Tax depreciation is a classification exercise before it is a calculation. Each asset gets a property class, a recovery period and a convention, and an error in any of the three flows through every later year. This article sets out the classes from IRS Publication 946, the three conventions and the mid-quarter test that catches clients who buy most of their equipment late in the year. For the accounting treatment of depreciation, see depreciation schedules: straight-line, declining balance and MACRS.
Property classes and recovery periods
Publication 946 lists the general depreciation system recovery periods:
| Class | Examples from the publication |
|---|---|
| 3-year | Over-the-road tractor units, certain horses |
| 5-year | Automobiles and trucks, office machinery such as copiers and calculators, research equipment |
| 7-year | Office furniture and fixtures such as desks and safes, used agricultural machinery |
| 10-year | Vessels, barges and tugs, single-purpose agricultural structures |
| 15-year | Land improvements such as fences, roads and bridges, retail motor fuels outlets |
| 20-year | Farm buildings other than single-purpose structures |
| 27.5-year | Residential rental property, where at least 80 percent of gross rental income comes from dwelling units |
| 39-year | Nonresidential real property such as office buildings, stores and warehouses |
Publication 946 also notes that qualified facilities, certain qualified property under section 48E and energy storage technology placed in service after December 31, 2024 are 5-year property. Solar or wind energy property was removed from 5-year property for construction beginning after December 31, 2024. Qualified improvement property has its own class entry in the publication.
The class follows the nature and use of the asset, not the vendor invoice. A purchase of a "furniture package" may contain 7-year furniture, 5-year office equipment and 15-year site work, and each belongs in its own class.
The three conventions
Publication 946 names three conventions: half-year, mid-quarter and mid-month. They determine how much depreciation is allowed in the year an asset is placed in service and in the year it is disposed of.
- Half-year. Used when neither the mid-quarter nor the mid-month convention applies. Property placed in service or disposed of during the tax year is treated as placed in service or disposed of at the midpoint of the year.
- Mid-quarter. Applies when the test below is triggered. The Instructions for Form 4562 state that under it, all property placed in service or disposed of during any quarter is treated as placed in service or disposed of at the midpoint of that quarter.
- Mid-month. Used for residential rental property, nonresidential real property and railroad gradings and tunnel bores, treating the asset as placed in service or disposed of at the midpoint of the month.
The 40 percent test
The Form 4562 instructions state that the mid-quarter convention generally applies when the total depreciable bases of MACRS property placed in service during the last three months of the tax year exceed 40 percent of the total depreciable bases of all MACRS property placed in service during the year. The depreciable bases are measured before any special depreciation allowance. The following are excluded from the test: property depreciated under a non-MACRS method, residential rental property, nonresidential real property, railroad gradings and tunnel bores, and property placed in service and disposed of in the same year.
Under Treasury Regulation 1.168(d)-1(b)(4) the bases used in the test are reduced by any section 179 deduction and by any non-business use percentage, but not by bonus. Because the test is measured before bonus depreciation, the convention can change the depreciation on assets that will mostly be recovered through bonus anyway. The effect is smaller when a client expenses nearly all of its additions, but it still matters for assets that are not fully expensed.
Worked illustration of the test
A calendar-year client places three assets in service with no section 179 election. Equipment A costs $60,000 and is placed in service in March. Equipment B costs $40,000 and is placed in service in June. Equipment C costs $70,000 and is placed in service in November. The fourth-quarter share is 70,000 / 170,000 = 41.2 percent, which exceeds 40 percent, so the mid-quarter convention applies to all three assets and each is treated as placed in service at the midpoint of its quarter. If C had cost $60,000, the share would be 60,000 / 160,000 = 37.5 percent and the half-year convention would apply to all three. If the client had elected a $30,000 section 179 deduction on C, its depreciable basis for the test would be $40,000 and the share would be 40,000 / 140,000 = 28.6 percent, so the half-year convention would apply.
The practical point: timing a purchase for the end of December can flip the convention for the whole year's additions. A planning conversation before year end should include the test.
Review checklist before finalizing the schedule
- Class and period. Confirm each addition's class against Publication 946 and the asset description, not the general ledger account.
- Placed-in-service date. Use the date the asset was ready and available for use, supported by an invoice, delivery receipt or commissioning record.
- Run the 40 percent test. Record the total, the fourth-quarter total and the percentage in the file.
- Apply the convention. Half-year, mid-quarter or mid-month, by asset.
- Apply section 179 and bonus. Follow the order in section 179 and bonus depreciation.
- Check disposals. A disposal is subject to the same convention in the year of sale.
- Reconcile. Tie the tax register to the book register and list differences by asset.
Common errors
- Putting leasehold improvements, site work and equipment in a single class.
- Using the invoice date rather than the placed-in-service date.
- Skipping the 40 percent test because bonus depreciation covers the additions.
- Carrying forward a convention from a prior year instead of recomputing it.
- Forgetting that residential rental property and nonresidential real property use mid-month and are excluded from the test.
FAQ
Does a client choose the convention?
No. The conventions are determined by the property type and, for personal property, by the 40 percent test.
Do assets placed in service in the first quarter ever trigger mid-quarter?
The test looks at the last three months of the tax year. First-quarter assets affect the denominator.
Is land depreciable?
No. Land is not depreciable under MACRS, and land improvements such as fences and roads are 15-year property in the publication.
CORAA prepares ready-to-review audit files for US CPA firms; see /us.
Sources
- IRS, Publication 946, How To Depreciate Property: https://www.irs.gov/publications/p946
- IRS, Instructions for Form 4562: https://www.irs.gov/instructions/i4562
- eCFR, 26 CFR 1.168(d)-1, Applicable conventions: https://www.ecfr.gov/current/title-26/section-1.168(d)-1
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