The half-year convention is the depreciation timing rule that treats all property placed in service during any taxable year, or disposed of during any taxable year, as placed in service or disposed of on the mid-point of that taxable year (26 U.S.C. 168(d)(4)(A)). That definition is given for purposes of section 168, the cost recovery section, and it is the default: except as otherwise provided in that subsection, the applicable convention is the half-year convention (26 U.S.C. 168(d)(1)).
A convention is not a method and it is not a recovery period. The method sets the shape of the write-off and the recovery period sets its length, both of which are covered in MACRS. The convention decides only one thing: what the first and last years are worth.
What the Convention Does to the Deduction
Under this convention a taxpayer deducts a half-year of depreciation for the first year and the last year that the property is depreciated, and a full year of depreciation for any other year during the recovery period (IRS, Publication 946, How To Depreciate Property).
The mechanics follow from that. The deduction for the year the property is placed in service is the depreciation for a full year divided by 2. If the property is disposed of before the end of the recovery period, the deduction for the year of the disposition is figured the same way. If the property is held for the entire recovery period, the deduction for the year that includes the final 6 months of the recovery period is the amount of the unrecovered basis in the property (IRS, Publication 946, How To Depreciate Property).
The convention also reaches beyond those two years, because it determines how much of the recovery period remains at the beginning of each year, and so it affects the depreciation rate for property depreciated under the straight line method (IRS, Publication 946, How To Depreciate Property). That is why a 5-year asset finishes in a sixth tax year rather than a fifth, a consequence worked through in accelerated depreciation.
The First Two Years, Worked
The publication’s own example runs property with a 5-year recovery period and a basis of $1,000 placed in service in February, under GDS and the 200% DB method, with no section 179 deduction and no special depreciation allowance, and with nothing placed in service in the last 3 months of the year (IRS, Publication 946, How To Depreciate Property).
Year 1 200% DB rate 40% on basis of $1,000 = $400
half-year convention applied, $400 / 2 = $200
Year 2 adjusted basis $1,000 less $200 = $800
DB rate 40% on $800 = $320The straight line comparison in the second year is the tell. Its rate is 1 divided by 4.5, not 1 divided by 4, because under the half-year convention only half a year of the recovery period was used in the first year (IRS, Publication 946, How To Depreciate Property). The half year is not a discount taken once, it is a shift in where the whole schedule sits.
When the Half-Year Convention Does Not Apply
Two rules displace it, and both live in the same subsection.
Real property takes the mid-month convention. In the case of nonresidential real property, residential rental property, and any railroad grading or tunnel bore, the applicable convention is the mid-month convention (26 U.S.C. 168(d)(2)).
A back-loaded year takes the mid-quarter convention. Except as provided in regulations, if during any taxable year the aggregate bases of property to which section 168 applies placed in service during the last 3 months of the taxable year exceed 40 percent of the aggregate bases of property to which section 168 applies placed in service during that taxable year, the applicable convention for all such property placed in service during that year is the mid-quarter convention (26 U.S.C. 168(d)(3)(A)). The test is a year-level test, so one late purchase can move every asset bought that year onto a different convention.
Two categories are left out of that test. Nonresidential real property, residential rental property and railroad grading or tunnel bore are not taken into account, and neither is any other property placed in service and disposed of during the same taxable year (26 U.S.C. 168(d)(3)(B)).
The regulation adds the cases a preparer meets at the desk. The depreciable basis of property described in section 168(f), the property section 168 does not apply to, is not taken into account in the 40-percent test, while the depreciable basis of listed property as defined in section 280F(d)(4) and the regulations under it is taken into account unless otherwise excluded (26 CFR 1.168(d)-1(b)-1)). And a short year is decided before it begins: if the depreciable property is placed in service during a taxable year that consists of three months or less, the mid-quarter convention applies to the property (26 CFR 1.168(d)-1(a)-1)).
Common Questions
Run the 40-percent test on the year as a whole. Add the depreciable bases of the property placed in service in the last 3 months of the taxable year, add the bases of everything placed in service across the whole year, drop the categories the statute excludes, and compare. The mid-quarter convention applies only where the first figure exceeds 40 percent of the second (26 U.S.C. 168(d)(3)). Otherwise the default in section 168(d)(1) stands.
Yes, on its own terms. The statutory definition treats property disposed of during a taxable year as disposed of on the mid-point of that year, not only property placed in service (26 U.S.C. 168(d)(4)(A)). There is one case where nothing is deducted at all: no depreciation deduction is allowed for property placed in service and disposed of during the same taxable year (26 CFR 1.168(d)-1(b)(3)(ii)-1)). What happens to the recovered cost on a sale is a separate question, covered in depreciation recapture.
Yes. The optional table for 3-, 5-, 7-, 10-, 15- and 20-year property under the general depreciation system is captioned Half-Year Convention, and its 5-year column carries rates for six years, opening at 20.00 percent and closing at 5.76 percent (IRS, Publication 946, How To Depreciate Property, Table A-1). A separate set of tables carries the mid-quarter rates, one for each quarter of placement. The basis those rates are applied to is set out in depreciable basis, and the choice of method behind the rate is in double declining balance method.
It is a tax rule. Section 168 governs the deduction on the return, not the charge on the books, so a firm carrying straight line depreciation on a client’s financial statements and MACRS on the return holds two different numbers for one asset, which is the split described in depreciated.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can run a real block of its own fixed-asset and depreciation work through a trial task before anything client facing depends on it.
