What is MACRS Depreciation?
MACRS Depreciation is the tax depreciation system that is currently employed in the United States. The MACRS, which stands for Modified Accelerated Cost Recovery System, was originally known as the ACRS (Accelerated Cost Recovery System) before it was rebranded to its current form after the enactment of the Tax Reform Act in 1986.
The MACRS tax depreciation system was intended to encourage investors to invest in depreciable assets by allowing large tax savings in the initial years of the asset’s life. Taxpayers can apply MACRS depreciation to various asset classes such as automobiles, office furniture, construction machinery, farm buildings, fences, computing equipment, etc.
How MACRS Depreciation Works
The Internal Revenue Service describes depreciation as an income tax deduction that businesses can use to recover the cost basis of certain assets. Depreciation is an annual deduction for assets that become obsolete, deteriorate, or are affected by wear and tear. It applies to both tangible (such as motor vehicles, machinery, buildings, etc.), as well as intangible assets (like patents, trademarks, and copyrights). MACRS serves as the most suitable depreciation method for tax purposes.
When purchasing an asset, the entire cost of that asset cannot be written off in the year of purchase. Instead, the IRS requires businesses to deduct a portion of the asset cost gradually over the number of years that the asset is expected to be used.
The MACRS depreciation method allows greater accelerated depreciation over the life of the asset. It means that the business can take larger tax deductions in the initial years of the asset and deduct less in later years of the asset.
MACRS depreciation is not added in the balance sheet because it is not approved by GAAP. Instead, the approved method for calculating depreciation is straight line depreciation method or other methods of accelerated cost depreciation.
Depreciation Systems to Use with MACRS Depreciation
There are two main depreciation systems that taxpayers may use to depreciate property under MACRS depreciation. The systems comprise the Alternative Depreciation Systems (ADS) and General Depreciation Systems (GDS). The system selected will determine the recovery period and depreciation method to use. Generally, taxpayers are expected to use GDS, but there are situations when the law requires them to use ADS or when taxpayers elect to use the system.
Properties that Apply Under GDS
There are various property classifications presented by the IRS. Taxpayers use the information to calculate depreciation for different types of qualified assets. Some example of the property classifications include:
|3-year property||Tractors, racehorse over 2-year-old, qualified rent-to-own property|
|5-year property||Automobiles, buses, taxis, office machinery, property used in research, computer and peripheral equipment, breeding cattle, dairy cattle, appliances, carpets, and furniture used in residential real estate activity|
|7-year property||Office furniture, fixtures, railroad truck, agricultural machinery, property with no class life and not assigned to any other class, natural gas collection lines|
|10-year property||Vessels, barges, agricultural structure, tree/vines bearing fruits, qualified small electric meter, smart electric grid systems|
|15-year property||Restaurant property, land improvements (fences, sidewalks, and bridges), municipal water treatment plant, retail motor fuel outlets, electricity transmission property that transmits 69 or more kilovolts, retail improvement property, telephone distribution plant, leasehold improvement property|
|20-year property||Farm buildings (excluding single purpose agricultural structures), municipal sewer (not classified under 25-year property)|
|25-year property||Municipal sewers, a property that is part of water distribution facilities|
|27.5-year property||Any building where at least 80% of its gross rental income for the year is from dwelling units|
|39-year property (Non-residential real property)||Office building, store, or warehouse that is not a residential property|
When ADS is Required by Law
There are situations when ADS must be used when depreciating certain asset classes. It can also be applied at the election of the individual or institutional taxpayer in lieu of regular depreciation. Some of the properties where ADS must be used include:
- Any property that is exempted from taxation
- Any bond-financed property that is exempted from taxation
- Any tangible property used outside the United States during the tax year
- A listed property in a qualified business use (50% or less)
- All property that is used in a farming business
Depreciation Methods Allowed Under MACRS
The main depreciation methods that are allowed under MACRS include the declining balance method and straight line method of computing depreciation.
1. Declining balance method
The declining balance method provides greater deductions in the initial years of the assets life and less in the last years of use. The depreciation is applied over the recovery period.
2. Straight line method
The straight line method deducts the same amount each year consistently except in the first year of service and the last year of service when the asset is disposed of.
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