Half Year Convention for Depreciation
The half year convention treats all business equipment placed in service during a tax year as placed in service in the midpoint of the tax year. The same rule applies in the year in which the property is disposed of. You deduct a full year of depreciation for any other year during the recovery period.
In the simplest terms, when you elect to use the half year convention a half-year of depreciation is allowed in the first year your property is placed in service, regardless of when the property is placed in service during the tax year. So it is assumed that the depreciable property is placed into service on July 1st. For each of the remaining years of the recovery period, a full year of depreciation is claimed.
If you hold the property for the entire recovery period, a half-year of depreciation is claimed for the year following the end of the recovery period. If you dispose of the property before the end of the recovery period, a half-year of depreciation is allowable for the year of disposition.
What is the Benefit of the Half Year Convention
The Internal Revenue Service is fond of the rule because without it, taxpayers would be tempted to buy property in the second half of the year and claim full depreciation deductions as if the property were used for the entire year. The Half Year Convention is beneficial to taxpayers because it does not require them to keep track of or prove exactly when depreciable property was placed into service.
However, the IRS can force a taxpayer to use the less beneficial “Mid-Quarter Convention” if they see abuse. An example would be if a taxpayer purchases a lot of depreciable assets in the last three months of the taxable year to use the Half-Year Convention.
Half Year Convention Example 1: Mike Gange purchased a computer in 2014 for $2,400. The computer is his only acquisition in 2014. The computer is a five-year property and is subject to the half-year convention. The depreciation rate for the first year is 20% (see the link above to view the depreciation chart for five-year property). Dan’s depreciation would be determined as follows:
Summary of Deductions for $2,400 computer:
|1||$480||$2,400 x 20%|
|2||$768||$2,400 x 32%|
|3||$460.80||$2,400 x 19.20%|
|4||$276.48||$2,400 x 11.52%|
|5||$276.48||$2,400 x 11.52%|
|6||$138.24||$2,400 x 5.76%|
Note that if you dispose of your property before the end of its recovery period, your deduction will be 1/2 of the deduction that would be allowed for the full year.
Half Year Convention Example 2: Using Mike’s example above, let’s assume he decides to dispose of the property in year 5. Mike’s deduction in year 5 would be $138.24 ( $276.48 x 1/2 ).
The half-year convention applies unless the total cost bases of depreciable assets placed in service during the year exceed 40% of the total bases of all property placed in service during the entire year. If this 40% test applies, you must use the mid-quarter convention to figure your annual depreciation deduction.
Lastly, you may even be able to deduct the entire amount of the property. You can elect this option under the Section 179 Election, which you can read about here.
Here’s a brief video of partial year depreciation using the half year convention: