What Is MACRS Depreciation And How Can Impact Your Tax Bill?

For some businesses, they may have to pay a flat 21% tax rate.

With such a high tax rate, many businesses are looking for ways to help reduce that tax bill and have a few tax deductions. Thankfully that’s where the 

Modified Accelerated Cost Recovery System (MACRS) depreciation comes in. But what is MACRS depreciation? Keep reading to find out!

What is MACRS Depreciation?

The Internal Revenue Service (IRS) defines depreciation as an income tax deduction. This allows businesses to recover some of the cost basis of some of their properties. 

It’s an annual allowance that will account for any deterioration, wear, tear, or obsolescence of a property. Most assets that are tangible will be depreciable, but there are some intangible assets that could be deducted as well. This includes things like copyrights or patents. 

The proper depreciation method falls under the Modified Accelerated Cost Recovery System. Under the MACRS, you’ll have a greater, accelerated depreciation over a longer period of time than you would under normal depreciation. 

This can be helpful because it allows individuals and businesses to deduct larger amounts, even when the asset is only a few years later. However, this means that they won’t be able to deduct as much later on down the road. 

What Are Recovery Classes?

To determine if something is applicable to MACRS, there are eight main categories that your property could fall into. Each category has its own set of recovery periods. 

There are also two categories that cover most real estate properties. For example, residential rental property has a 27.5-year period of recovery. For nonresidential property, the recovery period is about 31.5 years. 

There are many other examples of property that could depreciate, however. For example, tractors, rent-to-own property, or even racehorses have a depreciation value of 3 years.

If you own any automobiles, like trucks, buses, office machinery, or even computers and furniture, these will have a depreciation value of 5 years. 

If you have water utility property or municipal sewers, this could be a 25-year depreciation. If you search online, you’ll be able to find a more detailed MACRS depreciation table that will let you know what category all of your assets fall into. 

Depreciation Requirements

In order for your property to meet the requirements for MACRS, it has to be tangible (or one of the non-tangible exceptions). It also has to be subject to the allowance of depreciation. Some people also refer to these assets as wasting assets. 

You also have to use that asset in your trade or business in order to produce your income. 

How Do You Calculate It?

If you meet the requirements above, you’ll be able to start calculating your MACRS depreciation value. It’s relatively easy, but if you get confused, you should always consult a CPA. 

First off, you’ll have to determine the original value of your asset. Include the sales tax, shipping, installation costs, and the price of the item. 

After you’ve done that, you’ll need to figure out what class it belongs in. Once you’ve figured out the class, then you’ll need to work out the math with the depreciation method. For example, you may have to use a 200% declining balance, or even 150%. 

After you’ve done that, you can select the MACRS convention. This is where you’ll put in when you started using the asset so that you can find out how much time has passed. 

Using this formula, you’ll be able to itemize the deduction to put on your tax form!

Advantages

When it comes to capital allowance claims and an accelerated depreciation system, there are two main advantages. 

One of them is that you’ll have a higher upfront deduction. With this, you’ll be able to take a higher deduction early on in the life of the asset. 

When you receive the deduction now, it’ll reduce your current tax bill. However, you’ll also have more access to money in the short term, which is great for businesses that are struggling with increasing their cash flow. You can also get more of your money back now so that you can use it to grow your business and invest more money. 

While you might want to wait and take out the deduction later on for your assets, what if your business isn’t around by then? Then you would’ve lost all the money that you could’ve taken out to keep your business afloat. 

Another main advantage is that you’ll actually be getting a little bit more money now than you would later on because of inflation. Each year, your dollar is worthless and less because of inflation.

However, when you can take more money out now, your money is worth more than what it would be at the end of the asset’s 27-year cycle. 

For example, if you buy a tractor for $1, after a decade, that tractor will only be worth around 90 cents, or even less! It’s always better to try and expense an asset first before you depreciate it, but the IRS doesn’t always let you do that.

That’s where MACRS comes in as a good compromise.

Learn More About MACRS Depreciation

These are only a few things to know about MACRS depreciation, but there are many more things to keep in mind!

We know that running a business can be stressful and overwhelming, but we’re here to help you out!

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