Depreciation is the tax law's way of allowing you to recover, via annual deductions, the cost of business or investment property () which is likely to last for more than a year, but which is subject to wear and tear or obsolescence.1 (See .) Such property is sometimes called a Depreciable Asset.
Most business assets, such as buildings, fixtures, machines, furniture, and vehicles, are depreciable.2
Land, however, is not depreciable.3
Tax law authorizes several depreciation methods, but the main types are Straight-line Depreciation and Accelerated Depreciation.
Straight-line. Under this method, you deduct the same amount of depreciation each year.
Accelerated. Accelerated depreciation is any method that allows you to depreciate property at a rate faster than the straight-line method. The most common type of accelerated depreciation is some version of the Declining Balance Method of Depreciation.
The current depreciation system is called the Modified Accelerated Cost Recovery System (MACRS). MACRS applies to most business and investment property placed in service after 1986.
MACRS replaced the Accelerated Cost Recovery System (ACRS), which applies to most business and investment property placed in service after 1980 and before 1987. ACRS provided ultra-fast depreciation because of its short write-off periods.
MACRS consists of two depreciation systems, the General Depreciation System (GDS) (the favorable one) and the Alternative Depreciation System (ADS) (the one you use only if you have to).
GDS is the accelerated portion of MACRS. GDS uses the declining balance method of depreciation for depreciable assets than real estate, at either 150 percent or 200 percent rates, depending on the asset category. For real estate, GDS uses the straight-line method over periods of either 27.5 years (for residential rental property) or 39 years (for nonresidential real property, i.e., commercial property).
ADS is the penalty box for depreciation deductions. Under ADS, you depreciate property using the straight-line method over a longer class life than you would use under GDS. Thus, ADS generally makes for smaller depreciation deductions spread over a longer period of time.4
You can elect to use ADS, but we cannot think of a reason why you would want to.
1 IRC Section 167(a).
2 See IRS Publication 946, “How to Depreciate Property.”
3 Reg. Section 1.167(a)-2.
4 IRC Section 168(g).
5 IRC Section 280F(b)(1).