Accelerated Depreciation

Accelerated depreciation is any depreciation method that front-loads the charge, taking larger deductions in the early years an asset is in service and smaller ones later, against a straight line method that spreads the same cost in equal annual amounts. It names a class of methods rather than one method, and the two that carry the name are the declining balance method and the sum of the years-digits method. It does not enlarge the total deduction an asset produces over its life. It moves that deduction forward in time.

The Methods That Front-Load the Charge

Under the declining balance method a uniform rate is applied each year to the unrecovered cost or other basis of the property, meaning the basis adjusted for depreciation previously allowed or allowable and for the other adjustments the law provides (26 CFR 1.167(b)-2(a)). The rate holds steady while the base it runs on shrinks, so the charge falls year over year without anything else changing.

The rate has a ceiling, and a floor sits under the asset. Under that regulation the rate shall not exceed twice the appropriate straight line rate computed without adjustment for salvage, and while salvage is not taken into account in determining the annual allowances under this method, in no event shall an asset be depreciated below a reasonable salvage value (26 CFR 1.167(b)-2(a)). Double declining balance is the name for the version that runs at that ceiling, twice the straight line rate. What the salvage estimate is, and why the tax system treats it as zero, is set out in salvage value.

The sum of the years-digits method front-loads with a changing fraction instead of a fixed rate. Annual allowances are computed by applying changing fractions to the cost or other basis of the property reduced by estimated salvage, where the numerator changes each year to the remaining useful life of the asset including the year being computed, and the denominator stays constant at the sum of all the years digits corresponding to the estimated useful life (26 CFR 1.167(b)-3(a)(1)).

For an asset with an estimated useful life of five years that denominator is the sum of the digits 5, 4, 3, 2, and 1, or 15, so the numerator starts at 5 in the first year and falls to 1 in the last (26 CFR 1.167(b)-3(a)(1)). Both of these definitions sit in the depreciation regulations under section 167.

Why the US Tax Default Is Already Accelerated

The word sits inside the name of the system itself. The Modified Accelerated Cost Recovery System, MACRS, is what determines the depreciation deduction for tangible property it applies to (26 U.S.C. 168(a)), and the method, the recovery period and the convention it fixes for an asset are described in straight line depreciation.

Two of the methods it assigns are declining balance methods, which front-load by construction. MACRS provides three depreciation methods under the general depreciation system, the 200% declining balance method over a recovery period, the 150% declining balance method over a recovery period and the straight line method, plus one method under the alternative depreciation system (IRS, Publication 946, How To Depreciate Property). Sum of the years-digits is not one of them, so under this system the accelerated method is a declining balance one.

Which one an asset gets is a function of its property class, not an application. The 200% declining balance method applies to nonfarm 3-, 5-, 7-, and 10-year property, the 150% method applies to all 15- and 20-year property, and each changes to straight line when that method provides an equal or greater deduction (IRS, Publication 946, How To Depreciate Property). That split is statutory, written into the applicable depreciation method itself (26 U.S.C. 168(b)(1) and (b)(2)), and the classes the statute keeps on straight line from the start are in straight line depreciation.

The Rate, and the Year It Switches

The declining balance rate is arithmetic rather than a lookup. You figure it by dividing the specified declining balance percentage, 150% or 200% changed to a decimal, by the number of years in the property’s recovery period, so 3-year property on the faster method is 2.00 divided by 3, giving 0.6667, or a 66.67% declining balance rate, and 15-year property on the slower one is 1.50 divided by 15, giving 0.10, or a 10% rate (IRS, Publication 946, How To Depreciate Property).

The switch is not optional. When using a declining balance method you apply the same rate each year to the adjusted basis, and you must switch to the straight line method beginning in the first year for which it will give an equal or greater deduction, which is why the tables print a switch year for every class (IRS, Publication 946, How To Depreciate Property).

Source: IRS, Publication 946, How To Depreciate Property.

A Worked Example on 5-Year Property

Say a client places one item of 5-year property in service. The assigned method and the straight line election over the same recovery period produce these two columns on the same basis.

Basis in 5-year property placed in service        50,000
Declining balance rate, 200% over 5 years            40%

Year    200% DB, switching to straight line    Straight line
1                                    10,000            5,000
2                                    16,000           10,000
3                                     9,600           10,000
4                                     5,760           10,000
5                                     5,760           10,000
6                                     2,880            5,000
Total                                50,000           50,000

Both columns recover the whole basis, and both run into a sixth year because the first year is a partial one under the convention that applies. What differs is when. The faster column takes more than half the basis in its first two years, then falls below the straight line charge from the third year on, and the six charges in it are the percentage table’s 5-year rates applied to that basis, under the half-year convention (IRS, Publication 946, How To Depreciate Property).

Accelerated Depreciation Moves the Deduction Rather Than Creating One

The total is set by the basis, not by the method, so the choice is about timing. The benefit of the faster method is that it provides a greater deduction during the earlier recovery years (IRS, Publication 946, How To Depreciate Property), and the matching cost is that the later years of the same asset carry less. A client expecting thin income now and a stronger year later may be trading a deduction into the weaker year.

The second consequence is a split inside the client’s own records. A firm carrying straight line on its books and the assigned declining balance method on the return holds two different depreciated amounts for one asset, and the return reconciles those numbers rather than merging them, which is the ground depreciated covers. How the recovered cost is treated when the asset is sold is set out in depreciation recapture, and where the contra account sits while the asset is still in service is in fixed assets.

What Qualifies for Accelerated Depreciation?

Nothing qualifies for it the way property qualifies for an allowance. The method comes with the property class, so equipment in the shorter classes arrives on a declining balance method with no application and no election, and the elections that do exist move an asset toward straight line rather than away from it. A taxpayer with property in the 3-, 5-, 7-, or 10-year class can elect the 150% declining balance method by entering 150 DB under column (f) in Part III of Form 4562, or elect the straight line method over the same recovery period by entering S/L in that column (IRS, Publication 946, How To Depreciate Property).

What a client usually means by the question is the additional first year allowance under section 168(k), which does carry a qualified property test and is one statutory allowance rather than the category, set out in bonus depreciation. On a building the question is usually about cost segregation, which moves parts of the building into the shorter classes that carry these methods rather than changing the method on the building itself, and that work is in commercial real estate accounting.

What Is the Difference Between Accelerated Depreciation and Regular Depreciation?

Regular depreciation, in the way clients ask the question, means straight line, which spreads the cost in equal annual amounts across the life instead of loading it into the front. The formula, the three terms it needs and the classes of property the statute puts on it are in straight line depreciation.

If depreciation schedules are the close work that keeps sliding to the last week, a trial task runs a block of that work through Accountably’s review chain before it reaches your own reviewer.