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Understanding MACRS Depreciation

written by: N Nayab•edited by: Wendy Finn•updated: 4/1/2011

MACRS or "Modified Accelerated Cost Recovery System" is the system of depreciation stipulated by the Internal Revenue Service for tax purposes. Read on for an overview of MACRS depreciation.

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    MACRS Depreciation Depreciation is calculating the decline in value of an asset owing to wear and tear, deterioration, and obsolescence. There are many ways to calculate depreciation. MACRS (Modified Accelerated Cost Recovery System), is the depreciation system stipulated by the Internal Revenue Service for taxpayers, for calculating depreciation and the setting off of such depreciation from income.

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    Classes

    The MACRS depreciation system groups all assets into classes (or tax lives), of 3,5,7,10,15, 20, 27.5 and 31.5/39 years. Such tax lives denote the number of years in which the asset depreciates fully, and the value of the asset becomes zero.

    Common examples of each tax-life class are:

    • 3 year classes: small tools and specialized manufacturing devices
    • 5 year classes: computers, light trucks, and construction equipment
    • 7 year classes: office furniture and most machinery
    • 10 year classes: specialized heavy manufacturing equipment and mobile homes
    • 15 year classes: billboards and service station buildings
    • 20 year classes: sewer pipes, utilities, and landed property
    • 27.5 year classes: residential real estate property
    • 31.5 / 39 year classes: office and other commercial property. Pre 1993 assets have tax-life of 31.5 years and other assets 39 years tax-life.

    The MACRS depreciation system, has tables that provide the percentage depreciation allowed for each year, for each class.

    The system provides two alternative methods: general depreciation system (GDS), and alternative depreciation system (ADS). GDS provides more accelerated depreciation for assets, and as such, most taxpayers prefer this system.

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    Method

    MACRS depreciation mandate for calculating depreciation, bears similarity to the declining balance method of calculating depreciation; using a double rate of straight-line depreciation for 3, 5, 7, 10 year classes, and using a 1.5 rate of straight line depreciation for 15 and 20 year classes, and by single rate or straight line method for 27.5 and 31.5/39 year classes.

    The relevant percentage of depreciation for the depreciation year, is listed in Appendix A of IRS Publication 946.

    MACRS depreciation system also allows for a half year convention, that is considering the asset as purchased at the exact middle of the year, regardless of the actual date of purchase, and as such all assets receive half-year depreciation during the year of purchase. This means that an asset purchased even on the last day of the financial year, still enjoys a six-month depreciation write-off during the accounting year.

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    Example

    Referring to the MACRS depreciation table provided by the IRS, an asset group under the 5 year life class, enjoys depreciation of 20 percent in the first year, 32 percent in the second year, 19.2 percent in the third year, 11.52 percent in the fourth year, and 5.76 percent in the fifth year. Using the straight-line depreciation method, in contrast, means a flat 20 percent deprecation in each of the five years.

    For example, the straight-line depreciation of an asset in the 5-year life class asset is 20 percent. Since MACRS depreciation allows a double rate for 5-year life classes, the depreciation rate for the first year is 40 percent. Since MACRS depreciation also stipulates considering the purchase date of the asset at the middle of the financial year, regardless of the actual purchase, effective depreciation allowable for the first year is half of this 40 percent, or 20 percent.

    In the second year, the asset enjoys a depreciation of 32 percent instead of the 20 percent allowed by the straight-line method of deprecation. With 20 percent depreciated during the first year, 40 percent of the remaining 80 percent, translates to 32 percent.

    Similarly, 40 percent of the remaining 48 percent (100-20-32) being 19.2 percent, the allowable depreciation in the third year is 19.2 percent.

    In the fourth year, 40 percent of the remaining value of 27.8 percent (100-20-32-19.8) being 11.52, the claimable depreciation is 11.52 percent of the asset value.

    In the last year, the claimable depreciation is 5.76 percent, or the balance value of the asset. 100-20-32-19.8-11.52 = 5.76 percent.

    Using the MACRS depreciation allows writing off the entire value of the asset within the life of the asset. The revenue that accrues from the disposition of the asset, is then treated as fresh income.

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    Reference

    1. Seattle Central Community College. “MACRS Depreciation." http://seattlecentral.edu/faculty/moneil/Lectures/macrs.htm. Retrieved March 31, 2011.
    2. Internal Revenue Sercvice. “Figuring Deprecation under MARCS." http://www.irs.gov/publications/p946/ch04.html. Retrieved March 31, 2011

    Image Credit: geograph.org.uk/Robin Jones