MACRS Depreciation(p8)

Most business and investment property placed in service after 1986 is depreciated using MACRS.

This section explains how to determine which MACRS depreciation system applies to your property. It also discusses other information you need to know before you can figure depreciation under MACRS. This information includes the property's:

• Recovery class,
• Applicable recovery period,
• Convention,
• Placed-in-service date,
• Basis for depreciation, and
• Depreciation method.

MACRS consists of two systems that determine how you depreciate your property—the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Generally, you must use GDS for property used in most rental activities, unless you elect ADS.

You cannot use MACRS for certain personal property (such as furniture or appliances) placed in service in your rental property in 2008 if it had been previously placed in service before 1987 when MACRS became effective.

Generally, personal property is excluded from MACRS if you (or a person related to you) owned or used it in 1986 or if your tenant is a person (or someone related to the person) who owned or used it in 1986. However, the property is not excluded if your 2008 deduction under MACRS (using a half-year convention) is less than the deduction you would have under ACRS. For more information, see What Method Can You Use To Depreciate Your Property? in Publication 946, chapter 1.

If you choose, you can use the ADS method for most property. Under ADS, you use the straight line method of depreciation.

The election of ADS for one item in a class of property generally applies to all property in that class that is placed in service during the tax year of the election. However, the election applies on a property-by-property basis for residential rental property and nonresidential real property.

For property placed in service during 2008, you elect to use ADS by entering the depreciation on Form 4562, Part III, line 20.

Once you elect to use ADS, you cannot change your election.

Each item of property that can be depreciated under MACRS is assigned to a property class, determined by its class life. The property class generally determines the depreciation method, recovery period, and convention. The property classes under GDS are:

• 3-year property,
• 5-year property,
• 7-year property,
• 10-year property,
• 15-year property,
• 20-year property,
• Nonresidential real property, and
• Residential rental property.

Under MACRS, property that you placed in service during 2008 in your rental activities generally falls into one of the following classes.

• 5-year property. This class includes computers and peripheral equipment, office machinery (typewriters, calculators, copiers, etc.), automobiles, and light trucks.  This class also includes appliances, carpeting, furniture, etc., used in a residential rental real estate activity.
   Depreciation on automobiles, certain computers, and cellular telephones is limited. See chapter 5 of Publication 946.
  
• 7-year property. This class includes office furniture and equipment (desks, file cabinets, etc.). This class also includes any property that does not have a class life and that has not been designated by law as being in any other class.
• 15-year property. This class includes roads, fences, and shrubbery (if depreciable).
• Residential rental property. This class includes any real property that is a rental building or structure (including a mobile home) for which 80% or more of the gross rental income for the tax year is from dwelling units. It does not include a unit in a hotel, motel, inn, or other establishment where more than half of the units are used on a transient basis. If you live in any part of the building or structure, the gross rental income includes the fair rental value of the part you live in.

The recovery period of property is the number of years over which you recover its cost or other basis. The recovery periods are generally longer under ADS than GDS.

The recovery period of property depends on its property class. Under GDS, the recovery period of an asset is generally the same as its property class.

Class lives and recovery periods for most assets are listed in Appendix B of Publication 946. See Table 2-1 for recovery periods of property commonly used in residential rental activities.

Shorter recovery periods are provided under MACRS for qualified Indian reservation property placed in service on Indian reservations. For more information, see chapter 4 of Publication 946.

Treat additions or improvements you make to your depreciable rental property as separate property items for depreciation purposes.

The property class and recovery period of the addition or improvement is the one that would apply to the original property if you had placed it in service at the same time as the addition or improvement.

The recovery period for an addition or improvement to property begins on the later of:

• The date the addition or improvement is placed in service, or
• The date the property to which the addition or improvement was made is placed in service.

You own a residential rental house that you have been renting since 1986 and depreciating under ACRS. You built an addition onto the house and placed it in service in 2008. You must use MACRS for the addition. Under GDS, the addition is depreciated as residential rental property over 27.5 years.

A convention is a method established under MACRS to set the beginning and end of the recovery period. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property.

A mid-month convention is used for all residential rental property and nonresidential real property. Under this convention, you treat all property placed in service, or disposed of, during any month as placed in service, or disposed of, at the midpoint of that month.

