A depreciation convention is a rule used to determine basically four things:
- The depreciation table you must use, depending on when the property is placed in service.
- The amount of depreciation you may claim for a piece of property the first and last year of the property's recovery period depending on when the property is placed in service.
- The amount of depreciation you may claim when you dispose of property, depending when the property was placed in service.
- The depreciation method you may use.
There are three depreciation conventions:
- The half-year convention
- The mid-quarter convention
- The mid-month convention.
There are also depreciation tables associated with each of these conventions. Which one you use depends on when the property was placed in service and the type of property placed in service.
1. Half-year convention
If you place property in service between January and September (the first nine months), you must use the half-year convention. This convention assumes you placed property in service in the middle of the year even if it was placed in service the beginning of the year. It also assumes that when you dispose of the property, you disposed of it in the middle of the year even if you disposed of it on January 1.
Consequently, in the year the property is placed in service you may only deduct one-half of the annual depreciation and in the year the property is disposed of you may only deduct one-half of the annual depreciation.
2. Mid-quarter Convention
This convention considers the cost of business equipment (excluding realty) acquired in the last quarter of the year (October, November, and December).
If the total cost of business equipment acquired in the last quarter of the year exceeds 40% of the total cost of equipment acquired for the entire year, the mid-quarter convention must be used for all property placed in service in that tax year.
For example, if total annual acquisitions equal $50,000, which includes last quarter acquisitions of $30,000, the mid-quarter convention must be used ($30,000/$60,000 = 60%).
The depreciation table used for the mid-quarter convention is divided into four quarters.
- Each quarter includes the depreciation rates for each year of the asset's recovery period.
- The depreciation rate for each year is applied to each individual asset for each year of its recovery period.
- The rate used for each asset depends on the quarter the asset was placed in service.
- If the 40% test is not met, the half-year convention must be used.
3. Mid-month Convention
This convention applies to realty. Only the straight-line method may be used for realty.
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