MACRS depreciation is the modified accelerated cost recovery system of depreciation. This depreciation method was implemented as part of the U.S. Tax Reform Act of 1986. MACRS depreciation divides fixed assets into classes which define the useful life and depreciation period and uses a double declining balance method of depreciation.
The intent of MACRS depreciation is to permit asset owners to accelerate the write-off of assets for tax purposes. Higher depreciation claimed on a tax return reduces earnings and the resulting tax due on those earnings. Businesses are permitted to use MACRS for tax purposes and other methods of depreciation on financial statements. These depreciation methods spread out depreciation over longer time periods, resulting in lower expenses and a higher level of earnings reported on the financial statements.
To accommodate different purchase dates during a fiscal year, the MACRS depreciation method provides for what's called a half-year convention. This means that no matter when an asset is purchased during a fiscal year, the business may depreciate that asset by the value of half a year. Thus the depreciation for an asset with a useful life of five years is actually reported over six years, a half year in the first year, a full year in the next four years, and the remaining half year in the sixth year.
Assets are categorized into classes of three, five, seven, ten, 15, and 20 years, excluding real estate. Real estate is categorized into classes of 27.5 years or 39 years. The U.S. Internal Revenue Service specifies which assets must be included in each class.
MACRS depreciation is calculated by the double declining balance method, using depreciation that is exactly double that of straight-line depreciation. With straight-line depreciation, an asset with a five year useful life will be depreciated 20% each year. Under MACRS depreciation, the first year depreciation will be 40%; since the half-year convention applies, however, the actual deprecation is only 20%. In the second year, the remaining 80% value of the asset — i.e., the original value less the first year's 20% depreciation — is depreciated by 40%, or 32% of the original asset value. The same procedure applies during the third, fourth, and fifth years, with the final half-year depreciation recorded in the sixth year.
The Internal Revenue Service allows a shift in depreciation methods only one time during the asset life. The calculation of MACRS depreciation includes the presumption that the company will switch to straight line depreciation at the point when it is advantageous to do so. The depreciation percentages included in the MACRS tables reflect this calculation. A detailed analysis of MACRS depreciation can be found in IRS Publication 946, including asset class lists and depreciation tables.
