MACRS

What is the MACRS

The Modified Accelerated Cost Recovery System (MACRS) is the current method of accelerated asset depreciation required by the United States income tax code. Under MACRS, all assets are divided into classes which dictate the number of years over which an asset's cost will be recovered.

How MACRS Supplies Answers to what you need to know to depreciate

Pulication 947 Figuring Depreciation Under MACRS

The IRS created the above publication on how to figure depreciation to help simplify the reporting of asset value. The intention is to create a standardized method that can be easy to both report and to calculate the taxes that are owed. The choices they made, also helps a business to recapture the money that was spent on an asset quickly, to promote reinvestment. The method also simplifies the recapturing of depreciation when the asset is sold.

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Salvage Value

Historically, an asset would have a certain value that was called its salvage value, or residual value. This value was the "guess" as to how much you could still sell the asset for, even after you were finished depreciating it. The MACRS eliminated the salvage value and make all calculations use zero instead. This greatly simplifies discussions with tax auditors, regarding what value was used for each asset that has been depreciated. The actual value can be recovered by the IRS when the owner actually does sell the asset, since at that time, it will be a real transaction, and there wont be any speculation as to how much one might be able to sell it for. This also eliminates all the other factors that go into determining fair market value while the original owner owns it, since you only need to use the value from the actual sale. At the same time, the calculation and creation of tables becomes much more simple, since all assets can be handled the same in each category. This makes creating asset categories much simpler as well.

Methods

The MACRS uses the same method for depreciation for all of the asset groups except for Real Estate. The method they use starts with Double Declining method, then switches to straight line for the remainder of the life. Before MACRS, you could choose three or more different methods to depreciate an asset, but this often led to extra complications, when you may have a mixture of assets, and use different methods for each one. Also, since it is tied so closely to the Life of the asset, it can be complicated when you sell the asset before you completely depreciate it, depending on which method you used. MACRS simplifies everything by using a single method and making it the combination of Double Declining and Strait line, to allow companies to offset the cost of assets near the beginning of ownership. This tends to promote reinvesting in new assets.

Time Conventions

  • Mid-year
    • The year that you buy an asset in or sell an asset in you use a mid year convention. This means that you use 1/2 the years depreciation. It doesn't matter if you buy the asset on January 1st or December 31st.
  • Mid-month
    • 1/2 a month depreciation.
    • Mid month convention is used for nonresidential real property, residential rental property, and any railroad grading or tunnel bore. Under this convention1
  • Mid-quarter
    • 1.5 months depreciation.
    • 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 are more than 40% of the total depreciable bases of all MACRS property you placed in service during the entire year.2

Here is the section from the Publication 946 that helps you decide which Time Convention to choose:

Lives

MACRS allows the IRS to determine the life of an asset based on how quickly it may become obsolete and or how useful it may remain over a period of time. Before MACRS, the life of an asset was not completely defined, and may vary a little with the fluctuating residual value, since you had to know how old the asset would be when it reached its residual value. With MACRS defining an assets life and setting the salvage value to zero, the depreciation is much more standardized, and simplifies decisions based on the actual value of an investment. Also, if you review the link below about various life spans, as defined by the IRS, you will find that they lives are shorter then what may be the actual life of the item. Example : Office Furniture shows a class life of 10 years, but MACRS gives the asset life as of 7 years.

Depreciation Recapture

Investopedia has this definition of Depreciation Recapture (Link)

With MACRS using a salvage value of zero, the Recapture of depreciation is very simple when you sell the asset after the life of the assets, because the amount you get for the sale will be the same amount you will have to claim as gain. The only time there is special consideration, is when you sell the asset before you reach the end of the Life. This is considered early sale of an asset. Since MACRS also uses a time convention regarding the year an asset is put into use, it uses that very same time convention to calculate the gains or losses from an early sale. If your asset is using mid year convention, then, when you sell the asset in a year prior to the end of the life, you also use a half of the depreciation for that year. You can use the same tables (see below) but for the year that the sale is made, you can only depreciate half of the amount.

The IRS uses form 4797 to allow you to report Sales of Business Property, and the IRS Instructions are here. On the form you will see the 3 main requirements are Cost Basis, Depreciation and Sale amount. The simplicity is primarily due to the adoption of MACRS.

How to use the tables

Ex: November 2, 2006 you buy a car for $10,000 (a 5 year asset). What is the depreciation in 2008? You sell the car on Nov 1, 2008. What is the book value of the car when you sell it?

Year Depreciation Book Value
1 (2006) 10000*.20 = 2000 8000
2 (2007) 10000*.32 = 3200 4800
3 (2008) 10000*.1920/2 = 960 3840

In 2008 the depreciation is $960
When you sell the car in 2008 it's book value is $3,840

Assets Depreciated for Full Life

  • For taxation purposes, the salvage value is 0 at the end of the asset's life

Assets Sold Prior to Being Fully Depreciated

  • If you sell an item before it has fully depreciated, you use a mid year time convention to sell it and calculate the salvage value.
  • If the salvage value is less than the cost basis depreciation recapture occurs.
    • Gains (losses) = Salvage value - book value3
    • These gains are taxed as ordinary income.
  • If the salvage value it greater than the cost basis
    • Gains = Salvage value - book value = (Salvage value - cost basis)/Capital gains + (Cost basis - book value)/Ordinary gains4
      • These are divided into two parts for taxation purposes

MACRS Table

Midterm 2 Depreciation Problems

Class 3 5 7 10 15 20
Year Depreciation Rate 200% 200% 200% 200% 150% 150%
1 33.33 20.00 14.29 10.00 5.00 3.750
2 44.45 32.00 24.49 18.00 9.50 7.219
3 14.81* 19.20 17.49 14.40 8.55 6.677
4 7.41 11.52* 12.49 11.52 7.70 6.177
5 11.52 8.93* 9.22 6.93 5.713
6 5.76 8.92 7.37 6.23 5.285
7 8.93 6.55* 5.90* 4.888
8 4.46 6.55 5.90 4.522
9 6.56 5.91 4.462*
10 6.55 5.90 4.461
11 3.28 5.91 4.462
12 5.90 4.461
13 5.91 4.462
14 5.90 4.461
15 5.91 4.462
16 2.95 4.461
17 4.462
18 4.461
19 4.462
20 4.461
21 2.231

Example Depreciation

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