When to Start Depreciating an Asset?
Learn the principles for starting asset depreciation. An asset's readiness for use, not its purchase date, determines the correct timing and tax deduction.
Depreciation is a method for businesses to account for the cost of an asset over its useful life, providing a tax deduction. The timing for these deductions is determined by specific regulations. Understanding the precise moment an asset is considered active in a business is fundamental to correctly calculating and claiming these deductions.
The Placed in Service Rule
The start of an asset’s depreciation is determined by its “placed-in-service” date. According to the Internal Revenue Service (IRS), property is placed in service when it is in a state of readiness and availability for its assigned function. This means depreciation starts not when you order or pay for an asset, but when it is ready for its intended use.
For example, a business might purchase equipment in December, but if it remains in a crate awaiting installation, it has not been placed in service. Conversely, an asset does not have to be in active use for depreciation to begin. A new delivery van purchased late in the year is considered placed in service even if it doesn’t make a delivery until the new year, because it is ready and available.
This rule, established in Treasury Regulation §1.167(a)-10, applies to all depreciable business assets, whether used in a trade or business or held for the production of income. A depreciable asset must be placed in service during the tax year for a deduction to be claimed.
Determining the Placed in Service Date
Applying the placed-in-service rule varies depending on the asset’s nature. The circumstances surrounding how an asset is made ready for its business function dictate the date depreciation can begin.
Ready-to-Use Assets
For assets that are functional immediately upon delivery, determining the placed-in-service date is straightforward. Consider an office desk or a laptop computer. These items are ready for their intended function as soon as they are set up in the office, and this date is often the delivery date.
Assets Requiring Installation
Many business assets require installation, assembly, or testing. A large piece of manufacturing machinery, for instance, is not placed in service upon arrival at the factory. The placed-in-service date is the day these preparatory activities are complete and the machine is ready for operation, even if it has not yet produced a commercial product.
Buildings
The placed-in-service date for a building is not the date construction is finished. A building is placed in service when a certificate of occupancy is issued, which certifies the structure is compliant with building codes and safe. Alternatively, the date can be when the building is ready to be used for its business function, such as housing equipment and employees.
Self-Constructed Assets
For assets a business builds for its own use, the placed-in-service date is when the asset is complete and ready for its specific function. This includes all necessary testing and adjustments to ensure the asset is operational. The costs of construction are capitalized, and depreciation begins only when the asset is ready.
Converting Personal Assets to Business Use
When a personal asset is converted to business use, such as a vehicle or computer, the date of the change becomes the asset’s placed-in-service date. The depreciation timeline does not start from the original purchase date for personal use.
The basis for depreciation is the lesser of two values on the date of conversion: the asset’s adjusted cost basis or its fair market value (FMV). The adjusted cost basis is the original cost, while the FMV is what the asset would sell for on the open market.
For example, if you bought a car for personal use for $30,000 and its FMV is now $22,000, your depreciable basis would be $22,000 when you start using it for your business. This rule prevents taxpayers from depreciating the decline in value that occurred during the asset’s personal use period.
Applying Depreciation Conventions
The placed-in-service date influences the amount of depreciation you can claim in the first year through specific IRS conventions. The Modified Accelerated Cost Recovery System (MACRS) is the primary method used for most property.
The most common method is the half-year convention, which applies to property such as equipment and vehicles. It treats all property placed in service during the tax year as if it were placed in service in the middle of that year. This means you claim a half-year’s worth of depreciation in the first year, no matter if the asset was ready in January or December.
A different rule, the mid-quarter convention, must be used if more than 40% of the total basis of certain types of property is placed in service during the final three months of the tax year. When this 40% rule is met, all property placed in service during the year is grouped by the quarter it was placed in service.
Each asset is then treated as being placed in service in the middle of its respective quarter. This can significantly alter the first-year deduction amount compared to the half-year convention.
A mid-month convention is required for residential rental property and nonresidential real property, including assets like office or apartment buildings. Under this convention, the property is treated as being placed in service in the middle of the month in which it was actually placed in service. This provides a more precise calculation for real estate assets.