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L23: Tax Depreciation

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)

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L23: Tax Depreciation

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

  2. 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

  3. 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 • Zero salvage value

  4. MACRS Property Classifications (IRS Publication 534) ADR=Asset Depreciation Range ADR: Asset Depreciation Range

  5. Recovery Allowance Percentages=prescribed depreciation rates MACRS Table

  6. 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 11.52% $1152 Full 20% $2000 32% $3200 Full 19.20% $1920 Full 11.52% $1152 Full 5.76% $576 1 2 3 4 5 6 Half-year Convention

  7. 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

  8. 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

  9. 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%

  10. Depreciation Allowances for a 10-year Ownership of the Property Assume that the property will be sold in December of the10th year.

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