Machines and equipment are usually purchased by a business as needed, with only secondary concern for the tax consequences. Some assets cannot be deducted in a single year. Small business owners must begin to depreciate new depreciable assets based on when the assets are placed in service during the year.
Depreciation is a tax deduction for the gradual decline in value of an asset. Assets with a useful life greater than one year must be depreciated over additional years. Assets are categorized and depreciated according to the length of their useful life. Since a new asset is in use for only a portion of the first year, the deduction for the first year is usually smaller than for subsequent years.
If your business places only one new asset in service during a year, depreciation is taken for half the year. Referred to as the half-year convention, this method is also used for multiple depreciable assets if they are acquired evenly throughout the year. If additions of new depreciable assets are concentrated near the end of the year, a different depreciation method may be required.
Each year consists of four quarters, with each quarter consisting of three months. If the cost of depreciable assets added in the fourth quarter is more than 40 percent of the total depreciable assets added for the year, another method is required. Referred to as the mid-quarter convention, this method requires depreciation to begin in the quarter of acquisition.
If the mid-quarter convention is required, all new depreciable assets are depreciated from the midpoint of the quarter in which they are placed in service. The applicable depreciation convention does not change over the life of an asset. In its final year of depreciation, each asset is depreciated for the quarters of the year not depreciated in the first year.
Neither the mid-quarter convention nor the half-year convention apply to real estate. The depreciation of real estate begins in the middle of the month in which the property is first placed in service. Referred to as the mid-month convention, this method is generally not applicable to machines and equipment.
For depreciable assets other than real estate, the half-year convention must be used if possible. If the mid-quarter convention is required because of asset additions in the fourth quarter, the half-year convention is not available for any new assets that particular year. Contact a small business accountant for more information on asset depreciation.
For more information, contact Teri J Henderson, CPA, P.A. or a similar accounting professional.