Question

Essco Inc., a calendar year taxpayer, made two asset purchases this year. The first purchase was equipment costing $836,000, and the second purchase was a machine costing $494,000. Both assets are 7-year recovery property. Essco placed the machine in service on June 21 and the equipment in service on October 14. How many months of MACRS depreciation is Essco allowed for each asset this year?

Answer 1

Essco should depreciate the first asset using the half year convention, which establishes a 14.29%. Depreciation expense for year 1 = $836,000 x 0.1429 = $119,464.40 ≈ $119,464.

In order for the mid quarter convention to apply, the value of the second asset should represent at least 40% of Essco's depreciable basis, but in this case it represents only $494,000 / ($494,000 + $836,000) = 37%. Since the mid quarter convention doesn't apply, Essco can also use the half year convention to depreciate the second asset. Depreciation expense for year 1 = $494,000 x 0.1429 = $70,592.60 ≈ $70,593.

Step-by-step explanation:

A company will generally try to use the highest deprecation rate that it can or is allowed to. In this case, the company could depreciate the second asset using the mid quarter depreciation, but the depreciation rate is much lower. The idea is to pay less taxes, and unless required by regulations, a company should always choose the legal way to pay less taxes.