In his second article, Bill Hunt, addresses one of the most commonly-asked tax question for musicians: “How do I depreciate my instrument?” Bill explains the Modified Accelerated Cost Recovery System, which is divided into two basic systems: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Read on for a concise explanation of a most timely topic.
Send us your performing artist-related tax question, so Bill can address it in a future column.
The Internal Revenue Service (IRS) allows a deduction for property used in a business or income-producing activity. For property with a useful life of less than one year, the deduction is generally taken in the year the property is placed in service. The deduction for property that has a useful life of more than one year must be pro-rated over the life of the property. This method of deducting the cost of property is called depreciation and is the method used for most musical instruments. The rules for depreciating the costs of various types of property are rather complex; this discussion will focus only on the depreciation of musical instruments.
For many musical instruments, the ability to claim a depreciation deduction is not in question. Virtually any new instrument used in a business will be deductible. For old string instruments, however, this has not always been the case. In the past, the IRS has taken the position that old string instruments are antiques that appreciate in value and therefore are not depreciable. There have been several court cases involving this issue.
The most recent rulings have maintained that antique instruments used in a trade or business are subject to the same wear and tear as any other property used in a trade or business, and therefore are deductible. Based on these court cases it appears, at least for the present, that all musical instruments, including old string instruments, are deductible as long as they are actually used in a trade or business (i.e., having the instrument in a display case or hanging on a wall would not satisfy this requirement). However, the IRS disagrees with these decisions and may still disallow the deduction outside of the judicial circuits where the cases were decided.
The current method used to depreciate most property, including musical instruments, is called the Modified Accelerated Cost Recovery System, or MACRS. MACRS is, as its name implies, an accelerated depreciation system. This means that more of the asset’s value is deducted in the early years of use, and less in later years; the life of the asset for depreciation purposes may also be shorter than its actual life. MACRS is further divided into two basic systems.
In addition to the various methods listed above, taxpayers must choose a convention for each class of property. A convention is a method to determine that portion of the year used to depreciate property, both in the year the property is placed in service and in the year the property is removed from service. The two conventions used for instruments are the half-year convention and the mid-quarter convention.
Musical instruments are considered to have a useful life of seven years when depreciated using the 200% declining balance method. However, as noted above, it will take eight years to fully depreciate the instrument using the half-year convention.
The method begins by deducting twice the amount that would be deducted if the cost of the instrument were divided equally over its seven-year life (i.e., the straight-line method). At the point where straight-line depreciation is greater than what the 200% declining balance would yield, the method changes to straight-line.
To calculate the deduction for first-year depreciation, divide the purchase price of the instrument by 7 (years) and multiply the result by 200%. Then, because you’re using the half-year convention, divide the above result by 2. This division by 2 only applies in the first and last year of the asset’s life (or the year the asset is sold). If you were to do the above math, you would find the percent used to deduct depreciation in the first year is 14.29%.
For example, let’s assume that the purchase price of the instrument is $1000.
$1000 / 7= $142.86 X 2 = $285.71 / 2 = $142.86
or simply multiply $1000 by 14.29% and arrive at the same $142.86.
For the years following the first year, subtract depreciation claimed in prior years before performing the calculations. To avoid having to do this math each year, the IRS provides tables with the yearly percentages already calculated. These percentages are multiplied by the purchase price of the asset for each year. That is, the percentages already take into account subtracting the previous year(s) depreciation. The percentages for 7-year MACRS property, using the 200% declining balance method, are as follows:
1 - 14.29
2 - 24.49
3 - 17.49
4 - 12.49
5 - 8.93
6 - 8.92
7 - 8.93
8 - 4.46
Note that in years 5-8, the percentage is the same (year 8 is simply half of 8.93% and year 6 is 8.92% to correct for rounding errors). Year 5 is the point at which the method changes from 200% declining balance to straight-line.Also note that the above percentages total 100%, thereby enabling the entire purchase price of the instrument to be deducted over the recovery period.Other GDS Methods and ADS
To complicate the situation a bit more, taxpayers have other methods available to calculate depreciation. While elective for most individuals, those individuals subject to the Alternative Minimum Tax may be required to use one of these methods. (The scope of this discussion is too limited to address the Alternative Minimum Tax.)
The three elective methods are 150% declining balance method (7-year life), straight-line (SL) MACRS (7-year life), and the Alternative Depreciation System or ADS (12-year life, straight-line method). The calculations for these methods are similar to those described above for the 200% declining balance method and won’t be repeated here. The percentages for these elective depreciation methods are:
Recovery Year150% D.B.
Percentage SL MACRS PercentageADS
Percentage 1 10.7 17.14 4.17 2 19.13 14.29 8.33 3 15.03 14.29 8.33 4 12.25 14.28 8.33 5 12.25 14.29 8.33 6 12.25 14.28 8.33 7 12.25 14.29 8.34 8 6.13 7.14 8.33 9 8.34 10 8.33 11 8.34 12 8.33 13 4.17
A good strategy is to use an elective method for depreciation if you wish to spread out your deductions over a longer period of time. This may be beneficial if your income is expected to rise in future years, if you won’t receive the full benefit of accelerated depreciation deductions in early years, or if you think you may be subject to Alternative Minimum Tax either for the present or future years. One of the straight-line methods may also help keep the amount of deductions similar from year to year.
Even considering the above methods of depreciation, there is another option. While the bonus depreciation allowed after September 10, 2019 and until January 1, 2019 has expired for musical instruments, individuals can still take the Election to Expense, or Section 179 deduction.
The Section 179 deduction allows taxpayers to deduct up to $105,000 (tax year 2005) of the cost of assets the year the assets are placed in service. Taxpayers do not have to claim the entire cost of the asset(s), but rather can choose the amount to expense and depreciate the rest. The section 179 deduction cannot be greater than an individual’s Aggregate Taxable Income. (Aggregate Taxable Income is total income modified by several adjustments – it does not include investment income, income or loss from a hobby, unreimbursed employee business expenses, the deduction for 1/2 of self-employment taxes, and certain other less common adjustments.)
Any depreciation, including the election to expense, may have to be recovered when an asset is sold. For example, if a musician purchased a trumpet for $1000 and fully depreciated the instrument, its basis will be $0 ($1000 purchase price less $1000 total depreciation claimed equals $0). If the musician later sells the trumpet for $600, the entire $600 will be taxable income in the year the trumpet is sold.
This discussion is meant to provide basic information on the depreciation of musical instruments. Musicians will need to choose one of the depreciation methods discussed above, as well as decide whether or not to take a section 179 deduction (to recover more of the instrument’s cost in the first year). These decisions will affect the musician’s tax returns for several years, and all records should be kept throughout the depreciation period, as well as for at least three years after all depreciation is claimed. In fact, keeping permanent records for all depreciable assets is highly recommended.
Note: Information contained in this article is not to be considered tax advice. Please consult with your tax advisor to determine your specific tax situation.