Accelerated Depreciation -- deduct now, pay later
Nov 26 '02 (Updated Apr 26 '03)
The Bottom Line Accelerated Depreciation is a way of deducting the cost of durable business property over time, faster than straight line depreciation. It still has nothing to do with accounting principles.
See my essay on depreciation for the general definition of depreciation. A quick summary of terms:
Depreciation is a way of accounting for the cost of durable business property over time. In general, property is assigned a recovery period, and its cost is deducted over that period. I will use as an example property with a cost of $10,000 and a recovery period of 5 years, using the mid-year (MY) convention -- allocating expenses as if the property were put into service on July 1, regardless of when it's actually put into service. There's also the mid-month (MM) convention for real property (which now doesn't have accelerated depreciation), and the mid-quarter (MQ) convention which you may be forced to use if you put a lot of property into service in the fourth quarter.
Also, you may want to copy the tables below into a word processor with a mono-spaced font, so the table columns will align; I'll use "|" to separate columns, as well.
What isn't accelerated depreciation?
Any property can be depreciated using straight line (SL) depreciation. For our example:
Year 1 $1,000 deducted; $9,000 remaining
Year 2 $2,000 deducted; $7,000 remaining
Year 3 $2,000 deducted; $5,000 remaining
Year 4 $2,000 deducted; $3,000 remaining
Year 5 $2,000 deducted; $1,000 remaining
Year 6 $1,000 deducted
Nice and simple.
What is accelerated depreciation?
The most common method for property with a recovery period of 3, 5, or 7 years is the 200% declining balance (200% DB or DDB) method. Property with a longer recovery period may use 150% DB or 125% DB, and you generally have the option of depreciating property over a longer period of time, and always have the option of using a less accelerated method, if you select the method on the first tax return in which it's depreciated.
For our example; the normal depreciation rate is 20% of the original value -- so 200% DB would mean that we deduct 40% of the current value; but returning to straight line over the remaining life when that's faster.
Columns are:
1: current year straight line deduction for comparison
2: Current year accelerated deduction
3: Remaining non-deducted value
4: Remaining life (years)
5: 200% DB deduction
6: SL deduction for the remaining life
(If the Epinions ? bug is back that ˝ character represents one half.)
Year 1: $1,000.00 | $2,000.00 | $8,000.00 | 4 ˝ | $3,200.00 | $1,777.78
Year 2: $2,000.00 | $3,200.00 | $4,800.00 | 3 ˝ | $1,920.00 | $1,371.43
Year 3: $2,000.00 | $1,920.00 | $2,880.00 | 2 ˝ | $1,152.00 | $1,152.00
Year 4: $2,000.00 | $1,152.00 | $1,728.00 | 1 ˝ | $ 691.20 | $1,152.00
Year 5: $2,000.00 | $1,152.00 | $ 576.00 | ˝ | $ 238.40 | $1,152.00
Year 6: $1,000.00 | $ 576.00 | $ 0
As you can see you have more deductions in years 1 and 2, but smaller deductions in future years.
Of course, the IRS has tables for this, but you do have to write 200% DB or DDB and MY on the tax form, so I thought you might want to know what they mean.
Do I want to use accelerated depreciation?
Well, as in most tax questions, the answer is maybe. In most cases, you want deductions now to reduce your taxes now, but there are a few cases in which case later deductions will be worth more than current deductions.
Examples where you might want to defer expenses:
Negative taxable income: Suppose you have medical expenses exceeding your current income. Then current depreciation has no tax benefit, but you may have income in future years which the depreciation can be used against.
Alternative Minimum Tax: For AMT purposes, you can only take SL depreciation, usually over a longer recovery period than for normal taxes. If you are subject to AMT, you might want to defer your deductions to years in which you are not subject to AMT, or you might want to select the same depreciation method for regular taxes and AMT to avoid dual record-keeping.
Related reviews
http://www.epinions.com/content_911384708 on Alternative Minimum Tax (AMT)
http://www.epinions.com/content_2610471044 on Depreciation.
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Arthur.Rubin
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Member: Arthur Rubin
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Expert in mathematics, computers, income tax, with a wide variety of interests.
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