Typically, companies calculate depreciation for their own purposes using a method called straight-line depreciation. This method takes the acquired cost of the asset and divides its years of useful life. This is called book depreciation, as it is for the companies' own records. When it comes to calculating tax depreciation, things get more complicated. With a little information and some instruction, you will be able to accurately calculate your tax depreciation.
1. Obtain MACRS reference material. Modified Accelerated Cost Recovery System (MACRS) is the system used to depreciate most property for tax purposes in the U.S. The material is available in table form in IRS Publication 946 -- How to Depreciate Property (see Resources). You can also find MACRS information in book form. Many asset accounting software programs include MACRS information for calculations.
2. Determine which system of depreciation to use under MACRS. For most property, you should use the General Depreciation System (GDS). There are exceptions to this general rule, and they are specifically listed in IRS Publication 946. Property that does not fall under GDS should be depreciated using the Alternative Depreciation System (ADS).
3. Determine your property's useful life for tax purposes. IRS Publication 946 classifies properties by their useful life. For example, if you are trying to calculate the depreciation on a computer, look at Publication 946 under "Which Property Class Applies Under GDS?" This section tells you that computers are considered five-year property, meaning that your computer's useful life is five years.
4. Figure out the depreciation method. There are three main depreciation methods using GDS under MACRS. They are the 200 percent declining balance method, 150 percent declining balance method and the straight-line method. IRS Publication 946 provides tables to help you determine the method of depreciation based on your property's class of useful life. For example, a computer is five-year property and would be depreciated using the 200 percent method. ADS uses the straight-line method.
5. Determine your asset's convention. Convention refers to when the asset is placed into service and able to be depreciated. The mid-month convention assumes that the asset is placed into service or disposed of in the middle of the month. The mid-quarter convention assumes that applicable property is placed in service in the middle of the quarter. If you are using mid-quarter and purchase an asset in January, for depreciation purposes that asset would begin being depreciated as of Feb. 15 -- the exact middle of the quarter. The half-year convention allows depreciation expense for one half of the year in question. IRS Publication 946 provides tables based on convention to aid in calculations.
6. Calculate your depreciation using the above components. If your asset is a computer, using IRS Publication 946, you will use GDS. Computers are five-year property and are depreciated using the 200 percent declining balance method. Determine which convention to use and apply it, using the IRS tables in Publication 946.
- Depreciation software, such as Sage's Fixed Asset Software, can be extremely helpful in accurately calculating depreciation for tax purposes.
- Depreciation for tax purposes can be confusing. If you have a lot of assets to depreciate and aren't confident in your calculations, contact a tax expert.
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