment for $20,000 and spend another $2,000 to have it delivered and installed, the depreciable basis would be $22,000.
MACRS organizes assets into different classes based on their useful life. IRS Publication 946 includes several examples of the type of property included in each class. Here are a few common examples:
Three-year, 5-year, 7-year and 10-year property uses the 200% declining balance method. This means you take 200% of the amount that would be depreciated using the straight-line method. Fifteen-year property uses the 150% declining balance method, meaning you claim 150% of the amount that would be depreciated using the straight-line method.
In some cases, the placed-in-service date is the date the property was purchased, but those dates can be different. An asset is considered "in service" when it's ready and available to be used.
For example, say you purchase a piece of equipment in December, but it's not delivered and installed until January of the following year. Even though you paid for the equipment in December, you can't start deducting MACRS depreciation until January.
The convention you use determines the number of months you can claim depreciation in the asset's first year.
There are three conventions:
Now that you have all the necessary information, you can calculate the percentage of the asset's basis that you can deduct in the first year using the following MACRS formula:
First year depreciation = Basis x (1 / useful life) x Depreciation method x Depreciation convention
In the following years, the formula to use would be:
Subsequent years depreciation = (Basis – Depreciation in previous years) x (1/ useful life) x Depreciation method
To see how that works in practice, say you purchase a computer for $1,000, and the half-year convention applies. Computer equipment is 5-year property, so you need to use the 200% declining balance method.
Using this information, the first year's depreciation expense would be:
$1,000 x (1/5) x 200% x .5 = $200
The following year, depreciation expense for the computer would be:
($1,000 - $200) x (1/5) x 200% = $320
If you prefer, you can use the MACRS depreciation tables in Publication 946 to calculate depreciation or use a MACRS depreciation calculator.
Calculating MACRS depreciation can be complicated. If you don't want to handle it on your own, you might want to leave it to your accountant so you can focus on other aspects of running your small business.
by Janet Berry-Johnson
A freelance writer with a background in accounting and income tax planning and preparation for individuals and small ...
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