What is MACRS Depreciation?
The MACRS is an abbreviation which stands for the modified accelerated cost recovery system. The MACRS depreciation is basically a type of depreciation system that is applied to compute depreciation expenses for taxation purposes. The System allows the business to recover the capitalized cost of the tangible asset having certain useful life with the help of annual deductions.
Explanation of MACRS Depreciation
The MACRS system is a variant of depreciation which is different from the straight-line depreciation method. It is generally employed to meet up with the compliance requirement of US taxation, and it classifies the fixed asset into classes. Each class basis the useful life of the tangible asset has a pre-defined depreciation matrix and depreciation periods. The modified accelerated cost recovery system enables the organization to get back the cost basis of the tangible assets that generally burn out or deteriorate during the course of their useful life. The internal revenue service generally shares the guidelines for the organization on which the assets are qualified under the modified accelerated cost recovery system.
The MACRS enables faster depreciation of assets in the initial years during the asset’s useful life and then gradually slows down the depreciation component at the later stage of the useful life of the asset. Therefore, the MACRS system is regarded as fundamentally useful for the purpose of tax filing.
How Does It Work?
The internal revenue service generally lays down broad guidelines to determine depreciation expense. It identifies such an expense as a deduction on income tax. The business has to use the guidelines as prescribed by the internal revenue service to recover the tangible asset’s cost. When a business buys a new tangible asset, it cannot write off the amount in the purchase year itself. The internal revenue service asks the business to minus out a portion of the cost of the asset over the useful life of the asset or as and when the asset is utilized fully. When the business employs the method of MACRS, the asset is depreciated at a faster rate or at an accelerated pace over the asset’s life cycle. This enables the business to take large deductions of taxes at an early stage or in the initial period of the asset usage itself. When the asset starts approaching the end of the lifecycle or the useful life, it is depreciated at a slower pace and at a reduced rate of depreciation. Basis the usage of the asset over a set timeline, there is a defined matrix of the depreciation rates to be employed to compute depreciation. The generally accepted accounting principles do not identify and approve the MACRS system for arriving at the depreciation expense. It rather employs the straight-line depreciation method to arrive at the depreciation expense to be written off through the year.
The taxpayers may adopt two broad classes of depreciation systems to depreciate property as per the modified accelerated depreciation system. They are broadly termed as alternative depreciation systems and general depreciation systems. Any system employed would help in the computation of the recovery timeline and method of depreciation to be employed. As a general convention, the taxpayers have to use a general depreciation system, and in most exceptional cases, the taxpayers may adopt the alternative depreciation system. The exceptional system may comprise of change in-laws or to meet up the legal requirements.
How to Calculate MACRS Depreciation?
The computation of depreciation expense basis the modified accelerated recovery system would broadly require three steps, namely: –
- The business has to determine the asset class of the tangible asset. The classes are defined basis of the useful life of the tangible asset. There is a computation of the recovery period basis the asset class of the tangible asset.
- Once the depreciation matrix is determined, the internal revenue service has laid down guidelines to decide when the assets are acquired basis the acquisition month, quarter or at the end of the year. The conventions are broadly classified as the mid-quarter, mid-month and mid-year, respectively.
- The depreciation expense should be computed using three broad methods of depreciation, namely 150 % declining balance, 200% declining balance and the method of straight-line depreciation.
Example of MACRS Depreciation
Let us take the example of ABC company. The business has purchased a tractor with a useful life of three years. The asset costs around $340,000, and the asset has a useful life of 3 years. Help the management determine the depreciation expense through the useful life of the asset.
The depreciation matrix table basis the useful life of three years is provided below: –
| Percentage Rate of depreciation | |
| Time Period | 3-year |
| 1 | 33.33 |
| 2 | 44.45 |
| 3 | 14.81 |
| 4 | 7.41 |
Compute the depreciation expense for the year 1-4 as displayed below: –
Year 1:
Depreciation Expense is calculated as
Depreciation Expense = Rate of Depreciation * Cost of Asset
- Depreciation Expense = 0.3333 * $340,000
- Depreciation Expense = $113,322
Year 2:
Depreciation Expense is calculated as
Depreciation Expense = Rate of Depreciation * Cost of Asset
- Depreciation Expense = 0.4445 * $340,000
- Depreciation Expense = $ 151,130
Year 3:
Depreciation Expense is calculated as
Depreciation Expense = Rate of Depreciation * Cost of Asset
- Depreciation Expense = 0.1481 * $340,000
- Depreciation Expense = $50,354
Year 4:
Depreciation Expense is calculated as
Depreciation Expense = Rate of Depreciation * Cost of Asset
- Depreciation Expense = 0.0741 x $340,000
- Depreciation Expense = $25,194
The following is an excel template that displays computations on the depreciation expense through the period of 1-4:
The following are the results: –
| Cost of Asset=$340,000 | |
| Year | Depreciation Expense |
| 1 | $1,13,322.00 |
| 2 | $1,51,130.00 |
| 3 | $50,354.00 |
| 4 | $25,194.00 |
MACRS Depreciation Table
The MACRS depreciation table is formulated on the asset classes. The asset classes are defined on the basis of the useful life of an asset. The following table has formed the basis of the useful life of the asset as identified by the business: –
| Time Period | Percentage rate of depreciation | |||||
| 3-year | 5-year | 7-year | 10-year | 15-year | 20-year | |
| 1 | 33.33 | 20 | 14.29 | 10 | 5 | 3.75 |
| 2 | 44.45 | 32 | 24.49 | 18 | 9.5 | 7.219 |
| 3 | 14.81 | 19.2 | 17.49 | 14.4 | 8.55 | 6.677 |
| 4 | 7.41 | 11.52 | 12.49 | 11.52 | 7.7 | 6.177 |
| 5 | 11.52 | 8.93 | 9.22 | 6.93 | 5.713 | |
| 6 | 5.76 | 8.92 | 7.37 | 6.23 | 5.285 | |
| 7 | 8.93 | 6.55 | 5.9 | 4.888 | ||
| 8 | 4.46 | 6.55 | 5.9 | 4.522 | ||
| 9 | 6.56 | 5.91 | 4.462 | |||
| 10 | 6.55 | 5.9 | 4.461 | |||
| 11 | 3.28 | 5.91 | 4.462 | |||
| 12 | 5.9 | 4.461 | ||||
| 13 | 5.91 | 4.462 | ||||
| 14 | 5.9 | 4.461 | ||||
| 15 | 5.91 | 4.462 | ||||
| 16 | 2.95 | 4.461 | ||||
| 17 | 4.462 | |||||
| 18 | 4.461 | |||||
| 19 | 4.462 | |||||
| 20 | 4.461 | |||||
| 21 | 2.231 | |||||
Uses of MACRS Depreciation
- The MACRS depreciation is used for the computation of depreciation expense of an asset primarily employed for tax reporting purposes.
- The MACRS depreciation can be widely applied in the computer equipment, automobiles, fences, buildings such as farm buildings and office buildings, as well as on office furniture.
Conclusion
The MACRS depreciation system is a type of depreciation system that helps the organization determine depreciation expenses required for the tax filing purpose. The internal revenue service broadly lays down the guidelines to be followed by all of the organizations as to how they should use the depreciation system.
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