L23: Tax Depreciation ECON 320 Engineering Economics Mahmut Ali GOKCE Industrial Systems Engineering Computer Sciences

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) Under MACRS, Several Classes of Assets, each with lifespans called recovery period Recovery periods do not necessarily correspond to useful lives. Personal Property Depreciation method based on DB method switching to SL Half-year convention (put in service in mid-year. Half year depr. 1st year. Half year depreciation year following the recovery period) Zero salvage value Real Property SL Method Mid-month convention

MACRS Property Classifications (IRS Publication 534) ADR=Asset Depreciation Range Recovery Period ADR Midpoint Class Applicable Property 3-year Special tools for manufacture of plastic products, fabricated metal products, and motor vehicles. 5-year Automobiles, light trucks, high-tech equipment, equipment used for R&D, computerized telephone switching systems 7-year Manufacturing equipment, office furniture, fixtures 10-year Vessels, barges, tugs, railroad cars 15-year Waste-water plants, telephone- distribution plants, or similar utility property. 20-year Municipal sewers, electrical power plant. 27.5-year Residential rental property 39-year Nonresidential real property including elevators and escalators ADR: Asset Depreciation Range

MACRS Table Recovery Allowance Percentages=prescribed depreciation rates

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% $2000 32% $3200 Full 19.20% $1920 Full 11.52% $1152 Full 11.52% $1152 Full 5.76% $576 1 2 3 4 5 6 Half-year Convention

Year (n) 1 2 3 4 5 6 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 SL 11.52% 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 DDB DDB SL SL

Conventional DB Switching to SL 4,000 2,400 1,440 1,080 1,080 MACRS with half-year convention 2,000 3,200 1,920 1,152 1,152 576 CHECK OUT COURSE WEB PAGE FOR MACRS ANALYSIS TOOL

MACRS for Real Property Types of 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. 9.5 months of depreciation for first year allowed Find the depreciation allowance in year 1. D1 = (9.5/12)(100%/27.5) = 2.879%

Depreciation Allowances for a 10-year Ownership of the Property Year (n) Calculation Allowed Depreciation (%) 1 (9.5/12)(100%/27.5) 2.8788% 2 100%/27.5 3.6364% 3 4 5 6 7 8 9 10 (11.5/12)(100%/27.5) 3.4848% Assume that the property will be sold in December of the10th year.