What Are the GDS Recovery Periods for Assets?

When a business acquires an asset, such as a building or equipment, it cannot deduct the entire cost in the year of purchase. Instead, the cost is spread out over the asset’s useful life through depreciation. For tax purposes, the Internal Revenue Service (IRS) requires most businesses to use the Modified Accelerated Cost Recovery System (MACRS) to recover the cost of tangible property.

Under MACRS, the General Depreciation System (GDS) is the most frequently used method for calculating depreciation deductions. GDS is applied to most types of property and allows for a faster recovery of costs in the early years of an asset’s service. This involves identifying the correct recovery period for your asset, selecting the right convention, and applying the proper depreciation method.

Determining the Correct GDS Recovery Period

The foundation of calculating depreciation under GDS is assigning your asset to the correct property class. Each class has a specific recovery period, which is the number of years over which you can deduct the asset’s cost. These recovery periods are predetermined and are not necessarily the same as the asset’s actual expected useful life.

Assets are broadly categorized into personal property and real property. Personal property includes items like machinery, equipment, and vehicles. For example, 3-year property includes certain specialized tools for manufacturing and some racehorses. Property with a 5-year recovery period is a broad category that includes computers, office machinery like copiers, cars, and light-duty trucks.

A significant amount of business equipment falls into the 7-year property class. This includes office furniture and fixtures, such as desks, chairs, and filing cabinets. It also covers agricultural machinery and equipment. The 10-year property class includes assets like vessels, tugs, and certain agricultural structures. Land improvements, such as fences, sidewalks, and parking lots, are generally classified as 15-year property, while utility property like municipal sewers falls into the 20-year class.

Real property, which consists of buildings and their structural components, has much longer recovery periods. Residential rental property, such as apartment buildings and rental houses, is depreciated over 27.5 years. Nonresidential real property, which includes commercial buildings like offices, stores, and warehouses, has a recovery period of 39 years. It is important to correctly distinguish between personal and real property, as the recovery periods and depreciation rules differ significantly.

Selecting the Appropriate Convention and Method

Once you have determined the asset’s recovery period, you must select the correct depreciation convention. A convention determines when the recovery period begins and ends, dictating how much of a full year’s depreciation you can claim in the first and last year of the asset’s service life. The specific convention you must use depends on the type of property and when it was placed in service.

For most types of personal property, the half-year convention is the default. This convention treats all property placed in service during a tax year as if it were placed in service in the middle of that year. This means you can claim a half-year of depreciation for the first year. If more than 40% of the total basis of personal property is placed in service during the last three months of the tax year, you must use the mid-quarter convention. This convention treats assets as being placed in service in the middle of the quarter they were acquired.

Real property has its own specific rule. For both residential rental and nonresidential real property, you must use the mid-month convention. This convention treats the property as being placed in service in the middle of the month it was acquired. After selecting the convention, you must also identify the correct depreciation method. For property in the 3, 5, 7, and 10-year classes, the 200% declining balance method is used. The 150% declining balance method applies to 15 and 20-year property. These methods automatically switch to the straight-line method in the year it provides a greater deduction. For real property, the straight-line method is required from the start.

Calculating Depreciation Under GDS

With the recovery period, convention, and method identified, you can calculate the annual depreciation deduction. The calculation involves multiplying the asset’s basis—generally its cost—by a specific percentage for each year of the recovery period. The IRS provides depreciation percentage tables in Publication 946 that simplify the process.

To use these tables, you first find the table corresponding to your depreciation system (GDS) and convention. You then find the row for the recovery year you are calculating and the column for your asset’s recovery period. The number at the intersection is the depreciation rate for that year.

Consider a business that purchases $10,000 of office furniture (7-year property) and places it in service during the second quarter of the year. Since the mid-quarter convention does not apply, the business uses the half-year convention and the 200% declining balance method. Using the appropriate IRS table, the depreciation rate for the first year for 7-year property is 14.29%. The first-year depreciation deduction would be $1,429 ($10,000 basis x 0.1429).

For each subsequent year, you would use the percentage listed in the table for that year of the recovery period. The tables automatically account for the switch from a declining balance method to the straight-line method at the optimal point.