**MACRS General Depreciation System (GDS) property classes**: **3-year property** (200% declining balance): (1) Racehorses >2 years old at placed-in-service. (2) Qualified rent-to-own property. (3) Certain manufacturing tools. **Example**: $50,000 racehorse → Year 1: 33.33% = $16,665.

Year 2: 44.45% = $22,225.

Year 3: 14.81% = $7,405.

Year 4: 7.41% = $3,705 (half-year convention, 4 years total). **5-year property** (200% declining balance, most common): (1) **Cars, trucks, vans** (<6,000 lbs). (2) Computers, printers, copiers. (3) Office equipment. (4) Appliances, carpets, furniture (rental property). (5) Research & experimentation equipment. (6) Cattle (dairy/breeding). **Example**: $30,000 business vehicle → Year 1: 20.00% = $6,000.

Year 2: 32.00% = $9,600.

Year 3: 19.20% = $5,760.

Year 4: 11.52% = $3,456.

Year 5: 11.52% = $3,456.

Year 6: 5.76% = $1,728 (6 years total due to half-year convention). **7-year property** (200% declining balance): (1) Office furniture/fixtures. (2) Agricultural machinery. (3) Any property not assigned to other classes (catch-all). **15-year property** (150% declining balance): (1) Land improvements (sidewalks, fences, landscaping). (2) Restaurant property (2018+ TCJA). (3) Qualified improvement property (QIP, 2023+ post-technical correction). (4) Gas stations. **20-year property** (150% declining balance): Farm buildings (not dwellings).

Municipal sewers. **27.5-year property** (straight-line, residential rental): Apartment buildings, rental houses, duplexes (≥80% residential use). **Mid-month convention** (1st month depreciation = 50% of full month, regardless of actual placement date). **Example**: $275,000 rental duplex (excluding land) placed in service July → Year 1: (1/27.5) × (5.5 months ÷ 12) = **1.67%** = $4,593.

Years 2-27: **3.636%** = $10,000/year. **39-year property** (straight-line, commercial real estate): Office buildings, retail stores, warehouses (not residential). **Mid-month convention**. **Example**: $1.95M office building (excluding land) → Year 1 (mid-month): **0.963%** = $18,779.

Years 2-39: **2.564%** = $50,000/year. **Alternative Depreciation System (ADS)** (optional or required for certain property): **Longer recovery periods**: 5-year GDS → 6-year ADS (cars). 7-year GDS → 10-year ADS (furniture). 15-year GDS → 20-year ADS (land improvements). 27.5-year → 30-year (residential rental, if elected). 39-year → 40-year (commercial, if elected). **When ADS required**: Listed property used ≤50% business.

Tax-exempt use property.

Farming businesses electing out of interest limitation (IRC 163(j)).

AMT preference item (pre-2018, now largely repealed). **Straight-line method** (slower deductions).

**MACRS 200% declining balance (DB) calculation** (for 3/5/7-year property): **Step 1**: Calculate straight-line rate. **Formula**: 1 ÷ Recovery Period. **Example**: 5-year property → Straight-line = 1 ÷ 5 = **20%/year**. **Step 2**: Double the rate (200% DB). **Accelerated rate**: 20% × 2 = **40%/year**. **Step 3**: Apply half-year convention (1st year = 50% of full year). **Year 1**: 40% × 0.5 = **20%** (actual first-year deduction). **Step 4**: Declining balance (apply 40% to remaining book value each year). **Year 2**: (100% - 20%) × 40% = **32%**. **Year 3**: (100% - 20% - 32%) × 40% = **19.2%**. **Year 4**: (100% - 20% - 32% - 19.2%) × 40% = **11.52%**. **Step 5**: Switch to straight-line when it yields higher deduction. **Year 5 (straight-line switch)**: Remaining 17.28% ÷ 1.5 years = **11.52%**. **Year 6 (final, half-year)**: **5.76%**. **Full 5-year MACRS schedule** ($100,000 asset): Year 1: **20.00%** = $20,000.

Year 2: **32.00%** = $32,000 (peak year).

Year 3: **19.20%** = $19,200.

Year 4: **11.52%** = $11,520.

Year 5: **11.52%** = $11,520.

Year 6: **5.76%** = $5,760 (half-year in final year). **Total**: $100,000 over 6 years. **Comparison to straight-line** (5-year property, $100,000): Year 1: **10%** = $10,000 (50% × 20% for half-year).

Year 2-5: **20%** = $20,000 each.

Year 6: **10%** = $10,000 (half-year). **Cumulative comparison** (first 3 years): **MACRS 200% DB**: $20k + $32k + $19.2k = **$71,200** (71% recovered). **Straight-line**: $10k + $20k + $20k = **$50,000** (50% recovered). **Difference**: MACRS provides **$21,200 more** in first 3 years (42% faster). **Tax savings acceleration** (35% tax bracket): MACRS 3-year total: $71,200 × 0.35 = **$24,920** tax savings.

Straight-line 3-year total: $50,000 × 0.35 = **$17,500** tax savings. **Extra savings**: $7,420 in first 3 years (time value of money benefit). **Present value advantage** (7% discount rate, 6 years): MACRS PV: $83,426.

Straight-line PV: $81,054. **Benefit**: $2,372 (2.9% higher NPV) from accelerated deductions. **When 200% DB applies**: 3, 5, 7, 10-year property (GDS). **When 150% DB applies**: 15, 20-year property. **When straight-line required**: 27.5, 39-year property (real estate).

ADS elections (voluntary slower depreciation).

**Bonus depreciation (2025 rules)**: **Current rate**: **60%** of asset cost (down from 80% in 2024, phasing out). **Applicable property**: New or used qualified property with recovery period ≤20 years (includes 3/5/7/15/20-year MACRS property). **Placed-in-service deadline**: December 31, 2025 (60% rate). 2026: **40%**. 2027+: **0%** (fully phased out unless extended). **How bonus depreciation works**: **Step 1**: Deduct Section 179 first (if elected, up to $1.22M in 2025). **Step 2**: Deduct 60% bonus depreciation on remaining basis. **Step 3**: Apply regular MACRS on remaining basis (after bonus). **Example** ($100,000 machinery, 5-year property, placed in service 2025): **Without bonus**: Year 1 MACRS: 20% × $100k = $20,000. **With 60% bonus**: Step 1: Bonus depreciation: **60%** × $100k = **$60,000** (first-year deduction).

Step 2: Remaining basis: $100k - $60k = $40,000.

Step 3: Year 1 MACRS on remaining: 20% × $40k = **$8,000**. **Total Year 1**: $60,000 + $8,000 = **$68,000** (68% of cost in first year). **Subsequent years** (MACRS on $40k remaining basis): Year 2: 32% × $40k = $12,800.

Year 3: 19.2% × $40k = $7,680.

Year 4: 11.52% × $40k = $4,608.

Year 5: 11.52% × $40k = $4,608.

Year 6: 5.76% × $40k = $2,304. **Full 6-year schedule**: Year 1: **$68,000** (60% bonus + 20% MACRS).

Year 2: $12,800.

Year 3: $7,680.

Year 4: $4,608.

Year 5: $4,608.

Year 6: $2,304. **Total**: $100,000. **Tax savings impact** (35% tax bracket, $100k asset): **Without bonus**: Year 1 tax savings: $20,000 × 0.35 = $7,000. **With 60% bonus**: Year 1 tax savings: $68,000 × 0.35 = **$23,800** (extra $16,800 cash flow). **Bonus depreciation strategy considerations**: ✅ **Use bonus if**: Cash flow tight (need Year 1 deduction).

Profitable year (high taxable income to offset).

