What Is the Half-Year Convention for Depreciation?

What Is the Half-Year Convention for Depreciation?

Let me explain the half-year convention for depreciation directly: it's a depreciation schedule that treats all property you acquire during the year as if you got it exactly in the middle of the year. This means you only get half of the full-year depreciation in the first year, and the remaining balance gets deducted in the final year of the depreciation schedule or when you sell the property.

You can apply this half-year convention to all forms of depreciation methods.

Key Takeaways

Here's what you need to know: the half-year convention takes half of the typical annual depreciation expense in both the first and last years of an asset’s useful life. Its purpose is to better align your expenses with the revenues generated by the asset in the same accounting period, following the matching principle. Remember, it applies to all forms of depreciation, including straight-line, double declining balance, and sum-of-the-years’ digits.

Understanding the Half-Year Convention for Depreciation

As one of the U.S. generally accepted accounting principles (GAAP), the matching principle aims to match your expenses to the period where the related revenues were earned. Depreciation is an accounting tool that helps you match the expenses of a fixed asset with the revenues it generates over its useful life.

You record an item as a fixed asset on your company’s books at purchase if it exceeds your capitalization threshold and will provide value over several years. Instead of expensing the full cost in the purchase year, depreciation lets you expense a portion each year of the asset’s useful life. You track the book value by subtracting accumulated depreciation from the asset’s historical cost.

The half-year convention allows you to better match revenues and expenses in the year they occur by depreciating only half of the typical annual expense in year one if you buy the asset mid-year. This works for all depreciation methods, like straight-line, double declining balance, and sum-of-the-years’-digits.

Be aware there's also a mid-quarter convention you must use instead if at least 40% of the cost basis of all fixed assets you acquired in a year were put in service during the last three months of the year.

Example of the Half-Year Convention

Take this example: suppose your company buys a $105,000 delivery truck with a salvage value of $5,000 and an expected life of 10 years. Using the straight-line method, you calculate depreciation by dividing the difference between the cost and salvage value by the expected life—so $105,000 minus $5,000 divided by 10 years equals $10,000 per year. Normally, you'd expense $10,000 each year from one to ten.

But if you purchase the truck in July instead of January, the half-year convention makes more sense to align the cost with the value provided. You expense half, or $5,000, in year one. Then $10,000 in years two through ten, and the final $5,000 in year eleven. This extends the depreciation period but gives a more accurate match of expenses to revenues.

What Assets Can Use the Half-Year Convention?

You can apply the half-year convention to all property except residential rental property, nonresidential real property, railroad gradings, and tunnel bores—unless the mid-quarter convention applies.

When Can I Use the Half-Year Convention?

Use the half-year convention if the mid-quarter one doesn't apply. The mid-quarter convention kicks in if the aggregate basis of property you place in service during the last three months of your tax year exceeds 40% of the aggregate basis of all property placed in service that year.

For instance, if you buy a $2,000 machine in January, a $500 desk in April, and a $2,000 computer in November, the computer alone is over 40% of the total basis ($2,000 out of $4,500, or 44.4%). So all three assets must use the mid-quarter convention.

What Forms of Depreciation Can Use the Half-Year Convention?

The half-year convention works with any depreciation methods. Under the IRS Modified Accelerated Cost Recovery System (MACRS), there are two systems: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS), which you usually elect unless the IRS requires it.

MACRS allows three methods under GDS—200% declining balance, 150% declining balance, and straight-line—and only straight-line under ADS.

The Bottom Line

In summary, the half-year convention treats assets you purchase during the year as if acquired mid-year for depreciation purposes. Sometimes you'll need the mid-quarter convention instead. These rules help you better match revenues and expenses in the year they happen.