Half-Year Convention
The half-year convention is a method of calculating depreciation for tax purposes stipulated by the Internal Revenue Service (IRS) in the United States. It assumes that property placed in service or disposed of during a tax year was in service or disposed of at the midpoint of the year. This allows for one-half year’s depreciation to be allowed in the year the property was placed in service or disposed of, regardless of when it was actually placed in service or disposed of during that year.
For example, suppose a company buys a piece of equipment costing $100,000 on March 1, with an expected life of 5 years. If it used straight-line depreciation (which spreads the cost of the asset evenly over its useful life), it would typically depreciate $20,000 per year ($100,000 / 5 years).
However, under the half-year convention, it would only take half of the annual depreciation expense in the first year (assuming the asset was in service for half the year), and then full depreciation for the following four years. In the final year, it would again only take half of the annual depreciation expense.
So in this case, depreciation would be $10,000 in the first year (half of $20,000), $20,000 in the second, third, fourth, and fifth years, and then $10,000 in the sixth year.
The half-year convention helps to simplify accounting and tax calculations, and it also ensures that a full year’s depreciation isn’t claimed when the asset wasn’t actually in service for the entire year.
Example of the Half-Year Convention
Assume you’re a business owner and you purchase a machine on July 1, 2023, for $30,000. The machine has an estimated useful life of 5 years, and you’re using the straight-line method of depreciation, which means the asset’s value will be reduced equally over each year of its useful life.
Without the half-year convention, annual depreciation would be $6,000 per year ($30,000 / 5 years).
However, applying the half-year convention, you will only claim half of the typical annual depreciation in the first year, because you’re assuming the asset was only in service for half the year, regardless of when it was actually placed into service.
So, for the machine you bought in 2023:
- In 2023, you would claim $3,000 of depreciation ($6,000 / 2).
- For the full years 2024, 2025, 2026, and 2027, you would claim the full $6,000 depreciation each year.
- In 2028, you would again claim only half of the typical annual depreciation, so $3,000.
Here’s how the depreciation schedule would look:
| Year | Depreciation |
|---|---|
| 2023 | $3,000 |
| 2024 | $6,000 |
| 2025 | $6,000 |
| 2026 | $6,000 |
| 2027 | $6,000 |
| 2028 | $3,000 |
At the end of this schedule, you have fully depreciated the machine’s cost of $30,000. This demonstrates the use of the half-year convention for calculating depreciation.
