R2: Depreciation

What is the depreciation method used for tax purposes?

MACRS

• more depreciation up front compared to straight-line

• salvage value ignored under MACRS

real property

land & all items permanently affixed to the land (buildings, pavings, etc.)

personal property

tangible, movable property not affixed to the land (machinery, equipment, computers, & automobiles)

MACRS: personal property classes (most commonly tested)

• 5-year: cars, light trucks, computers, & copiers

• 7-year: furniture & fixtures, machinery, & equipment

Other MACRS personal property classes

• 3-year: special tools & certain racehorses

• 10-year: boats & water transportation equipment

• 15-year: qualified improvements to the interior of existing nonresidential buildings & certain improvements made directly to land

• 20-year: farm buildings & municipal sewers

MACRS personal property half-year convention

• half-year convention applies to personal property

• this convention is built into the MACRS tables

MACRS personal property mid-quarter convention

• if >40% of depreciable personal property is placed in service in the last quarter of the year, the mid-quarter convention applies (use the quarter applicable to the property)

• mid-quarter tables used to calculate depreciation

mid-quarter convention disposals

*for personal property using the mid-quarter convention only

• Q1 (disposed of Jan-Mar) → 0.5/4.0 = 12.5%

• Q2 (disposed of Apr-Jun) → 1.5/4.0 = 37.5%

• Q3 (disposed of July-Sep) → 2.5/4.0 = 62.5%

• Q4 (disposed of Oct-Dec) → 3.5/4.0 = 87.5%

MACRS real property

*remember land is never depreciated

• residential rental property: 27.5 year straight-line

• nonresidential real property: 39 year straight-line

real property mid-month convention

• SL depreciation is computed based on the # of months the property was in service

• ½ month is taken the month the property is placed in service & disposed

Depreciation conventions used for personal property vs. real property

Personal property	Real property
Half-year convention	Mid-month convention
Mid-quarter convention

Sec. 179 expense deduction

• taxpayer can elect to immediately expense a fixed amount of qualified business-use property purchased & placed in service during the year

eligible property:

• tangible personal property or anything to related to the real property that improves it (must be a nonresidential building)

• can’t use Sec 179 to create a loss or if you already have a loss

Sec. 179 limitations

• 2025 allowance is $1,250,000

• maximum amount is reduced dollar-by-dollar by any amount that exceeds $3,130,000

• deduction is limited to taxable income

bonus depreciation

• taxpayer can expense an additional % of qualified property that is placed into service in the current year

• property must be personal property with a recovery period of 20 years or less

• cannot be acquired from a related party

• % is 40% in 2025 & 20% in 2026

order of depreciation deductions

1. Sec. 179

2. Bonus depreciation

3. MACRS

amortization

intangible assets are amortized using the straight-line method with a full-month convention (full month of amortization is taken in the month of acquisition & disposition)

most common recovery period for amortization of intangible assets

180 months (15 years)

Section 197 purchased intangibles

amortize over 180 months beginning w/ the month purchased, regardless of the asset’s useful life

• examples: goodwill, patents, & copyrights owned by the purchased business

capitalized R&D costs

• amortize over 5 years for domestic research, 15 years for foreign research

• beginning with the midpoint of the year in which the costs were paid or incurred

• costs are no longer amortized once a patent is obtained

amortization of purchased vs. self-created patents & copyrights

• purchased → amortize over remaining life for any patents/copyrights purchased separately & not as part of a business acquisition

• self-created → amortize over the life of the patent or copyright

amortization of loan costs

amortize debt-issuance costs over the term of the loan

capitalized organizational costs & start-up costs

• can immediately expense the first $5,000 of start-up and the first $5,000 of organizational costs

• any amount over the allowance is amortized over 180 months beginning in the month the business starts