How to Avoid a Last-Quarter Tax Trap

Maximize depreciation deductions for business

Under the “midyear convention,” business assets placed in service during the year are treated as being placed in service on July 1 for depreciation deduction purposes. Thus, you may be able to claim the equivalent of a half-year’s worth of depreciation—besides any Section 179 deduction (see below)—even if you use the equipment for only a few days in December. 

However, there is a hidden tax trap if you overdo this at year-end. In effect, your annual depreciation deduction may be drastically reduced. Astute tax planning can avoid this pitfall. 

Details: A special rule applies if the cost of business assets placed in service during the last quarter of 2014 exceeds 40% of the cost of all assets placed in service during the year (not counting real estate). In that case, your depreciation deductions for all assets placed in service during the year are figured under the midquarter convention. 

Thus, the depreciation deduction for equipment is based on the equivalent of one-half the quarterly period the property is placed in service (plus a full amount for any subsequent quarters). For instance, a company that places equipment in service during the last three months of the year—either October, November or December—is entitled to 1½ months’ worth of depreciation. But equipment purchased earlier in the year—January, February or March—may be entitled to 10½ months’ worth of depreciation (1½ months for the first quarter and nine months for the next three quarters). 

Example: XYZ Co. buys a new machine on October 1 costing $10,000. Using the table for seven-year property, the first-year depreciation deduction is normally $1,429 under the half-year convention. 

However, the machine is the only equipment XYZ places in service during the year. Since more than 40% of the cost of equipment is placed in service during the last quarter, XYZ must use the midquarter rule. Result: The depreciation deduction is reduced to $357. 

Depending on your situation, it may be tax-wise to purchase equipment earlier than usual and make sure it is placed in service before the last quarter of the year. Just a few days before October can make a big tax difference. 

This discussion is absent the application of any Section 179 deduction. At this writing, Section 179 can provide a maximum first-year write-off of only $25,000 for qualified property placed in service in 2014. We will keep you posted on any new developments in this area.