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The Modified Accelerated Cost Recovery System (MACRS) is the current tax depreciation system in the United States. Under this system, the capitalized cost (basis) of tangible property is recovered over a specified life by annual deductions for depreciation.
Depreciable property that is not eligible for a section 179 deduction is still deductible over a number of years through MACRS depreciation according to sections 167 and 168. The 179 election is optional, and the eligible property may be depreciated according to sections 167 and 168 if preferable for tax reasons. [3]
U.S. Internal Revenue Service Publication 946, How to Depreciate Property. Washington, D.C.: U.S. Government Printing Office. IRS Rev. Proc. 87-56 and 87-55 (shown in Publication 946 as tables, as currently updated) Fox, Stephen C., Income Tax in the USA, chapter 24, 2013 edition ISBN 978-0-9851823-3-5, ASIN B00BCSNOGG
Section 168(e)(1) provides a table for determining the applicable recovery period. Following our 7 year railroad track, the table states that property with a useful life of more than 4 years but less than 10 years will be treated as 5 year property. Finally, it is important to determine the applicable convention for depreciation.
If more than 40% of the total basis of property is placed in service during the last three months of the tax year, the mid-quarter convention applies. Exemptions include: Property that is being depreciated under a method other than MACRS. Any residential rental property, nonresidential real property, or railroad gradings and tunnel bores.
Consider you are a taxpayer with five-year property worth $50,000. Also, assume that the property depreciates $10,000 per year. Year 1- limited to half of the deduction normally entitled in a full year. One deduction of $5,000 allowed at the end of the year, since the property is put into service on July 1, year 1. Year 2- $10,000 deduction taken.
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Under rules contained in the current Internal Revenue Code, real property is not subject to depreciation recapture. However, under IRC § 1(h)(1)(D), real property that has experienced a gain after providing a taxpayer with a depreciation deduction is subject to a 25% tax rate—10% higher than the usual rate for a capital gain.