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YEAR-END: MID-QUARTER?
December 23, 2007
One of the more obscure tax traps at year-end is the "mid-quarter convention." Normally the tax law computes depreciation on fixed assets as if they were placed in service in the middle of the year - the so-called "half-year convention."
When a company places more than 40% of its new assets in service in the last three months of the year, different rules apply. When that happens, depreciation for each asset starts at the midpoint of the quarter in which it is placed in service. This can have an unhappy effect on your deductions.
Example: Snow Co. has placed in service two assets during the year: a machine costing $600,000 that went into service July 31, and another machine costing $399,000 that was up and running October 15. Both assets have five-year tax depreciation lives. The depreciation for these two assets for the year would be $199,800, computed for 1/2 year under the tax law's 200% declining balance depreciation method.But then Snow decides to go online and buy a $1,001 computer, which is placed in service December 29. Suddenly more than 40% of the new assets for the year have been placed in service in the last three months of the year, and the mid-quarter convention applies. The depreciation for the $600,000 machine is computed starting in the middle of the third quarter and comes out to $90,000. The depreciation for the other $400,001 is computed for 1/8 of a year, as the assets are deemed to go into service at the midpoint of the fourth quarter; that deduction comes out to $20,000.05.
So, by adding a $1,001 asset at year-end, Snow Co. has reduced its depreciation deduction from $199,800 to $110,000. And five cents.
So if you are in a hurry to get assets in service before year-end, slow down and make sure that you don't end up reducing your depreciation by going into the mid-quarter convention.
Stop by daily through December 31 for another year-end tax planning post. Collect them all!
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Comments
Shouldn't you mention that some of the 4th quarter purchases could be written off under Sec. 179?
Sincerely
Posted by: Milt Baker CPA | December 24, 2007 5:55 AM
Milt, that's an excellent point. I used an example beyond the Sec. 179 phase-out range to keep it simple, but your point is well-taken. For the benefit of other folks: assets for which you take the Sec. 179 deduction are not part of the computation of whether mid-quarter convention applies. You can sometimes avoid the mid-quarter convention simply by taking the Sec. 179 deduction for 4th quarter asset acquisitions.
Posted by: Joe Kristan | December 24, 2007 7:33 AM