Calculating the Depreciation Deduction
You still need to collect a few more pieces of information before you're ready to use the IRS depreciation tables.
Placed in Service Date
With depreciation, you can deduct a larger percentage of the cost of the item in the first year of service than the second year, even less the third year and so on. The depreciation tables make this clear, but it's important to record the month and year you first purchased and began using the business property.
If you use the item exclusively for business, then the "basis" is the cost of the property. If you only use the property 75 percent of the time for business, then the basis is 75 percent of the cost.
The recovery period is the total number of years you can depreciate a piece of business property and corresponds with the nine property classes above. So a 15-year property has a recovery period of 15 years. Residential rental property has a recovery period of 27.5 years and nonresidential real property can be depreciated for 39 years.
This one is about figuring out when the recovery period begins and ends. The simplest method is the half-year convention (HY), in which the depreciated item is said to be placed in service and disposed of at the midpoint of the year. Therefore, it will take four years to depreciate a three-year asset. The mid-quarter convention is used when more than 40 percent of all depreciable property is placed into service during the last months of the tax year. The mid-month convention is reserved for real estate and railroad property.
Yes, this is somehow different than the depreciation "system" or the depreciation "convention." There are three different depreciation methods under the more common GDS system:
- 200 percent declining balance method – provides a greater deduction benefit in the first few years by doubling the percentage deducted each year. This is useful for property like cars and trucks that lose value quickly
- 150 percent declining balance method – also provides greater benefits in the earlier years of the recovery period
- Straight line method – provides equal deductions during each year of the recovery period except the first and last years
The good news is that you don't have to decide for yourself which method to use. Table 4-1 of IRS Publication 946 matches each depreciation method with specific classes of depreciable property.
Next, we'll dive into the depreciation tables themselves.