Editor’s Note: We continue to get questions pertaining to the mid-quarter convention. So, to help you understand it a little better, we thought it best to update and republish this article. Feel free to let us know if you have any additional questions!
Many small business owners may not be familiar with the mid-quarter convention and how it can affect their taxes. Unfortunately, if you are not familiar with this issue, your business’s taxable income may be higher than expected.
Here’s the deal: per the federal tax law, the mid-quarter convention allows businesses to take depreciation deductions on fixed assets used in the conduct of a trade or business acquired during a reporting quarter as though they were acquired at the mid-point of the quarter. Many of the assets in question are depreciated under the Modified Accelerated Cost Recovery System or MACRS. Under MACRS, most of the time, taxpayers may use the half-year convention, which 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.
Listen to episode 182, “State Taxation Overkill,” featuring Joe Popp, on Rea & Associates’ award-winning podcast, unsuitable on Rea Radio.
The mid-quarter convention for MACRS assets can severely limit the amount of depreciation a business can take in the year an asset is purchased. Using this convention, even though assets may have been acquired at the beginning or the end of a quarter, assets must be recognized as though the were acquired as of the middle of the quarter. Additionally, mid-quarter convention rules also apply at the end of a fixed asset’s “useful life.” This is done so that the last quarter of the asset’s depreciation only covers one-half of that quarter.
What types of assets are affected by the mid-quarter convention?
The IRS requires the mid-quarter convention for tax reporting purposes – if at least 40 percent of the cost basis of all tangible personal property acquired over the course of the year occurs in the last three months of the tax year. That being said, property that is both acquired and disposed of over the course of the tax year (as well as residential rental property, nonresidential real property and any other property not being depreciated with MACRS depreciation rates, is exempt.
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.
The mid-quarter convention can be tricky to navigate. If you think that you may have a mid-quarter convention issue or questions, contact your Rea & Associates advisor to discuss.