When fixed assets are placed in service, you need to decide how to recover the cost for depreciation purposes. Under GAAP, the period over which an asset is depreciated is the expected useful life. This can result in a wide variety of useful lives for similar types of assets. For income tax purposes, the IRS has published rules that state the recovery period over which depreciation is to be taken for various asset classes.
The source for finding the proper recovery period for tax purposes is Rev. Proc. 87-56. This Revenue Procedure has an extensive listing of fixed asset types categorized by asset description and asset class. The IRS also provides this listing of recovery periods in Appendix B of its Annual Publication 946 -- How to Depreciate Property.
In looking at the list of assets, there are three categories of lives for each asset class. For most taxpayers, it is the recovery period listed under General Depreciation System (“GDS”) that is relevant is determining the appropriate accelerated depreciation recovery period. This GDS life is the period under which the asset is depreciated using MACRS (typically 200 percent double-declining balance). The other two periods are utilized for other purposes (alternative minimum tax, straight-line and other elections).
Some of the more common asset classes from the list are as follows:
- Office furniture, fixtures and equipment (asset class 00.11) use a 7-year recovery period;
- Information Systems, including computers, (asset class 00.12) use a 5-year recovery period;
- Land Improvements (asset class 00.3) use a 15-year recovery period;
- Assets used in Construction (asset class 15.0) use a 5-year recovery period.
Taxpayers should review the list of asset categories because they may discover some asset types that have a shorter recovery period than they would expect. For instance, assets used in Distributive Trades and Services (asset class 57.0) use a 5-year recovery period. Included in this asset class are assets used in wholesale and retail trade, and personal and professional services. Under asset class 57.0, assets like shelving, counters and tables that were thought to be furniture, fixtures and equipment and depreciated over 7 years may instead be eligible for a 5-year recovery. Depending on the size of the asset addition, this could result in large tax savings.
A lengthy listing of asset classes specific to manufacturing is included in Rev Proc. 87-56. The recovery periods of these assets varies from 3 years to 15 years. Each of these manufacturing asset classes is specific to a certain product or industry (e.g., automotive, aerospace, rubber, semiconductor, metal products, etc.). A careful review of the details of each asset class is required because the assigned recovery periods are not always logical. For example:
- Assets used in the manufacture of cement, not including assets used in the manufacture of concrete (asset class 32.2), use a 15-year recovery period;
- Assets used in the manufacture of other stone and clay products, including assets used in the manufacture of concrete (asset class 32.3), use a 7-year recovery period.
This example illustrates that the details provided in the description of the particular asset class can significantly vary the recovery period even when the asset types seem to be similar. A careful reading of the descriptions is required.
Finally, assets that do not fit into one of the listed asset classes are given a 7-year recovery period. This default category is rarely used as the asset class list provided in the Revenue Procedure is fairly extensive.
A careful review of existing fixed assets may also yield savings. If assets placed in service in prior years have been classified with too long of a recovery period, an accounting method change may be available that allows for a “catch-up” of the under-depreciation. This catch-up depreciation may be fully deductible in the current tax year.
Your CBIZ MHM tax advisor can help in categorizing assets into the appropriate recovery periods. Their assistance can be invaluable as the descriptions for certain asset classes contain some very specific language that could include or exclude certain types of assets. Your CBIZ MHM tax advisor can also provide the necessary assistance to see if there are any opportunities to accelerate deductions by applying for an accounting method change to “catch up” your depreciation.
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