A mid-quarter convention must be used if the mid-month convention does not apply and the total depreciable basis of MACRS property placed in service in the last 3 months of a tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) is more than 40% of the total basis of all such property you place in service during the year.

Under this convention, you treat all property placed in service, or disposed of, during any quarter of a tax year as placed in service, or disposed of, at the midpoint of the quarter.

During the tax year, Tom Martin purchased the following items to use in his rental property. He elects not to claim the special depreciation allowance, discussed earlier.

• A dishwasher for $400 that he placed in service in January.
• Used furniture for $100 that he placed in service in September.
• A refrigerator for $800 that he placed in service in October.

Tom uses the calendar year as his tax year. The total basis of all property placed in service that year is $1,300. The $800 basis of the refrigerator placed in service during the last 3 months of his tax year exceeds $520 (40% × $1,300). Tom must use the mid-quarter convention instead of the half-year convention for all three items.

The half-year convention is used if neither the mid-quarter convention nor the mid-month convention applies. Under this convention, you treat all property placed in service, or disposed of, during a tax year as placed in service, or disposed of, at the midpoint of that tax year.

If this convention applies, you deduct a half year of depreciation for the first year and the last year that you depreciate the property. You deduct a full year of depreciation for any other year during the recovery period.

You can figure your MACRS depreciation deduction in one of two ways. The deduction is substantially the same both ways. You can either:

• Actually compute the deduction using the depreciation method and convention that apply over the recovery period of the property, or
• Use the percentage from the MACRS percentage tables, shown later.

In this publication we will use the percentage tables. For instructions on how to compute the deduction, see chapter 4 of Publication 946.

You must use the straight line method and a mid-month convention for residential rental property. In the first year that you claim depreciation for residential rental property, you can claim depreciation only for the number of months the property is in use, and you must use the mid-month convention (explained under Conventions, earlier on this page).

For property in the 5- or 7-year class, use the 200% declining balance method and a half-year convention. However, in limited cases you must use the mid-quarter convention, if it applies. For property in the 15-year class, use the 150% declining balance method and a half-year convention.

You can also choose to use the 150% declining balance method for property in the 5- or 7-year class. The choice to use the 150% method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. You make this election on Form 4562. In Part III, column (f), enter "150 DB." Once you make this election, you cannot change to another method.

If you use either the 200% or 150% declining balance method, you figure your deduction using the straight line method in the first tax year that the straight line method gives you an equal or larger deduction.

You can also choose to use the straight line method with a half-year or mid-quarter convention for 5-, 7-, or 15-year property. The choice to use the straight line method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. You elect the straight line method on Form 4562. In Part III, column (f), enter "S/L." Once you make this election, you cannot change to another method.

You can use the percentages in Table 2-2 (on the next page) to compute annual depreciation under MACRS. The tables show the percentages for the first few years or until the change to the straight line method is made. See Appendix A of Publication 946 for complete tables. The percentages in Tables 2-2a, 2-2b, and 2-2c make the change from declining balance to straight line in the year that straight line will give a larger deduction.

If you elect to use the straight line method for 5-, 7-, or 15-year property, or the 150% declining balance method for 5- or 7-year property, use the tables in Appendix A of Publication 946.

You must apply the table rates to your property's unadjusted basis (defined below) each year of the recovery period.

Once you begin using a percentage table to figure depreciation, you must continue to use it for the entire recovery period unless there is an adjustment to the basis of your property for a reason other than:

1. Depreciation allowed or allowable, or
2. An addition or improvement that is depreciated as a separate item of property.

If there is an adjustment for any reason other than (1) or (2), for example, because of a deductible casualty loss, you can no longer use the table. For the year of the adjustment and for the remaining recovery period, figure depreciation using the property's adjusted basis at the end of the year and the appropriate depreciation method, as explained on this page under Figuring Your Depreciation Deduction. See Figuring the Deduction Without Using the Tables in Publication 946, chapter 4.

This is the same basis you would use to figure gain on a sale (see Basis of Depreciable Property earlier), but without reducing your original basis by any MACRS depreciation taken in earlier years.

However, you do reduce your original basis by other amounts claimed on the property, including:

• Any amortization,
• Any section 179 deduction, and
• Any special depreciation allowance.

For more information, see Publication 946, chapter 4.