Figuring Depreciation Under MACRS

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.

To be sure you can use MACRS to figure depreciation for your property, see Can You Use MACRS To Depreciate Your Property, earlier.

This part explains how to determine which MACRS depreciation system applies to your property. It also discusses the following information that you need to know before you can figure depreciation under MACRS.

• Property's recovery class.
• Placed-in-service date.
• Basis for depreciation.
• Recovery period.
• Convention.
• Depreciation method.

Finally, this part explains how to use this information to figure your depreciation deduction.

Which Depreciation System (GDS or ADS) Applies?

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. You generally must use GDS unless you are specifically required by law to use ADS or you elect to use it.

Required use of ADS. You must use ADS for the following property.

• All property used predominately in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect.
• Listed property used 50% or less for business. For information on listed property, see Additional Rules for Listed Property, later.
• Any tax-exempt use property.
• Any tax-exempt bond-financed property.
• Any imported property covered by an executive order of the President of the United States.
• Any tangible property used predominately outside the United States during the year.

Electing ADS. Although your property may qualify for GDS, you can elect to use ADS. The election generally must cover all property in the same property class you placed in service during the year. However, the election for residential rental property and nonresidential real property can be made on a property-by-property basis. Once you make this election, you can never revoke it.

You make the election by completing line 16 in Part II of Form 4562.

Which Property Class Applies Under GDS?

The following is a list of the nine property classes under GDS.

1. 3-year property.
2. 5-year property.
3. 7-year property.
4. 10-year property.
5. 15-year property.
6. 25-year property.
7. 20-year property.
8. Residential rental property.
9. Nonresidential real property.

See chapter 3 of Publication 946 for examples of the types of property included in each class.

What Is the Placed-in-Service Date?

You begin to claim depreciation when your property is placed in service for use either in a trade or business or the production of income. The placed-in-service date for your property is the date the property is ready and available for a specific use. It is therefore not necessarily the date it is first used. If you converted property held for personal use to use in a trade or business or for the production of income, treat the property as being placed in service on the conversion date. See Placed in Service under When Does Depreciation Begin and End, earlier, for examples illustrating when property is placed in service.

What Is the Basis for Depreciation?

The basis for depreciation of MACRS property is the property's cost or other basis multiplied by the percentage of business/investment use. Reduce that amount by the following items.

• Any deduction for section 179 property.
• Any deduction for removal of barriers to the disabled and the elderly.
• Any investment credit, disabled access credit, or enhanced oil recovery credit.

For information about how to determine the cost or other basis of property, see What Is the Basis of Your Depreciable Property, earlier.

Which Recovery Period Applies?

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.

Recovery periods. See Table 8-1 for recovery periods under both GDS and ADS for some commonly used assets. For a complete list of recovery periods, see the Table of Class Lives and Recovery Periods in Appendix B of Publication 946.

Table 8-1

House trailers for farm laborers. To depreciate a house trailer you supply as housing for those who work on your farm, use one of the following recovery periods if the house trailer is mobile (it has wheels and a history of movement).

• A 10-year recovery period under ADS.
• A 7-year recovery period under GDS.

However, if the house trailer is not mobile (its wheels have been removed and permanent utilities and pipes attached to it), use one of the following recovery periods.

• A 25-year recovery period under ADS.
• A 20-year recovery period under GDS.

Water wells. Water wells used to provide water for raising poultry and livestock are land improvements. To depreciate them, use one of the following recovery periods.

• A 15-year recovery period under GDS.
• A 20-year recovery period under ADS.

The types of water wells that can be depreciated were discussed earlier under Irrigation systems and water wells.

Which Convention Applies?

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. Use one of the following conventions.

• The half-year convention.
• The mid-month convention.
• The mid-quarter convention.

The mid-month convention. Use this convention for all nonresidential real property and residential rental property.

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.

