Tax Depreciation Lecture No.23 Professor C. S. Park Fundamentals of Engineering Economics Copyright © 2005

Tax Depreciation Purpose: Used to compute income taxes for the IRS Assets placed in service prior to 1981 Use book depreciation methods (SL, DB, SOYD) Assets placed in service from 1981 to 1986 Use ACRS (Accelerated Cost Recovery System) Table Assets placed in service after 1986 Use MACRS (Modified ACRS) Table

Modified Accelerated Cost Recovery Systems (MACRS) Personal Property Depreciation method based on DB method switching to SL Half-year convention Zero salvage value Real Property SL Method Mid-month convention Zero salvage value

MACRS Property Classifications (IRS Publication 534) Recovery PeriodADR Midpoint ClassApplicable Property 3-yearSpecial tools for manufacture of plastic products, fabricated metal products, and motor vehicles. 5-yearAutomobiles, light trucks, high-tech equipment, equipment used for R&D, computerized telephone switching systems 7-yearManufacturing equipment, office furniture, fixtures 10-yearVessels, barges, tugs, railroad cars 15-yearWaste-water plants, telephone- distribution plants, or similar utility property. 20-yearMunicipal sewers, electrical power plant yearResidential rental property 39-yearNonresidential real property including elevators and escalators ADR: Asset Depreciation Range

MACRS Table

MACRS Rate Calculation Asset cost = $10,000 Property class = 5-year recovery period DB method = Half-year convention, zero salvage value, 200% DB switching to SL 20% $ % $3200 Full 19.20% $1920 Full 11.52% $1152 Full 11.52% $1152 Full 5.76% $ Half-year Convention

Year (n) Calculation in % (0.5)(0.40)(100%)20% (0.4)(100%-20%)32% SL = (1/4.5)(80%)17.78% (0.4)(100%-52%)19.20% SL = (1/3.5)(48%)13.71% (0.4)(100%-71.20%)Switch to SL11.52% SL = (1/2.5)(29.80%)11.52% SL = (1/1.5)(17.28%)11.52% SL = (0.5)(11.52%)5.76% MACRS (%) DDB SL

Conventional DB Switching to SL MACRS with half-year convention 2,0003,2001,9201,1521, ,0002,4001,4401,0801,080

MACRS for Real Property 27.5-year (Residential) 39-year (Commercial) SL Method Zero salvage value Mid-month convention Example: Placed a residential property in service in March. Find the depreciation allowance in year 1. D 1 = (9.5/12)(100%/27.5) = 2.879% Types of Real Property

Depreciation Allowances for a 10-year Ownership of the Property Year (n)CalculationAllowed Depreciation (%) 1(9.5/12)(100%/27.5)2.8788% 2100%/ % 3100%/ % 4100%/ % 5100%/ % 6100%/ % 7100%/ % 8100%/ % 9100%/ % 10(11.5/12)(100%/27.5)3.4848% Assume that the property will be sold in December of the10th year.