Depreciation Methods

The depreciation method that you use for any particular asset is fixed at the time you first place that asset into service. Whatever rules or tables are in effect for that year must be followed as long as you own the property. Since Congress has changed the depreciation rules many times over the years, you may have to use a number of different depreciation methods if you've owned business property for a long time.

For most business property placed in service after 1986, if you don't claim the equipment expensing deduction for the full cost of the item, the IRS requires you to depreciate the asset using a method called "MACRS," which stands for Modified Accelerated Cost Recovery System. However, in 2008 and 2009, Congress is temporarily allowing businesses to recover the costs of capital assets faster than normal by permitting the immediate write-off of 50 percent of the cost of the depreciable property. Again, this "bonus" depreciation deduction is available only in 2008 and 2009.

The MACRS method categorizes all business assets into classes and specifies the time period over which you can write off assets in each class. The most commonly used items are classified as shown in the chart that follows.

Some assets are not eligible for MACRS depreciation, including intangible assets such as patents, trademarks, and business goodwill. Generally these must be amortized (written off in equal amounts) over a 15-year period, beginning in the month of acquisition. Off-the-shelf computer software must be amortized over 36 months.

Once you know the classification and the tax basis of the asset you need to depreciate, you can use a special table provided by the IRS to determine the percentage of the item's tax basis that can be deducted each year. MACRS provides for a slightly larger write-off in the earlier years of the cost recovery period. The full set of depreciation tables showing the MACRS percentages are available in the IRS's free publication 946, How to Depreciate Property, available on the Internet at the IRS web site or by calling 1-800-TAX-FORM.

Planning Tools You can print these commonly used depreciation tables to aid in your financial planning.

As an example, the following chart shows the depreciation amounts under MACRS for office furniture purchased in 2008 for $10,000 and used 100 percent for business. The amounts in the third column are taken from the MACRS half-year convention table, which is the one most commonly used. Notice that the asset's tax basis does not change over the years -- only the percentage used as a multiplier changes each year.

If you do not use the asset 100 percent for business, then each year you must multiply the asset's total tax basis by the business percentage for that year, and then multiply the result by the fraction found in the table.

Example If, in 2009, you use the office furniture from the previous example only 50 percent for your business, you would multiply the $10,000 tax basis by .50, and then multiply the result by .2449 to get your final depreciation figure.

Some special variations of MACRS, or other depreciation methods, are available (or even mandatory) in certain situations.

• Assets of similar types may be grouped into general asset accounts.
• Variations on MACRS are available, for those who desire slower depreciation. They are mandatory for farm property and for 15- and 20-year property.
• Straight-line depreciation is also available, and is mandatory for some alternative minimum tax purposes
• Older methods of depreciation are used for pre-1987 property.