Why are assets depreciated over time?

Key Takeaways:
  • The IRS assigns specific recovery periods for different types of assets under MACRS.
  • The placed-in-service date is when the asset is ready and available for use.
  • Both the recovery period and placed-in-service date affect the amount and timing of available tax deductions.
  • Accurate documentation is important for tax compliance and maximizing tax benefits.

 

Not all business purchases are treated equally—especially when it comes to depreciation. The IRS uses a system called MACRS (Modified Accelerated Cost Recovery System) to determine how and when you can deduct the cost of assets over time. To get the most out of your tax strategy, it’s important to understand two key concepts: the type of asset and the placed-in-service date.

Why Are Assets Depreciated Over Time?

Most business assets—like machinery, equipment, and buildings—aren’t used up all at once. Instead, they provide value in the form of tax deductions over several years. Depreciation allows you to match the cost of these long-term assets with the income they help generate, spreading the deduction out across their useful life. It’s a way to reflect wear and tear, aging or obsolescence for tax purposes. This also helps businesses avoid taking one massive deduction in the year of purchase, giving a more accurate view of ongoing profitability.

What are Recovery Periods Under MACRS?

The IRS assigns specific recovery periods for different types of assets under MACRS. The recovery period for the asset is also commonly referred to as the “depreciation life” or “asset life” and is primarily used to calculate the tax depreciation under the MACRS system. The cost of the asset will be recovered and deducted on your tax return over the years of the recovery period. The asset might still be useful after the recovery period has ended.

Here are a few common examples:

  • Computers and Equipment: 5 years
  • Office Furniture and Fixtures: 7 years
  • Residential Rental Property: 27.5 years
  • Nonresidential Real Property: 39 years

*Additional classifications are available for certain assets and industries.

Even after those years are up, your asset might still be in use—but from a tax standpoint, its depreciable life is over. Knowing this timeline helps you plan for when deductions will show up on your return.

What is the Placed-in-service Date?

The placed-in-service date is when the asset is ready and available for use. This is when the asset is ready for its intended business use, regardless of whether it is actively being used at that time. This date is important because it determines the following:

  • Which tax year you can start claiming depreciation deductions.
  • Which depreciation convention applies (half-year, mid-quarter, or mid-month). This affects the amount of depreciation you can claim in the first and last years of the asset recovery period.
  • Determines if the asset is eligible for special accelerated depreciation deductions, such as Section 179 expensing and Bonus depreciation.

For example: You place a down payment or pay in full for a new piece of equipment in December, but the asset will be delivered and ready for use in February. In this case, the asset placed-in-service date will be in February when it is ready for use.

Importance of Documentation & Updating Depreciation Schedules

It’s important to maintain records showing when each asset was purchased and placed in service in case the IRS requests additional information. This can include invoices and installation records to show that the asset was ready and available for its intended business use.

It’s best practice to retain a copy of the invoice and also send a copy to your accountant so depreciation schedules can be updated for purchases and disposals throughout the year. Keeping depreciation schedules updated can help create a clearer picture of your business assets and assist with tax planning opportunities.

Additional Items

If you have any questions about how these items apply to your specific situation or if you need assistance in planning the timing for an asset purchase or disposal, please contact an Adams Brown advisor.