Does the method of accounting (cash vs. accrual) affect the depreciation start date?
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The method of accounting—cash versus accrual—does not affect the fundamental rule for when depreciation begins under the Internal Revenue Code. Depreciation for federal income tax purposes begins when property is “placed in service,” regardless of whether the taxpayer uses the cash or accrual method of accounting.
1. Legal Framework
Section 167(a) allows a depreciation deduction for property used in a trade or business or held for the production of income. The deduction is based on the property’s adjusted basis, and the depreciation period begins when the property is placed in service.
Section 168(d)(1) (MACRS) states that the applicable convention (half-year, mid-quarter, or mid-month) determines the timing of depreciation, but the key event is when the property is “placed in service.” The “placed in service” date is when the property is ready and available for its specific use in a trade or business or for the production of income, even if it is not yet actually used.
2. Method of Accounting
- Accrual Method: Under the accrual method, expenses are generally deductible when all events have occurred that fix the liability and the amount can be determined with reasonable accuracy, and economic performance has occurred.
- Cash Method: Under the cash method, expenses are generally deductible when paid.
However, for depreciation, the timing is not based on when the cost is paid (cash method) or when the liability is incurred (accrual method), but rather when the property is placed in service. This is a specific rule for depreciation that overrides the general timing rules for deductions under the taxpayer’s method of accounting.
IRS Guidance: The IRS Cost Segregation Audit Technique Guide and Chief Counsel Advice confirm that depreciation begins when the property is placed in service, not when it is paid for or when the liability is incurred. For example, in FAA 20140202F, the IRS stated that for self-constructed property, the “placed in service” date is when the property is ready and available for its intended use, and this is the same for both cash and accrual method taxpayers.
Treas. Reg. § 1.167(a)-11(e)(1)(i): This regulation also provides that depreciation begins when the asset is placed in service, regardless of the taxpayer’s method of accounting.
3. Practical Implications
- Cash Method Taxpayers: May not have paid for the property in full, but if the property is placed in service, depreciation begins.
- Accrual Method Taxpayers: May have incurred the liability, but if the property is not yet placed in service, depreciation does not begin.
4. Example
Suppose a taxpayer purchases machinery in December, pays for it in January, and places it in service in February. Depreciation begins in February, the month the machinery is placed in service, regardless of whether the taxpayer is on the cash or accrual method.
4. Conclusion
The method of accounting (cash vs. accrual) does not affect the depreciation start date. Depreciation always begins when the property is placed in service, as defined by the Internal Revenue Code and Treasury Regulations, not when it is paid for or when the liability is incurred.
If you have a specific scenario involving partial payments, construction, or other complexities, please provide more details for a tailored analysis.
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