The mid-quarter convention. Use this convention if the mid-month convention does not apply and the total depreciable bases of MACRS property you placed in service during the last 3 months of the tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) are more than 40% of the total depreciable bases of all MACRS property you placed in service during the year. However, see Exception, next.

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.

Exception. If the third quarter of your tax year includes September 11, 2001, you can elect to apply the half-year convention, discussed next, to all property (other than nonresidential real property and residential rental property) placed in service during the 2001 tax year. The third quarter begins on the first day of the seventh month of the tax year. To make this election, write "Election pursuant to Notice 2001-70" across the top of your 2001 Form 4562.

The half-year convention. Use this convention 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.

Which Depreciation Method Applies?

MACRS provides three depreciation methods under GDS and one depreciation method under ADS.

• The 200% declining balance method over a GDS recovery period.
• The 150% 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.

You cannot use the 200% declining balance method for farm property placed in service after 1988.

Farm property. For personal property placed in service in a farming business after 1988 you must use the 150% declining balance method over a GDS recovery period or you can elect one of the following methods.

• The straight line method over a GDS recovery period.
• The straight line method over an ADS recovery period.

For property placed in service before 1999, you could have elected to use the 150% declining balance method using the ADS recovery periods for certain property classes. If you made this election, continue to use the same method and recovery period for that property.

Real property. You can depreciate real property using the straight line method under either GDS or ADS.

Depreciation table. The following table lists the types of property you can depreciate under each method. The declining balance method is abbreviated as DB and the straight line method is abbreviated as SL.

Depreciation Table

Switching to straight line. If you use a declining balance method, you switch to the straight line method in the year it provides an equal or greater deduction. If you use the MACRS percentage tables, discussed later under How Is the Depreciation Deduction Figured, you do not need to determine in which year your deduction is greater using the straight line method. The tables have the switch to the straight line method built into their rates.

Fruit or nut trees and vines. Depreciate trees and vines bearing fruit or nuts under GDS using the straight line method over a 10-year recovery period.

ADS required for some farmers. If you elect not to apply the uniform capitalization rules to any plant produced in your farming business, you must use ADS for all property you place in service in any year the election is in effect. See chapter 7 for a discussion of the application of the uniform capitalization rules to farm property.

Farming business. A farming business is any trade or business involving cultivating land or raising or harvesting any agricultural or horticultural commodity and includes certain incidental processing activities (discussed next). A farming business includes any of the following.

• Operating a nursery or sod farm.
• Raising or harvesting crops.
• Raising or harvesting trees bearing fruit, nuts, or other crops.
• Raising ornamental trees. (An evergreen tree is not considered an ornamental tree if it is more than 6 years old when it is severed from its roots.)
• Raising, shearing, feeding, caring for, training, and managing animals.

Processing activities. In general, a farming business includes processing activities that are normally part of the growing, raising, or harvesting of agricultural products. However, a farming business generally does not include the processing of commodities or products beyond those activities that are normally part of the growing, raising, or harvesting of such products.

Example 1. If you are in the trade or business of growing fruits and vegetables, you can harvest, wash, inspect, and package the fruits and vegetables for sale. Such activities are normally part of the raising of these crops by farmers. You will be considered to be in the business of farming with respect to the growing of fruits and vegetables and the processing activities that are part of their harvest.

Example 2. You are in the business of growing and harvesting wheat and other grains. You also process grain you have harvested in order to produce breads, cereals, and other similar food products. You then sell these products to customers in the course of your business. Although you are in the farming business with respect to the growing and harvesting of grain, you are not in the farming business with respect to the processing of the grain to produce the food products.

Electing a different method. As shown in the Depreciation Table, you can elect a different method for depreciation for certain types of property. You must make the election by the due date of the return (including extensions) for the year you placed the property in service. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of your return (excluding extensions). Attach the election to the amended return and write "Filed pursuant to section 301.9100-2" on the election statement. File the amended return at the same address you filed the original return. Once you make the election, you cannot change it.

