Many small business owners may not be familiar with the mid-quarter convention and how it can affect their taxes. If you are not familiar with this issue, your business’s taxable income may be higher than you expected.
The federal tax law allows businesses to take depreciation deductions on many assets that are used in the conduct of a trade or business. Many of these assets are depreciated under the Modified Accelerated Cost Recovery System or MACRS. Under MACRS, most of the time taxpayers may use the half-year convention. This convention allows a taxpayer to take one-half of the depreciation for the first year no matter when the asset is placed into service during the year. The mid-quarter convention for MACRS assets can severely limit the amount of depreciation that a business can take in the year that an asset is purchased.
What types of assets are affected by the mid-quarter convention?
For the most part, it affects assets such as machinery and equipment or office furniture and fixtures. It does not affect non-residential real property or residential rental property.
When does the mid-quarter convention apply?
It applies when more than 40 percent of your depreciable assets (excluding non-residential real property and residential rental property) purchased during the year are purchased within the last three months of the tax year. Under this convention all property placed in service during any quarter is treated as being placed in service at the midpoint of the quarter. So, under the mid-quarter convention your depreciation deduction will be lower than if you were using the half-year convention.
What can be done to avoid the mid-quarter convention?
There is some good news – possibly. The Sec. 179 expense deduction “may” be used to get you out of a mid-quarter convention situation. The Sec. 179 deduction is allowed for taxpayers (other than estates, trusts or certain non-corporate lessors) who elect to treat the cost of qualifying property as an expense rather than a capital expenditure. If your asset purchases qualify for Sec. 179 treatment, then they will be excluded from the mid-quarter convention test. So, you may be able to take Sec. 179 on enough of the assets that you purchased in the last three months of the year to get below the 40 percent threshold.
However, there are many limitations and restrictions on the use of the Sec. 179 deduction. If you think that you may have a mid-quarter convention issue, please contact your Rea & Associates advisor to discuss your situation.
This article was originally published in Illuminations: Facts & Figures from people with a brighter way, a Rea & Associates enewsletter, 10/25/2006.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.