Phaseout urgency (60% in 2025, only 40% in 2026). ❌ **Avoid bonus if**: Loss year or low-income year (deduction wasted, non-refundable).

Section 179 sufficient (simpler, up to $1.22M).

Future higher tax rates expected (defer deductions).

AMT concerns (pre-2018, now mostly repealed). **Coordination with Section 179**: **Section 179 first**: $1.22M deduction limit (2025), dollar-for-dollar reduction after $3.05M asset purchases (phaseout). **Then bonus**: 60% on remaining basis (no dollar limit). **Then MACRS**: Regular schedule on remaining basis. **Example** ($2M equipment purchase, 2025): Section 179: **$1.22M** (max).

Remaining: $2M - $1.22M = $780k.

Bonus (60%): $780k × 0.60 = **$468k**.

Remaining: $780k - $468k = $312k.

Year 1 MACRS (20%): $312k × 0.20 = **$62.4k**. **Total Year 1**: $1.22M + $468k + $62.4k = **$1.75M** deduction (87.5% of $2M in first year).

**MACRS conventions** (determine first and last year depreciation): **Half-year convention** (most common, default): **Rule**: Treat all property as placed in service at midpoint of tax year, regardless of actual date. **Effect**: First year = 50% of full-year depreciation.

Last year = 50% of full-year depreciation (recovery period extends by 1 year). **Example** (5-year property, $100k, placed in service January 2025): Year 1 (2025): 20% × 50% = **10%** = $10,000 (half-year).

Year 2-6: Full years (32%, 19.2%, 11.52%, 11.52%).

Year 7 (2031): 5.76% × 50% = **2.88%** = $2,880 (final half-year). **Total recovery period**: 6 years (not 5). **Mid-quarter convention** (triggered by 40% test): **Rule**: Applies if **>40%** of total depreciable property (by basis) is placed in service in **last quarter** (Oct 1 - Dec 31). **Effect**: Property placed in mid-point of quarter (not mid-year).

Q1 (Jan-Mar): Treated as placed in service Feb 15 → **10.5 months** depreciation in Year 1 (10.5/12 = 87.5%).

Q2 (Apr-Jun): Treated as placed in service May 15 → **7.5 months** (62.5%).

Q3 (Jul-Sep): Treated as placed in service Aug 15 → **4.5 months** (37.5%).

Q4 (Oct-Dec): Treated as placed in service Nov 15 → **1.5 months** (12.5%). **Example triggering mid-quarter**: Total 2025 asset purchases: $500k.

Q1-Q3 purchases: $250k (50%). **Q4 purchases: $250k (50%)** → Exceeds 40% threshold → **Mid-quarter applies to ALL 2025 assets**. **Impact on Q4 asset** ($100k machinery, 5-year, placed Dec 2025): Half-year convention: Year 1 = 20% × 50% = 10% = $10,000. **Mid-quarter (Q4)**: Year 1 = 20% × (1.5 ÷ 12) = **2.5%** = $2,500 (only 1.5 months). **Loss**: $7,500 in first year (25% of half-year amount). **Strategic year-end planning** (avoid mid-quarter trap): **Scenario**: Purchased $300k equipment Jan-Sep.

Considering $250k equipment in December (Q4). **Test**: $250k Q4 ÷ $550k total = **45.5%** → **Exceeds 40%** → Mid-quarter triggered. **Solution options**: **Option 1**: Delay $250k purchase to January 2026 (avoid triggering, preserve half-year for existing $300k). **Option 2**: Accelerate purchase to September 30 (Q3) → Q4 = $0 = 0% → Half-year preserved. **Option 3**: Accept mid-quarter but optimize: Place larger assets in Q1 (10.5 months = 87.5% of year).

Place smaller assets in Q4 (1.5 months = 12.5%). **Calculation**: Q1 asset ($200k): Year 1 = 20% × 87.5% = **17.5%** = $35,000.