If you elect to use a different method for one item in a property class, you must apply the same method to all property in that class placed in service during the year of the election. However, you can make the election on a property-by-property basis for residential rental and nonresidential real property.

Straight line election. Instead of using the declining balance method, you can elect to use the straight line method over the GDS recovery period. Make the election by entering "SL" in column (f) of Part II of Form 4562.

ADS election. As explained earlier under Which Depreciation System (GDS or ADS) Applies, you can elect to use ADS even though your property may come under GDS. ADS uses the straight line method of depreciation over fixed ADS recovery periods. The ADS recovery periods for many assets used in the business of farming are listed in Table 8-1. Additional ADS recovery periods for other classes of property may be found in the Table of Class Lives and Recovery Periods in Appendix B of Publication 946.

Make the election by completing line 16, Part II of Form 4562.

How Is the Depreciation Deduction Figured?

To figure your depreciation deduction under MACRS, you first determine the depreciation system, property class, placed-in-service date, basis amount, recovery period, convention, and depreciation method that applies to your property. Then you are ready to figure your depreciation deduction. You can figure it in one of two ways.

• You can use the percentage tables provided by the IRS.
• You can figure your own deduction without using the tables.

Figuring your own MACRS deduction will generally result in a slightly different amount than using the tables.

Using the MACRS Percentage Tables

To help you figure your deduction under MACRS, the IRS has established percentage tables that incorporate the applicable convention and depreciation method. These percentage tables are in Appendix A of Publication 946.

Rules for using the tables. The following rules cover the use of the percentage tables.

1. You must apply the rates in the percentage tables to your property's unadjusted basis (defined later).
2. You cannot use the percentage tables for a short tax year. See chapter 3 of Publication 946 for information on how to figure the deduction in a short tax year.
3. You must generally continue to use them for the entire recovery period of the property.
4. You must stop using the tables if you adjust the basis of the property for any reason other than--
1. Depreciation allowed or allowable, or
2. An addition or improvement to the property. (An addition or improvement is depreciated as a separate property.)

Basis adjustment due to casualty loss. If you reduce the basis of your property because of a casualty, you cannot continue to use the percentage tables. For the year of the adjustment and the remaining recovery period, you must figure the depreciation yourself using the property's adjusted basis at the end of the year. See Figuring the Deduction Without Using the Tables in chapter 3 of Publication 946.

Figuring the unadjusted basis of your property. You must apply the table rates to your property's unadjusted basis each year of the recovery period. Unadjusted basis is the same basis amount you would use to figure gain on a sale but figured without reducing your original basis by any depreciation taken in earlier years. However, you do reduce your original basis by the following amounts.

• Any amortization taken on the property.
• Any section 179 deduction claimed on the property.
• Any deduction claimed for a clean-fuel vehicle or clean-fuel vehicle refueling property.
• Any electric vehicle credit. (The lesser of $4,000 or 10% of the cost of the vehicle, even if the credit is less than that amount.)

The clean-fuel vehicle and clean-fuel vehicle refueling property deductions and the credit for electric vehicles are discussed in chapter 12 of Publication 535.

For business property you purchase during the year, the unadjusted basis is its cost minus these adjustments. If you trade property, your unadjusted basis in the property received is the cash paid plus the adjusted basis of the property traded minus these adjustments.

Figuring depreciation using 150% DB and the half-year convention. Table 8-2 has the percentages for 3-, 5-, 7-, and 20-year property. The percentages are based on the 150% declining balance method with a change to the straight line method. This table covers only the half-year convention and the first 8 years for 20-year property. See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention.

The following examples show how to figure depreciation under MACRS using the percentages in Table 8-2.

Example 1. During the year, you bought an item of 7-year property for $10,000 and placed it in service. You do not elect a section 179 deduction for this property. The unadjusted basis of the property is $10,000. You use the percentages in Table 8-2 to figure your deduction.

