Construction Equipment Depreciation Rate Explained

There are several IRA-approved ways to calculate the rate of depreciation on construction equipment. Some methods depreciate equipment gradually whereas others provide an accelerated rate of depreciation.

The typical way to calculate equipment depreciation for federal tax purposes is using the MACRS method, a system that allows businesses to distribute an asset’s depreciation expense across its useful life. Some businesses may be eligible to deduct the total cost of a new asset in that tax year’s return rather than depreciating the asset, under Section 179. 

In addition to IRS-approved depreciation methods, there are a couple of other depreciation methods that are approved under GAAP for accounting purposes. However, these methods can’t be used to calculate depreciation on your business tax return.

Methods of Calculating Depreciation for Tax Purposes

There are several methods for calculating depreciation with different results for your return. It’s advisable to hire an accounting professional who specializes in construction accounting services to help you take full advantage of this and other tax deductions for construction.

MACRS Method

MACRS stands for Modified Accelerated Cost Recovery System. The MACRS method encompasses two different approaches to depreciation: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). The GDS includes the straight-line and declining balance methods. You will state the method chosen when you fill out IRS Form 4562 - Depreciation and Amortization.

Straight-Line Method

This is the simplest and most common method. It involves estimating an asset's useful life and salvage value (or “residual value”) at the end of its life. When using this method, depreciation must be deducted linearly during each year of the asset's estimated useful life.

Declining Balance Method (150% or 200%)

The Declining Balance Method is an accelerated depreciation method with two benefits: deducting equipment costs quicker and reducing your taxable income by a greater amount upfront. Unlike with straight-line depreciation, fixed assets depreciate more in their early years using the Declining Balance Method. This makes this method appealing if an asset loses value quickly.

The Declining Balance Method is calculated using the following formula:

Depreciation per Annum = Current Book Value x Depreciation Rate (%)

For 150% or 200% depreciation, multiply the straight-line depreciation rate by 1.5 or 2, respectively.

Alternative Depreciation System

ADS is a depreciation method that works for some businesses by increasing the number of years over which you can depreciate an asset. Some businesses may use this method to reduce their taxable income over a longer period of time.

GAAP Methods for Calculating Depreciation

The methods we’ve covered so far are approved by the IRS for tax purposes. However, there are other methods you can use to calculate depreciation for accounting purposes. These include the Units of Production Depreciation method and the Sum-of-the-Years’ Digits method. An accountant can advise you on the best depreciation methods to use for accounting purposes in your business.

Special Allowances and Benefits

There are a couple of bonus allowances businesses in the construction sector may be eligible for. It’s important to take into account that there are some updates to these laws in 2023.

Section 179

Section 179 provides an alternative way to recover the costs of qualifying property. This rule allows businesses to recover all or some of the cost of an asset immediately instead of capitalizing and depreciating the asset over time. If you are interested in this option, it’s essential to consult a tax professional as regulations regarding how much you can claim are changing in 2023.

Bonus Depreciation

Bonus Depreciation allows businesses to deduct all or a large portion of asset purchases that exceed the limits set under Section 179. This has been helpful for construction companies that have high-cost pieces of equipment like trucks and heavy machinery. Bonus Depreciation is being phased out starting in 2023 with tax implications for construction companies. 

Factors that Affect the Rate of Construction Equipment Depreciation

Several factors affect the depreciation rate of construction equipment aside from the method used. You’ll need to know how to determine the “useful life” of a piece of equipment and its “basis” to calculate depreciation.

How to Determine the Useful Life of a Piece of Equipment

The useful life of a piece of equipment starts when it is placed in service or is ready and available for service—even if it is not used at that time. The end of an item's useful life will be either when its cost basis has been recovered or when it is retired from service.

IRS Publication 946, Appendix B lists estimated lifespans for assets in specific industries. Most construction machinery depreciates over 5 or 7 years under the General Depreciation System. Other factors that can affect the useful life of a piece of equipment include:

• Asset history

• Condition of the asset

• Manufacturer specifications

Climate may also be a factor. For example, a bulldozer that’s used in Jacksonville, Florida will be exposed to greater humidity during its lifespan than one in Austin, Texas, making it more prone to rust damage and potentially reducing its useful life. A local accountant can help you determine the correct recovery period for each asset, taking all of these factors into account.

How to Determine the Basis of a Piece of Equipment 

Before you can commence the depreciation process, you’ll also need to calculate the basis of your asset. The basis can be calculated in two ways:

Cost Basis

According to the IRS, the main basis of your asset is its cost to you. This includes the purchase price as well as costs like sales tax and delivery.

Adjusted Basis 

An adjusted basis can come as a consequence of events that increase or decrease its basis. According to IRS regulations, construction businesses may need to adjust the basis due to a casualty, theft, or loss of part of the asset.

• If any parts of an asset, such as the forks on a forklift, are lost, stolen, or damaged, you will decrease the basis by any reimbursement you receive from your insurance company, then by any deductible loss that your insurance doesn't cover.

• If your asset gains in value due to what you spend on repairs that increase its useful life, you must increase its basis. Consult a tax professional for more information if you think this might apply to you.

Please note: If you replace the broken, lost, or stolen part of an asset, you must capitalize the cost of the replacement part and depreciate the new part separately from the original asset.

Hire a Tax Expert to Optimize Your Depreciation Expenses

Depreciation is an important and complex topic that can have significant tax and accounting implications. For companies in the construction industry that require many high-price items with significant maintenance costs, optimizing depreciation could save you hundreds or even thousands of dollars.

Rather than trying to figure out depreciation on your own, consult an experienced tax professional who understands the ins and outs of depreciation in the construction industry. They will be able to help you compare the different methods and keep you up-to-date on any changes to regulations that could affect the amounts you claim each year.