by Bob Rywick
Under the Modified Accelerated Cost Recovery System, the half-year depreciation convention generally applies to personal property.
Under this convention, only a half-year of depreciation is allowed for personal property for the acquisition or disposition year. However, when more than 40 percent of the total basis of all personal property placed in service during a tax year is placed in service during the last three months of that tax year, the mid-quarter convention applies to all "personal" property placed in service that year.
The mid-quarter convention treats personal property depreciable under MACRS as placed in service in the middle of the quarter in which it is actually placed in service.
Unless the taxpayer elects out, property qualifying for the special depreciation allowance automatically gets a 30 percent, first-year depreciation deduction (bonus depreciation), plus regular depreciation on the adjusted basis, i.e., the basis after being reduced to reflect the bonus depreciation.
The amount of bonus depreciation is determined without any proration, based on the length of the tax year in which the qualifying property is placed in service, and is equal to 30 percent of the adjusted basis of the qualifying property.
Does bonus depreciation affect whether the half-year or mid-quarter convention applies?
In determining whether the half-year or mid-quarter convention applies to personal property that is placed in service during a tax year, is the basis of the property determined before or after taking the 30 percent bonus depreciation into account? If all the personal property bought and placed in service during the year were new property, it would make no difference. This is because the basis of all the property would be reduced proportionately, i.e., by 30 percent before determining the amount of regular depreciation.
Example (1): Your client, a calendar year taxpayer, bought and placed in service $300,000 of new five-year MACRS property in March of 2002. In October of 2002, it bought and placed in service $190,000 of new seven-year MACRS property. Your client did not buy or place in service any other depreciable personal property in 2002. All of the property was
used only in your client’s business, and all of the property purchased was eligible for the 30 percent bonus depreciation.
The half-year convention would apply regardless of whether basis was determined before or after taking the 30 percent bonus depreciation into account. In either case, the basis of the MACRS property bought and placed in service in the last quarter of 2002 was only 38.78 percent of the basis of all the MACRS property bought and placed in service in 2002.
Example (2): The same facts apply as above except that $90,000 of the seven-year MACRS property bought in October 2002 was used property not eligible for the 30 percent bonus depreciation.
After deducting the 30 percent bonus depreciation from the $300,000 of five-year MACRS property placed in service in the first quarter, the adjusted basis for purposes of determining regular depreciation is $210,000 ($300,000 less $90,000). After deducting the 30 percent bonus depreciation on the $100,000 of new seven-year MACRS property that was placed in service in the fourth quarter that is eligible for the 30 percent bonus depreciation, the adjusted basis of all the adjusted basis for purposes of determining regular depreciation is $160,000.
If the adjusted basis, instead of the original cost of the property, were taken into account in determining which convention applies, the mid-quarter convention would apply. This is because the adjusted basis of the property bought and placed in service in the fourth quarter is 43.24 percent of the adjusted basis of all the property placed in service in 2002 - $160,000 divided by 370,000 ($210,000 plus $160,000).
While the Internal Revenue Service hasn’t specifically addressed this issue, it would seem that the determination of which convention applies is made with respect to the basis before reduction for the additional 30 percent depreciation allowance. Internal Revenue Code § 168(d)(3)(A) says that, except as provided in regulations, "the mid-quarter convention applies if during any taxable year (i) the aggregate bases of property to which this section [IRC § 168] applies placed in service during the last 3 months of the taxable year, exceed (ii) 40 percent of the aggregate bases of property to which this section applies placed in service during such taxable year ... ."
Qualified property under the special depreciation allowance rules of IRC § 168(k) is property to which IRC § 168 applies, and the amount of bonus depreciation is determined under § 168(k).
Since regulations have not been issued to exclude bonus depreciation from the aggregate bases taken into account, presumably the full basis of qualified property must be taken into account in determining whether the half-year or mid-quarter convention applies.
Observation: Reg. § 1.168(d)-1(b)(4)(i) makes it clear that the basis of property is not taken into account to the extent the taxpayer elects to expense the basis under IRC §179. This makes sense because any part of the basis that is expensed under IRC § 179 cannot be depreciated under IRC ¤ 168.
However, the 30 percent additional first year depreciation allowed by IRC § 168(k) is depreciation allowed under IRC § 168. Accordingly, it seems unlikely that the tax service will issue regulations providing that basis will be reduced by the bonus depreciation allowance in determining which depreciation convention applies.
When you want the mid-quarter convention to apply
There are situations where a taxpayer may get a bigger depreciation deduction for a tax year if the mid-quarter and not the half-year convention applies. This would happen where most of the assets subject to those conventions (determined by basis) are placed in service in the first quarter of the year.
If the mid-quarter convention applies, the depreciation deduction for assets placed in service in the first quarter equals 7/8 of a full year’s depreciation. However, the mid-quarter convention can apply only if more than 40 percent of the aggregate bases of assets placed in service during the year are placed in service in the last quarter. The depreciation deduction for assets that are placed in service in the last quarter is only 1/8 (12.5 percent) of a full year’s depreciation.
In some situations, instead of placing assets in service at the end of the third quarter, a business should delay putting them into service until the beginning of the fourth quarter. In other situations, a business should accelerate the purchase and placing in service of assets to the fourth quarter of one tax year from the first quarter of the next tax year.
Observation: In Example (2), your client would get a larger depreciation deduction for 2002 if the mid-quarter convention applied. If the half-year convention applied, using the double-declining balance method, your client would be entitled to a depreciation deduction of $42,000 on the five-year MACRS assets placed in service in the first quarter (20 percent of adjusted basis on $210,000).
Your client would also be entitled to a deduction of $22,864 on the seven-year MACRS assets placed in service in the fourth quarter (14.29 percent of adjusted basis of $160,000). The total depreciation deduction for 2002 would be $184,864 (bonus depreciation of $120,000 ($90,000 for first quarter and $30,000 for fourth quarter), plus $42,000, plus $22,864).
If the mid-quarter convention could be used, your client could deduct depreciation of $73,500 for the first quarter (35 percent of $210,000), and $5,712 for the fourth quarter (3.57 percent of $160,000). The total depreciation deduction for 2002 would be $199,212 (bonus depreciation of $120,000, plus $73,500, plus $5,712.
However, to be able to use the mid-quarter convention for 2002, your client would have to buy additional assets with a basis of at least $10,001 and place them in service in the fourth quarter.
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