Since this is 7-year property, you multiply $10,000 by 10.71% to get this year's depreciation of $1,071. For next year, your depreciation will be $1,913 ($10,000 × 19.13%).

Example 2. You had a barn constructed on your farm at a cost of $20,000. You placed the barn in service this year. The barn is 20-year property and you use the table percentages to figure your deduction. You figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 3.75% to get $750. For next year, your depreciation will be $1,443.80 ($20,000 × 7.219%).

Figuring depreciation using straight line and the half-year convention. The following table has the straight line percentages for 3-, 5-, 7-, and 20-year property using the half-year convention. The table covers only the first 8 years for 20-year property. See Appendix A in Publication 946 for complete MACRS tables, including tables for the mid-quarter and mid-month convention.

Straight Line Percentages

The following example shows how to figure depreciation under MACRS using the straight line percentages in the table.

Example. If in Example 2 you had elected the straight line method, you figure this year's depreciation by multiplying $20,000 (unadjusted basis) by 2.5% to get $500. For next year, your depreciation will be $1,000 ($20,000 × 5%).

Figuring Depreciation Without the Tables.

If you are required to or would prefer to figure your own depreciation without using the tables, see Figuring the Deduction Without Using the Tables in chapter 3 of Publication 946.

Figuring the Deduction for Carried-Over-Basis Property

If your property has a carried-over basis because you acquired it in an exchange or involuntary conversion of other property or in a nontaxable transfer, you may have to figure depreciation for the property as if the exchange, conversion, or transfer had not occurred.

Property acquired in an exchange or involuntary conversion. You generally must depreciate MACRS property that you acquired in a like-kind exchange or an involuntary conversion of other MACRS property over the remaining recovery period of the exchanged or involuntarily converted property. You also generally continue to use the same depreciation method and convention. You can depreciate the part of the acquired property's basis in excess of its carried-over basis (the adjusted basis of the exchanged or converted property) as newly purchased MACRS property. For information on like-kind exchanges, see chapter 10. For information on involuntary conversions, see chapter 1 in Publication 544.

If you placed the acquired MACRS property in service before January 3, 2000, you continue to use your original method of depreciating that property.

Property acquired in a nontaxable transfer. You must depreciate MACRS property acquired by a corporation or partnership in certain nontaxable transfers over the property's remaining recovery period in the transferor's hands, as if the transfer had not occurred. You must continue to use the same depreciation method and convention as the transferor. You can depreciate the part of the property's basis in excess of its carried-over basis (the transferor's adjusted basis in the property) as newly purchased MACRS property. For information on the kinds of nontaxable transfers covered by this rule, see chapter 3 of Publication 946.

How Do You Use General Asset Accounts?

To make it easier to figure MACRS depreciation, you can group separate properties into one or more general asset accounts (GAAs). You can then depreciate all the properties in each account as a single item of property. Each account can include only property with the same asset class (if any), recovery period, depreciation method, and convention. You cannot include property if you use it in both a personal activity and a trade or business (or for the production of income) in the year in which you first place it in service.

After you have set up a GAA, you generally figure the depreciation for it by using the applicable depreciation method, recovery period, and convention for the property in the GAA. For each GAA, record the depreciation allowance in a separate depreciation reserve account.

There are additional rules for grouping property in a GAA, figuring depreciation for a GAA, disposing of GAA property, and terminating GAA treatment. For more information on GAAs, see chapter 3 in Publication 946.

When Do You Recapture MACRS Depreciation?

When you dispose of property you depreciated using MACRS, any gain on the disposition is generally recaptured (included in income) as ordinary income up to the amount of the depreciation previously allowed for the property. Depreciation, for this purpose, includes any section 179 deduction claimed on the property and any deduction claimed for clean-fuel vehicles and clean-fuel vehicle refueling property. There is no recapture for residential rental and nonresidential real property. For more information on depreciation recapture, see chapter 11.

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