When Do You Start Depreciating an Asset?

Depreciation is an accounting method used to spread the cost of a physical asset over its useful life, reflecting its wear and tear or obsolescence. This process allows a business to allocate a portion of the asset’s cost as an expense on its income statement each year. The start date for depreciation determines the timing and amount of deductions a business can claim, directly impacting its taxable income.

The Placed in Service Rule

Depreciation on a business asset does not begin on its purchase date, but rather when it is “placed in service.” According to the Internal Revenue Service (IRS), an asset is placed in service when it is ready and available for its specific function in a business or income-producing activity. The clock for depreciation starts ticking only when the asset is in a state of readiness.

This “ready and available” standard is based on facts and circumstances. For example, a vehicle purchased for business deliveries is not considered placed in service on the day it is driven off the dealership lot. It is placed in service only after it has been registered, insured, and is fully prepared for its intended business routes.

Similarly, a new computer for an employee is not placed in service while it remains in its packaging. It becomes ready and available only after it has been unboxed, set up, and loaded with the necessary software for the employee to perform their duties. For real estate, such as a rental property, the placed-in-service date is when the property is ready and available for rent, which often coincides with the issuance of a certificate of occupancy. The property does not need to be actively occupied, just available for that use.

First Year Depreciation Conventions

The IRS provides specific rules, known as conventions, that dictate the amount of depreciation that can be claimed in the first year an asset is placed in service. These conventions standardize the calculation, regardless of the specific day the asset became operational. The appropriate convention depends on the type of property being depreciated.

The most common method for property other than real estate is the half-year convention. This rule treats all assets as if they were placed in service in the middle of the tax year, no matter the actual date. This means a business can only claim six months’ worth of depreciation in the first year, even if the asset was purchased and made ready in January.

The mid-quarter convention is mandatory if the total cost basis of certain types of property placed in service during the final three months of the tax year exceeds 40% of the total basis of all such property placed in service throughout the entire year. If this 40% threshold is met, all property of that type placed in service during the year must use the mid-quarter convention. This rule treats assets as being placed in service at the midpoint of the quarter they were actually made ready and prevents businesses from purchasing a large volume of assets at the end of the year to maximize deductions.

For residential rental property and nonresidential real property, a different rule applies: the mid-month convention. This convention treats the property as being placed in service in the middle of the month it was actually made ready and available. For example, if a rental property is ready for tenants on March 28th, it is treated as being placed in service on March 15th for depreciation calculation purposes.

Special Scenarios for Starting Depreciation

Converting Personal Property to Business Use

When an asset previously used for personal purposes is converted to a business function, depreciation begins on the date of the conversion, which is considered its placed-in-service date. For instance, if a personal vehicle is repurposed for a new delivery service, the placed-in-service date is the day it becomes ready and available for making those deliveries.

The basis for calculating depreciation in this scenario is the lesser of the asset’s fair market value (FMV) on the date of conversion or its adjusted cost basis. The adjusted cost basis is typically the original purchase price. This rule prevents taxpayers from claiming depreciation on a personal asset’s decline in value that occurred before it was used for business.

Self-Constructed Assets

For assets that a business constructs for its own use, such as a new office building or a custom-built piece of machinery, depreciation does not begin until the construction is complete and the asset is in a state of readiness for its intended function. The process of building the asset does not count as it being in service.

All costs incurred during the construction period, including materials, labor, and certain overhead costs, are capitalized. This means they are not expensed immediately but are added together to form the asset’s total cost basis. Once the asset is complete and placed in service, the business will begin to depreciate this capitalized basis over the asset’s useful life according to the applicable depreciation rules and conventions.