Q4 asset ($100k): Year 1 = 20% × 12.5% = **2.5%** = $2,500. **Total**: $37,500 (vs $30,000 half-year for both) = **$7,500 better**. **Mid-month convention** (real estate only, 27.5/39-year): Property placed in service at mid-month. **Example**: Rental property placed July 15 → Treated as July 15 (5.5 months in Year 1).

Year 1: (1 ÷ 27.5) × (5.5 ÷ 12) = **1.667%** depreciation.

**Residential rental property (27.5-year MACRS)**: **Qualifying use**: ≥80% of gross rental income from dwelling units (apartments, single-family rentals, duplexes). **Not qualifying**: Hotels, motels (transient lodging <30 days).

Mixed-use buildings <80% residential. **Depreciable basis**: Purchase price + closing costs + improvements - land value. **Land exclusion** (not depreciable): Allocate purchase price between land and building using: (1) Property tax assessment ratio (most common). (2) Appraisal allocation. (3) Replacement cost method. **Example**: $500,000 duplex purchase.

Tax assessment: Land $150k (30%), Building $350k (70%). **Depreciable basis**: $350,000 (70% of $500k). **Land basis**: $150,000 (not depreciable, recovered on sale). **Annual depreciation**: $350,000 ÷ 27.5 years = **$12,727/year** (straight-line). **Mid-month convention** (first and last years): **Placed in service July 2025**: Months owned in 2025: July-Dec = 6 months (treat July as 0.5 month = 5.5 months).

Year 1 (2025): $12,727 × (5.5 ÷ 12) = **$5,833**.

Years 2-27 (full years): **$12,727** each.

Year 28 (final year, 2052): $12,727 × (6.5 ÷ 12) = **$6,894** (remaining 6.5 months). **Total**: $350,000 over 28 calendar years. **Commercial real estate (39-year MACRS)**: **Qualifying property**: Office buildings, retail stores, warehouses, storage facilities.

Mixed-use buildings <80% residential. **Depreciable basis**: Same calculation as residential (purchase price + costs - land). **Example**: $1,950,000 office building.

Land allocation: 20% = $390k (not depreciable). **Depreciable basis**: $1,560,000 (80% of $1.95M). **Annual depreciation**: $1,560,000 ÷ 39 years = **$40,000/year** (straight-line). **Mid-month convention** (placed in service March 2025): Months in 2025: March-Dec = 10 months (treat March as 0.5 month = 9.5 months).

Year 1 (2025): $40,000 × (9.5 ÷ 12) = **$31,667**.

Years 2-39 (full years): **$40,000** each.

Year 40 (final year, 2064): $40,000 × (2.5 ÷ 12) = **$8,333**. **Total**: $1,560,000 over 40 calendar years. **Qualified Improvement Property (QIP, post-2023)**: **2023+ (after TCJA technical correction)**: QIP = **15-year recovery period** (not 39-year). **Eligible for bonus depreciation** (60% in 2025). **Qualifying improvements**: Interior improvements to nonresidential buildings (after initial occupancy): HVAC replacement, fire protection, security systems, interior walls/ceilings/flooring. ❌ **Not QIP**: Elevators/escalators, internal structural framework, building expansion. **Example**: $200,000 HVAC system installed in existing office (2025). **Without bonus**: 15-year MACRS = $200k ÷ 15 = $13,333/year (straight-line, half-year convention → Year 1 = $6,667). **With 60% bonus**: Bonus: $200k × 60% = $120,000 (Year 1).

Remaining: $80k ÷ 15 = $5,333/year MACRS (half-year → Year 1 = $2,667). **Total Year 1**: $120,000 + $2,667 = **$122,667** (61% in first year). **Land improvements** (15-year MACRS, 150% DB): Sidewalks, parking lots, fences, landscaping (separate from building). **Not bonus-eligible** (land improvements excluded).

