MACRS

MACRS stands for modified accelerated cost recovery system. It is the current system allowed in the United States to calculate tax deductions on account of depreciation for depreciable assets (other than intangible assets). IRS Form 4562 is used to claim depreciation deduction.

It allows a larger deduction in early years and lower deductions in later years when compared to the straight-line method.

There are two sub-system of MACRS: the general depreciation system (GDS) and alternate depreciation system (ADS). GDS is the most relevant and is used for most assets.

Formulas

Depreciation in 1st Year =
Cost ×1× A × Depreciation Convention
Useful Life
Depreciation in Subsequent Years =
(Cost − Depreciation in Previous Years) ×1× A
Recovery Period

Where,
A is 100% or 150% or 200%.

However, where the depreciation calculated using the above formula is lower than depreciation under straight line method, the straight line depreciation for the previous year is taken as the relevant depreciation deduction for the rest of the recovery period.

Alternatively, tables provided by IRS can be used. Following table (taken from IRS website) shows rates for 200% declining balance method using half-year convention:

YearDepreciation Rate in % for Recovery Period
3-year5-year7-year10-year15-year20-year
133.3320.0014.2910.005.003.750
244.4532.0024.4918.009.507.219
314.8119.2017.4914.408.556.677
47.4111.5212.4911.527.706.177
511.528.939.226.935.713
65.768.927.376.235.285
78.936.555.904.888
84.466.555.904.522
96.565.914.462
106.555.904.461
113.285.914.462
125.904.461
135.914.462
145.904.461
155.914.462
162.954.461
174.462
184.461
194.462
204.461
212.231

Steps in Calculation

Calculating depreciation under MACRS involves the following steps:

  1. Figure out the class of the property: properties are classified into different classes on the basis of their useful life and a recovery period is determined for each class of property.
  2. Figure out the required depreciation convention: to simplify the calculation, the IRS has prescribed whether an asset should be treated as acquired at the mid of the month, the quarter or the year. These conventions are called mid-month, mid-quarter and half-year conventions respectively.
  3. Determine the depreciation method to be applied: depreciation is charged on the cost based on 3 different depreciation methods: 150% declining balance, 200% declining balance and straight-line method.

IRS publication available here provides information that help find the relevant system, class, convention and method for any property.

Example

Safe Windpower recently installed 50 wind turbines at a cost of $100 million. They started operations on 30 May 2009. Calculate the depreciation under MACRS method for the turbines assuming the half-year convention is relevant. Assume that the company's year end is 31 December.

Solution

The calculation is performed in the following steps:

Find out from Appendix B of Publication 946 that the wind power installations are a 5 year property.

Since the property does not fall into mid-month or mid-quarter convention, the half-year convention is relevant.

Table 4-1 of the publication outlines the methods allowed. Since it is a non-form 5-year property, the company can elect to use either the 150% or 200% declining balance method.

Depreciation for year ended 31 December 2009 = $100 million × 1/5 × 200% (declining balance method) × 1/2 (for half-year convention) = $20 million

Depreciation for financial year 2009 can also be calculated using rates given in table. For 5 year property with half-year convention and 200% declining balance method, rate for the first year is 20% as given in Table A-1 of Appendix A.

Depreciation for 2009 using Table A-1 is $100 million × 20% = $20 million

Depreciation in 2010 = ($100 million - $20 million) × 1/5 × 200% = 32 million

Depreciation in 2010 using Table = $100 million × 32% = $32 million

The following is the complete depreciation schedule

YearDepreciationCalculation Using FormulaCalculation Using Table
2009$20 million$100 × 1/5 × 200% × 0.5$100 million × 20%
2010$32 million($100 − $20) × 1/5 × 200%$100 million × 32%
2011$19.2 million($100 − $20 − $32 million) × 1/5 × 200%$100 million × 19.2%
2012$11.52 million($100 − $20 − $32 − $19.2) × 1/5 × 200%$100 million × 11.52%
2013$11.52 million(Note A)$100 million × 11.52%
2014$5.76 million$11.52 million × 0.5 (Note B)$100 million × 5.76%

Note A: MACRS declining balance changes to straight-line method when that method provides an equal or greater deduction. Deduction under 200% declining balance MACRS for 2013 would be $6.91 million ($100 - $20 - $32 - $19.2 - 11.52) × 1/5 × 200%. This is lower than depreciation under straight line method over the remaining recovery period which comes out to be $11.52 million (=100 - 20 - 32 - 19.2 - 11.52 ) × 1/1.5).

Note B: Due to half-year convention, depreciation charged for half-year in 2014.

Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork