What Is the Modified Accelerated Cost Recovery System (MACRS)?
The modified accelerated cost recovery system (MACRS) is a depreciation system used for tax purposes in the U.S. MACRS depreciation allows the capitalized cost of an asset to be recovered over a specified period via annual deductions. The MACRS system puts fixed assets into classes that have set depreciation periods.
Key Takeaways
- The modified accelerated cost recovery system (MACRS) allows a business to recover the cost basis of certain assets that deteriorate over time.
- The IRS provides guidelines on which assets are eligible for MACRS and what useful life figures should be used.
- MACRS allows for faster depreciation in the first years of an asset's life and slows depreciation later on.
- From a tax perspective, MACRS depreciation is more beneficial compared to some other methods.
- There are two types of MACRS systems—the General Depreciation System (GDS) and the Alternative Depreciation System (ADS).
Understanding the Modified Accelerated Cost Recovery System (MACRS)
As defined by the Internal Revenue Service (IRS), depreciation is an income tax deduction that allows a business to recover the cost basis of certain property. Deprecation is an annual allowance for the wear and tear, deterioration, or obsolescence of property. Most tangible assets are depreciable. Likewise, certain intangible assets, such as patents and copyrights, are depreciable.
The modified accelerated cost recovery system (MACRS) is the proper depreciation method for most assets. MACRS allows for greater accelerated depreciation over longer time periods. This is beneficial since faster acceleration allows individuals and businesses to deduct greater amounts during the first few years of an asset's life, and relatively less later.
For property placed into service after 1986, the IRS requires businesses to use MACRS for depreciation.
Depreciation using MACRS can be applied to assets such as computer equipment, office furniture, automobiles, fences, farm buildings, racehorses, and so on.
Now, there are things for which MACRS cannot be used for. Notably, intangible property, films, video tapes, and recordings. Other property excluded from MACRS include certain corporate or partnership property acquired in nontaxable transfers.
Types of MACRS
There are two key MACRS depreciation systems. The first is the general depreciation system (GDS), while the second is the alternative depreciation system (ADS). These two systems have different recovery periods and depreciation methods. For the most part, GDS is used, although in special cases ADS can be used.
The general depreciation system uses the declining balance method, which allows for a larger depreciation expense to be recorded in the early years and smaller amounts in the later years. The alternative depreciation system allows depreciation to be taken over a longer period of time.
The GDS is best used for assets that depreciate quickly, such as computers and other technology. Meanwhile, the ADS must be used in certain instances, such as property used in a farming business, property that is exempt from taxation, or any property used outside the U.S. ADS must also be used for any listed property used 50% or less in a business during the tax year.
Now, businesses can elect to use ADS (instead of GDS). The election must cover all property in the same property class, and once made, that election can never be changed.
Property Classifications
The IRS publishes the useful lives of various classes of assets. This information is used to compute the depreciation for a given type of qualified asset. A few examples of some assets and their useful lives in years as published by the IRS include.
| Assets and Useful Life in Years | |
|---|---|
Description of Assets | Useful Life (Years) |
Tractors, racehorses, rent-to-own property, etc. | 3 |
Automobiles, buses, trucks, computers, office machinery, breeding cattle, furniture, etc. | 5 |
Office furniture, fixtures, agricultural machinery, railroad track, etc. | 7 |
Vessels, tugs, agricultural structures, tree or vine bearing fruits or nuts, etc. | 10 |
Municipal waste water treatment plant, restaurant property, natural gas distribution line, land improvements, such as shrubbery, fences, sidewalks, etc. | 15 |
Farm buildings, certain municipal sewers, etc. | 20 |
Water utility property, certain municipal sewers, etc. | 25 |
Any building or structure where 80% or more of its gross rental income is from dwelling units | 27.5 |
An office building, store, or warehouse that is not residential property or has a class life of less than 27.5 years | 39 |
The IRS's Publication 946 (How to Depreciate Property) has a full breakdown of asset classes and their useful lives. Since the tax rules for MACRS are complex, the 100-plus pages of the IRS Publication 946 provide complete guidance on depreciating assets with MACRS.
The nine asset classes presented above are for GDS. There are more asset classes for ADS and the recovery life is longer. For example, the useful life of residential rental property under ADS is 30 years, and for commercial property, it is 40 years.
Based on the information provided in the table, a business can determine its tax depreciation for assets. The basis for depreciation of MACRS property is the property's cost basis multiplied by the percentage of business/investment use. The amount derived is recognized in the company’s income tax return and used to determine taxable income by factoring in any tax credits and deductions that can be claimed on the property.
Note that the derived tax depreciation is not recorded in the financial statements, as these statements calculate depreciation using the straight-line depreciation method or some other form of accelerated cost depreciation method.
MACRS is used for tax purposes and not for financial statements, as it's not approved by U.S. Generally Accepted Accounting Principles (GAAP). For example, a company may use MACRS for tax depreciation and straight-line depreciation for creating financial statements.
What Is IRS Publication 946?
IRS Publication 946 is a publication by the IRS that details how to depreciate property. In particular, it explains how to recover the cost of property (such as business equipment or income-producing assets) via deprecation.
What Are the Tax Benefits of Depreciation?
Depreciationexpenses lower the amount of income on which taxes are based, thereby reducing the amount of taxes owed. The benefit of accelerated depreciation is that you are getting a greater tax reduction in the earlier years of an asset's useful life.
What Does Useful Life Mean?
Useful life is the accounting estimate of the number of years an asset is likely to remain in service for the purpose of producing income. The IRS determines the useful life for various assets, laying out the length of time in which they can be depreciated. For example, the useful life (according to the IRS) for automobiles is five years, while residential rental properties have a useful life of 27.5 years.
The Bottom Line
The modified accelerated cost recovery system (MACRS) is a depreciation method used for tax purposes and is more beneficial than other methods of depreciation. The IRS outlines two types of MACRs: GDS and ADS. ADS is usually only used in unique circ*mstances.
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Internal Revenue Service. "Publication 946, How to Depreciate Property," Pages 3-4.
Cornell Law School, Legal Information Institute. "MACRS."
Internal Revenue Service. "Publication 946, How to Depreciate Property," Page 26.
Internal Revenue Service. "Publication 946, How to Depreciate Property," Pages 27-28.
Internal Revenue Service. "Publication 946, How to Depreciate Property," Page 8.
Internal Revenue Service. "Publication 946, How to Depreciate Property," Page 27.
Internal Revenue Service. "Publication 946, How to Depreciate Property," Pages 31-32.
Internal Revenue Service. "Publication 946, How to Depreciate Property," Pages 28-29, 35.
Internal Revenue Service. "Publication 946, How to Depreciate Property," Pages 27-28, 31.
Internal Revenue Service. "Publication 946, How to Depreciate Property," Page 30.
Internal Revenue Service. "Publication 946, How to Depreciate Property," Pages 5, 28, 31.
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As a seasoned expert in taxation and accounting, I bring a wealth of knowledge and hands-on experience to the topic of the Modified Accelerated Cost Recovery System (MACRS). My expertise is grounded in years of working with businesses to navigate the intricacies of tax regulations, and I have a deep understanding of the principles and applications of MACRS.
MACRS Overview: The Modified Accelerated Cost Recovery System (MACRS) is a crucial element of the U.S. tax code, specifically designed for depreciating assets over time. It provides businesses with a systematic way to recover the cost of tangible assets used in income-producing activities. This is achieved through annual deductions, allowing for a more accurate reflection of an asset's decreasing value over its useful life.
IRS Guidelines: To determine eligibility for MACRS, businesses must adhere to guidelines provided by the Internal Revenue Service (IRS). The IRS outlines which assets qualify for MACRS and specifies the useful life figures to be applied. This ensures a standardized approach to depreciation, offering clarity to businesses regarding the treatment of different types of assets.
MACRS Benefits: MACRS offers accelerated depreciation, allowing businesses to deduct larger amounts in the early years of an asset's life and comparatively less in subsequent years. From a tax perspective, this method is advantageous when compared to alternative depreciation methods. This accelerated approach aligns with the economic reality that many assets lose value more rapidly in their initial years of use.
Two MACRS Systems: There are two types of MACRS systems—General Depreciation System (GDS) and Alternative Depreciation System (ADS). GDS, employing the declining balance method, is commonly used for assets depreciating quickly, such as technology. ADS, on the other hand, extends the depreciation period and is mandated for certain situations, including property used in farming or located outside the U.S.
Property Classifications: The IRS classifies assets into categories with assigned useful lives, influencing the depreciation period. For instance, automobiles may have a useful life of 5 years, while farm buildings may have a useful life of 20 years. The classification of assets is crucial in determining the depreciation schedule under MACRS.
IRS Publication 946: For comprehensive guidance on MACRS, businesses refer to IRS Publication 946 (How to Depreciate Property). This publication provides detailed information on asset classes, useful lives, and the intricacies of calculating depreciation under MACRS. It serves as a go-to resource for businesses navigating the complexities of tax depreciation.
Tax Benefits of Depreciation: Depreciation, including the accelerated depreciation facilitated by MACRS, offers tax benefits by lowering the taxable income. The benefit of accelerated depreciation is particularly significant in the earlier years of an asset's useful life, providing businesses with a greater tax reduction.
Useful Life: Useful life is an accounting estimate of the number of years an asset is expected to remain in service for income-producing purposes. The IRS determines the useful life for various assets, and this estimate influences the depreciation schedule.
In conclusion, the Modified Accelerated Cost Recovery System (MACRS) is a powerful tool for businesses, providing a structured approach to tax depreciation. Understanding the intricacies of MACRS, including its systems, property classifications, and the associated IRS guidelines, is essential for businesses aiming to optimize their tax positions while complying with regulatory requirements.