**Mistake #1: Depreciating land** (most common). **Error**: Including land value in depreciable basis.

Land never depreciates (IRC Section 167). **Example**: $600k property purchase, allocated 100% to building. **Tax assessment**: 25% land, 75% building. **Correct**: Depreciable basis = $600k × 0.75 = $450k.

Land = $150k (not depreciable). **Incorrect**: Depreciating full $600k. **Consequence**: $150k ÷ 27.5 = $5,455/year overstated deduction → **IRS audit risk, penalties, interest**. **Fix**: Use property tax assessment ratio or appraisal to allocate.

Document allocation method in tax records. **Mistake #2: Wrong recovery period** (5-year vs 7-year confusion). **Error**: Classifying office furniture as 5-year (should be 7-year). **Example**: $50,000 desks/chairs. **Correct**: 7-year property → Year 1 MACRS (200% DB, half-year) = 14.29% = $7,145. **Incorrect (using 5-year)**: 20% = $10,000. **Difference**: Overstated $2,855 in Year 1. **Consequence**: IRS adjustment, recapture tax in audit years. **Fix**: Review IRS Pub 946 Table B-1 (asset class list).

When uncertain, use 7-year catch-all category. **Mistake #3: Ignoring mid-quarter convention** (last-minute Q4 purchase). **Error**: Purchasing >40% of year's assets in Q4, unaware of mid-quarter impact. **Example**: $400k equipment in Q4 (60% of annual total). **Expected (half-year)**: Year 1 = 20% × 50% = 10% = $40,000. **Actual (mid-quarter Q4)**: Year 1 = 20% × 12.5% = 2.5% = $10,000. **Lost deduction**: $30,000 in Year 1 (30% of expected). **Fix**: Track cumulative asset purchases by quarter throughout year.

If approaching 40% in Q4, delay purchases to January or accelerate to Q3. **Mistake #4: Forgetting bonus depreciation election** (missing 60% in 2025). **Error**: Filing return without checking bonus depreciation box (Form 4562, Part II). **Example**: $500k machinery (2025). **With bonus**: Year 1 = 60% × $500k = $300k bonus + $100k MACRS = $400k total. **Without bonus (error)**: Year 1 MACRS only = 20% × $500k = $100k. **Lost deduction**: $300,000 in Year 1 → **$105,000 tax cost** (35% bracket). **Fix**: Review Form 4562 instructions, confirm bonus election for qualifying property.

File amended return (Form 1040-X) if missed (3-year window). **Mistake #5: Section 179 exceeding taxable income**. **Error**: Deducting $1.22M Section 179 when business has only $500k taxable income. **Consequence**: **$720k disallowed** (Section 179 limited to taxable business income, cannot create loss).

Excess carries forward to next year (but delays benefit). **Fix**: Calculate taxable income before Section 179 election.

Coordinate with bonus depreciation (no taxable income limit) if income insufficient. **Mistake #6: Failing to adjust basis for bonus/179**. **Error**: Continuing to depreciate full cost under MACRS after taking bonus/Section 179. **Example**: $100k asset.

Section 179: $50k. **Correct MACRS basis**: $100k - $50k = $50k (depreciate remaining). **Incorrect**: Continuing MACRS on full $100k → **Double deduction** of $50k over asset life. **Consequence**: IRS adjustment + penalties for "substantial understatement" (>10% of tax). **Fix**: Reduce MACRS basis by Section 179 and bonus amounts.

Software typically handles automatically if entries correct. **Mistake #7: Disposing of asset without recapture calculation** (selling/trading). **Error**: Selling $100k machinery (originally) with $80k depreciation taken → Adjusted basis $20k.

Sale price: $35k. **Gain**: $35k - $20k = **$15k** (ordinary recapture income, not capital gain). **Incorrect**: Treating as capital gain or ignoring entirely. **Consequence**: Underpayment of ordinary income tax. **Fix**: Track accumulated depreciation (Form 4797, Part II).

All gains up to depreciation taken = ordinary income (IRC 1245 recapture).