With the expiration of bonus depreciation and the introduction of the tangible property rules, now is good time to review your tax depreciation methods to ensure that you are optimizing your deductions. Any review of fixed asset accounting policies should also include a review of the tax lives and the most appropriate method for depreciating the assets. In a previous In Touch article, we looked at the appropriate depreciation lives for fixed assets under Revenue Procedure 87-56. Now let's focus on the methods that are available to depreciate fixed assets over those tax lives for federal income tax purposes.

How to Choose a Depreciation Method

1. Regular MACRS (Modified Accelerated Cost Recovery System);
2. 150% DDB (Double-Declining Balance) in lieu of 200% DDB over the GDS (General Depreciation System) life;
3. Straight-line over the GDS life;
4. Straight-line over the ADS (Alternative Depreciation System) life

Regular MACRS

Regular MACRS is the most common depreciation method since it results in the quickest write-off of a fixed asset. The appropriate life over which to depreciate most assets is under the GDS. Most personal property with a GDS life of under 15 years is depreciated at a rate of 200% DDB. Assets with a 15 or 20 year GDS life are depreciated using a 150% DDB method. Real property is depreciated over 39 years on a straight-line basis.

150% DDB in lieu of 200% DDB

Taxpayers may elect to depreciate assets over the GDS life using 150% DDB instead of 200% DDB. By making this election, regular tax depreciation and alternative minimum tax depreciation will be the same on the affected assets, thus reducing the potential for alternative minimum tax.

Straight-line over the GDS life

Taxpayers may elect to depreciate assets over the GDS life on a straight-line basis. This election would benefit taxpayers looking to minimize the tax depreciation deduction so that they could utilize net operating losses, create passive income, or utilize tax credits. 

Straight-line over the ADS life

Taxpayers may elect to depreciate assets over the ADS life on a straight-line basis. The ADS life is typically longer than the GDS life and it results in least amount of tax depreciation expense in a tax year. This election also would benefit taxpayers looking to minimize the tax depreciation deduction so that they could utilize net operating losses, create passive income, or utilize tax credits. 

Each of these alternate depreciation methods is elected on a class-by-class basis for additions within the tax year. These elections can be made on a year-by-year basis and are irrevocable for that tax year. Typically, the elections are made by attaching a statement to the tax return detailing the asset classes for which the alternate method is to apply. These alternate methods are not accounting methods that lock the taxpayer into those methods for future years without an accounting method change.

In certain cases, the straight-line over the ADS life method is the required method for computing tax depreciation. Straight-line over the ADS life is required when:

1. The property is used predominantly outside the United States;
2. The asset is "tax-exempt use property"; or
3. The property was financed with the proceeds of tax-exempt bonds;

Depreciation Conventions

Another factor that impacts the tax depreciation calculation is the depreciation convention that is applied. The timing of fixed asset additions during the tax year may impact the overall tax depreciation calculation for that year because of these depreciation conventions. Personal property generally is depreciated using a half-year convention, meaning that one-half of the allowable depreciation is allowed in the first year and one-half is allowed in the last year. The result is that a five-year asset is actually depreciated over six years. If over 40% of the personal property is placed in service in the last quarter of the year, however, a mid-quarter convention must be used. This results in slightly more first year depreciation for assets added in the first half of the year and slightly less depreciation for assets added in the last half of the year. Real property is not impacted since it uses a mid-month convention in all cases. 

The implementation of the tangible property rules will result in more attention being given to fixed assets and depreciation over the next few years. Fixed asset lives and fixed asset depreciation methods need to be considered during any fixed asset review. Most taxpayers will utilize the maximum depreciation benefits under the Regular MACRS method, but an alternate method may prove useful for taxpayers looking to maximize or target a certain taxable income. Please contact you your local CBIZ MHM tax professional to review and assist in the tax planning for your tax depreciation.

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