1 : There are main 3 conventions : 1) Based on months held, 2) Half Year Convention, and 3) Full year convention
2 : Is it ok to pick any convention for depreciation calculation or there are some rules pertaining to each asset?
For instance : When there is an asset of start up cost, the asset will be amortized over a period of 5 years and amortization should be calculated based on monthly convention.
3 : Real Estate can be based on monthly convention.
How about other assets like equipment, F/F : I have taken half yearly convention many times.
4 : But I would like to know the rules laid out by IRS? Can someone guide me / send me the link to read the rules?
Answer :
1 : A convention is a method established under MACRS to set the beginning and end of the recovery period. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property. So, a convention simply refers to figuring how much of the item basis you may depreciate the first year, based on when during that year you purchased and put the item to use in your business. Under the half-year convention, your item is treated as though it was purchased and placed in service at the mid-point of the first year, no matter when during that year the purchase was actually made. Therefore, only half of the otherwise allowable depreciation amount is able to be deducted during the first year. Thus, the half-year convention is standard with all depreciation and must be used unless the mid-quarter convention rules apply. (Except in the case of depreciating the business use of your home, in which case the mid-month convention applies the first year). For example, by using the S/L method of depreciation , a TP is able to depreciate her office desk ,7 yr property, used 100% for business, over a seven year recovery period. Her basis in it ,the amount she paid, is $7K She is able to take equal, $1K deductions each of the seven years. Because of the half-year convention, however, she may only deduct half of that in the first year. Year 1; $.5K Years 2-7 - $100 each year; year 8;$.5K.
The mid-month convention applies only to real property. Under the mid-month convention, one-half month of depreciation is allowed for the month the asset is placed in service or disposed of and a full month of depreciation is allowed for each additional month of the year that the asset is in service.
The full month convention will treat the asset as if placed in service on the first day of the month. No depreciation will be calculated for the last month of the asset's life or the month the asset is sold. This convention normally applies under ACRS Tax System.For all other months and years, full month and year of depreciation is deducted.For example,assume that the depreciation amount computed for the first year of the asset is $10K. Some additional details pertaining to this depreciation calculation for this example are: 1)Full tax year is January to December. (2)Asset was placed in service on April 18 . (3)Full month convention applies to this asset. To apply the full month convention,you need to multiply the full year depreciation by a fraction. The numerator of the fraction will be the number of full months the asset has been in service, and the denominator will be 12. Because the asset is placed in service in April, the number of full months will be nine (asset treated as if placed in service on first of April).In this case, $10K * 9 / 12 = $7.5K The depreciation amount for the first tax year will be $7.5K. Similarly, assuming that the asset lives its full life, the amount of depreciation in the sixth tax year will be full year depreciation multiplied by 3/12, $10K*3/12=$2.5K.
Under the actual month convention, if the asset was placed in service on or before the fifteenth day of the month, the asset is treated as if placed in service on the first day of the month. If the asset was placed in service after the fifteenth day of the month, the asset is treated as if placed in service on the first day of the next month. For all other months and years, full month and year of depreciation is deducted.
If the method of depreciation computation has switched from DB to SLM in the later years, the actual month convention will apply to the depreciation amount computed as per SLM in the last year. Thus, the convention applies, irrespective of the method of depreciation. For example, the depreciation amount computed for the first year of the asset is $12K. And the Asset was placed in service on April 18.Then to apply the actual month convention,you need to multiply the full year depreciation by a fraction. The numerator of the fraction will be the number of full months the asset has been in service, and the denominator will be 12. Because the asset is placed in service on April 18, the number of full months will be eight.; An asset placed in service after the fifteenth of a month is considered as placed in service on the first day of the next month.In this case, the depr amount for the first yr ; $12K * 8 / 12 = $8K. Similarly, assuming that the asset lives its full life, the amount of depreciation in the sixth tax year will be full year depreciation multiplied by 4/12. (Numerator will be the number of months the asset was in service in the year of disposal or retirement.) Because the asset will be in service until April 18 of the last year, it will be considered to be in service for the whole of April.In this case, $12K*4/12= $4K , annual depreciation amount for the last tax year.
2 : You must use theMACRS to depreciate most properties. HOWEVER,you cannot use MACRS to depreciate the Property ; you placed in service before 1987; Certain property owned or used in 1986; Intangible property;Property you elected to exclude from MACRS.
3 : As mentioned above it depends on the situation; for example, under MACRS rule, you can choose either HY or Mid-Qtr convention. It applies when more than 40 percent of your depreciable assets (excluding non-residential real property and residential rental property) purchased during the year are purchased within the last three months of the tax year. Under this convention all property placed in service during any quarter is treated as being placed in service at the midpoint of the quarter. So, under the mid-quarter convention your depreciation deduction will be lower than if you were using the half-year convention.
4 : Please visit the IRS web site for more info in detail;
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