Modified Accelerated Cost Recovery System (MACRS)Explained & Defined

Written By:
Lisa Borga

What is the Modified Accelerated Cost Recovery System (MACRS)?

The modified accelerated cost recovery system (MACRS) method of depreciation depreciates fixed assets by assigning the asset to a certain category of assets with their own accelerated depreciation schedule.

MACRS is used by businesses in the United States for tax purposes.

When businesses depreciate their assets, it lowers the income on which taxes will be paid, thus lowering their taxes.

If MACRS is used for depreciation, the company will have a larger tax reduction in the asset’s early years.

Explaining MACRS

Depreciation allows a business to deduct the cost of certain assets over their useful life.

Depreciation is mandatory in accounting under the matching principle because it matches part of the cost of an asset to the revenue it generates.

Tangible assets can generally be depreciated.

Whereas amortization is used for intangible assets with a finite useful life.

Intangible assets with a perpetual life are not amortized.

Most tangible assets will be depreciated using the modified accelerated cost recovery system for tax purposes.

When using the MACRS method of depreciation, an asset will be depreciated more quickly during the first few years of the asset’s life.

Then, the asset will be depreciated more slowly.

Although, it is possible when using MACRS for the asset to be fully depreciated before its useful life has ended.

The modified accelerated cost recovery system can be used for a number of different assets, such as machinery, computer equipment, and office furniture, among others.

The IRS requires that businesses use MACRS to depreciate any tangible property that they placed in service after December 31, 1986.

Some properties cannot be depreciated using MACRS.

This includes some partnership or corporate properties that are acquired as part of a non-taxable transfer.

Other properties that cannot use MACRS include particular types of property acquired by corporations or partnerships in non-taxable transfers.

The Two Modified Accelerated Cost Recovery Systems

Taxpayers have two primary systems they can use when depreciating assets with the modified accelerated cost recovery system.

These systems are the General Depreciation System (GDS) and the Alternative Depreciation System (ADS).

The General Depreciation System (GDS)

The General Depreciation System is the most commonly used system of depreciation for those businesses using the modified accelerated cost recovery system.

This system of depreciation uses the declining balance approach.

When using this system, the depreciation expense is greater in the earlier years of the asset’s life than in later periods.

When using this system businesses must use a specific asset life that is dependent on the tangible asset being depreciated.

Then, the depreciation rate for the asset is applied to the non-depreciated balance each year the asset is being depreciated.

The GDS works best when you have assets that tend to depreciate in a short amount of time.

One example of this would be computers or other types of technology, which can become outdated quickly.

The Alternative Depreciation System (ADS)

The ADS method of depreciation is not used as frequently as the GDS method. Generally, businesses will use the GDS method of depreciation unless they are required to use the ADS method.

The Alternative Depreciation System uses a straight-line method of depreciation.

This means that the business will subtract an asset’s salvage value from its cost and then divide the remaining amount by the asset’s expected years of service.

This method does typically increase the number of years over which the asset will be depreciated.

The Alternative Depreciation System is useful for small businesses or businesses with a high level of growth that have insufficient current taxable income.

Using the ADS method of depreciation can allow these businesses to record lower depreciation in an asset’s first years which will result in higher levels of profit.

However, if a business does choose to use this method of depreciation for an asset, it must use it for the entire asset class and cannot revoke this choice.

There are some properties for which the IRS requires the Alternative Depreciation System to be used. This includes:

• Tax-exempt property that is bond-financed
• Tangible property that is primarily used outside of the United States during the year
• Property being listed that is used for business purposes 50% or less of the time
• Tax-exempt use property
• Property that is mainly used as part of a farming business

Classification of Property

The IRS classifies assets and assigns them useful lives.

You can use this information to determine the asset’s depreciation.

Publication 946 by the IRS

For those who want more complete information, Publication 946 by the IRS gives complete information on asset classes as well as the useful lives of the assets.

It also gives the tax rules for using the modified accelerated cost recovery system.

This can be very useful for businesses as depreciating assets using MACRS can be complicated and confusing.

The General Depreciation System has nine assets classes which are listed in the table above, but the Alternative Depreciation System has more asset classes, and these assets have longer recovery lives.

An example of this is natural gas gathering lines which have a useful life of seven years under the GDS, but fourteen years under the ADS.

The IRS has tables that will allow businesses to calculate the depreciation for their assets using either of the two primary modified accelerated cost recovery systems, the General Depreciation System and Alternative Depreciation System.

To find the depreciation for an asset using MACRS, a business will take the cost basis of the asset and multiply this by the percentage for which the asset is used for business or investment purposes.

This amount is used by the company in their income tax returns which determines the taxable income for the company once the business’s tax deductions and tax credits are taken into account.

The depreciation that is calculated for tax purposes is not used on the business’s financial statements.

MACRS is used by businesses for tax purposes and cannot be used on financial statements by companies following U.S. Generally Accepted Accounting Principles (GAAP) because it is not an approved method.

Instead, businesses need to use straight-line depreciation or an approved accelerated depreciation method for their financial statements.

How Depreciation is Beneficial for Tax Reporting

Depreciation reduces the income which is used for calculating a company’s tax burden.

This means that depreciation in turn reduces a company’s tax burden when the time value of money is considered.

This is why an accelerated depreciation method that results in a larger tax reduction earlier in an asset’s useful life is beneficial.

What is an Asset’s Useful Life?

The useful life of an asset refers to an estimate created for accounting purposes of the time period that an asset will create benefits for the company.

The IRS provides a guide to useful lifetimes for many assets which companies can use to determine the period of time over which an asset may be depreciated.

Key Takeaways

• The modified accelerated cost recovery system is the method of depreciation most businesses use for the tangible depreciable property that they have put in service after 1986.
• For tax purposes, the modified accelerated cost recovery system is considered more advantageous than some other methods of depreciation.
• The IRS does have guidelines businesses can use to determine which assets they can depreciate using MACRS and what predetermined schedule they should use when depreciating the asset.
• MACRS consists of two main depreciation systems: the Alternative Depreciation System (ADS) and the General Depreciation System (GDS).
• When MACRS is used for depreciating an asset, it will be depreciated more quickly in the early years of the asset’s life and then depreciate more slowly.