Understanding Depreciation Conventions

When choosing to depreciate a business asset, you need to choose both a method and a convention. A convention simply refers to figuring how much of the item basis you may depreciate the first year, based on when during that year you purchased and put the item to use in your business. This article will explain the differences between the half-year convention, the mid-quarter convention, and the mid-month convention.

Half-Year Convention (H/Y) Under the half-year convention, your item is treated as though it was purchased and placed in service at the mid-point of the first year, no matter when during that year the purchase was actually made. Therefore, only half of the otherwise allowable depreciation amount is able to be deducted during the first year.

The half-year convention is standard with all depreciation and must be used unless the mid-quarter convention rules apply. (Except in the case of depreciating the business use of your home, in which case the mid-month convention applies the first year. This is explained below.) The half-year convention is built into depreciation tables found in IRS Publication 946.

-Example: Using the straight-line method of depreciation (because it is easier for me to demonstrate the half-year example using S/L), Morgan is able to depreciate her office desk (seven year property), used 100% for business, over a seven year recovery period. Her basis in it (the amount she paid) is $700. She is able to take equal, $100 deductions each of the seven years. Because of the half-year convention, however, she may only deduct half of that in the first year.

Year One - $50

Years Two through Seven - $100 each year

Year Eight - $50

Morgan may continue to take a deduction into an additional year (year eight) beyond the desk recovery period (seven years) in order to fully depreciate it.

Mid-Quarter Convention Under the mid-quarter convention, all property placed in service during a particular quarter of the year is treated as having been acquired at the mid-point of that quarter. Depreciation tables with the mid-quarter convention built in may be found in IRS Publication 946.

The mid-quarter convention only applies if more than 40% of the combined bases of property is placed in service during the last three months of the tax year. Section 179 deductions are not included when figuring this amount.

You can avoid the mid-quarter convention in a couple of ways. Plan your purchases, so over 40% of the cost of them does not get spent at the end of the year, by buying early or waiting until January. You could also choose to use Section 179 to expense some of your end of the year equipment purchases. Those items' bases would then not be a part of your calculation of the 40% mark.

Mid-Month Convention When you depreciate the business percentage of your home office, you will use the mid-month convention in the first year. This means you may only deduct expenses beginning in the month you first began using the home for business purposes. This not only includes using mid-month depreciation tables, but it also means you may only deduct other business-related expenses for the home from that month forward.

Simon Elisha, author, Taxes for Online Sellers-
A How-To Guide for Individuals on Federal Tax for Internet Sales
ISBN: 978-0-9796328-0-8
http://www.taxesforonlinesellers.com/
Copyright 2007 -2008