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Will your last quarter throw you into midquarter?

When you want to maximize your tax deductions -- very much a normal and healthy impulse, by the way -- usually you think in terms of spending more money.  In our last post, for example we talked about using "Section 179" to get current deductions for fixed assets placed in service before year-end.

20071022_2 Yet sometimes getting more fixed assets on the shop floor, can actually reduce your current deductions. 

Unless Section 179 applies, the tax law makes you capitalize your cost for long-lived assets and depreciate them over a period of years.  For property other than real-estate, the tax law normally computes depreciation for new property as if it were placed in service in the middle of the tax year.  This is called the "half-year convention."

But if you put 40% or more of your new personal property for the year in service in the last three months of the year, the "half-year convention" goes out the window.  You instead treat all property acquired during the year as if it were placed in service at the midpoint of the quarter in which it was placed in service - the "mid-quarter convention."

For example, lets say Bobby, a calendar year taxpayer, places in service $201,000 in fixed assets in the first quarter, $200,000 in the second, $200,000 in the third, and $399,000 in the fourth quarter - all "five year" property.  This means he put 39.9% of his new personal property fixed assets in service in the last three months of the year; as 39.9 is less than 40, this means the half year convention applies, and the depreciation deduction for the year under the current tax law (200% declining balance x 1/2 year) is $200,000.

If instead Bobby put only $200,000 in service in the first quarter and $400,000 in service in the fourth quarter, he would hit the magic 40% figure for the final three months.  That means the depreciation deduction for the year would work out instead to only $190,000.

Tip: Section 179 property doesn't count in figuring the mid-quarter convention; sometimes avoiding the mid-quarter convention is a simple as electing the Section 179 deduction for property placed in service in the last three months of the year.

The Moral?  Watch your fourth quarter fixed asset additions; sometimes saving some fixed asset additions to next year can actually increase your deductions this year.

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