The Alternative Depreciation System (ADS) is a system the IRS requires to be used in special circumstances to calculate depreciation on certain business assets. It generally increases the number of years over which property is depreciated, thus decreasing the annual deduction.
Learn more about the ADS method and how it could apply to your business.
What Is the ADS?
The ADS method calculates depreciation using a straight-line method, which divides the difference between the asset's cost and expected value after use by the number of years it's expected to be used. The ADS is one of two methods the IRS has approved for companies wanting to accelerate depreciation on business equipment; the other is the General Depreciation System (GDS).
How the ADS Works
Before an asset can be depreciated, you must know several things:
- The asset class and recovery period
- The depreciation system
- The percentage of the time the asset is used by the business
You can only depreciate the part of the item that is used more than 50% of the time by your business.
Each general kind of business asset is assigned an asset class, based on the asset's expected life. The expected useful life is different depending on the depreciation system used. For example, your office desk is under the category of office furniture, Asset Class 00.11, that has a recovery period (useful life) of 10 years under the ADS and seven years under the GDS. Asset classes for businesses include:
- Office furniture
- Information systems (computers and peripherals)
- Equipment used in the manufacture of various types of products
The ADS system sets depreciation as an equal amount each year, except for the first and last year, because they might not be a full twelve months. Using this method will result in more years of depreciation and lower the annual depreciation cost.
Let's assume a company buys a piece of farming machinery for $30,000 that's expected to be worth $5,000 after 10 years of use. Using the ADS method, they would use the following formula: ($30,000 - $5,000) / 10 = $2,500. This means that the company would expense $2,500 each year until reaching the $5,000 salvage value.
You must use the ADS system for all assets in a specific class, but you can depreciate real estate on a property-by-property basis. Once you have chosen the alternative depreciation system for an asset, you can't go back to the general depreciation system.
You can find a complete list of asset classes for a business, including their useful life, GDS and ADS recovery periods, in IRS Publication 946 (Table B-1).
ADS vs. GDS
Businesses generally use the General Depreciation System (GDS) unless they are required to use the Alternative Depreciation System. The General Depreciation System uses a declining balance system of applying depreciation where the depreciation expense each year is based on the initial cost minus accumulated depreciation from all previous years.
For example, if your office desk's initial cost is $1000 and first-year depreciation is $143 (using a seven-year recovery period), the balance at the end of the first year is $857. In the second year, the depreciation is calculated at $857, and the second year depreciation expense is $122.
Do I Need to Use the ADS?
Certain properties will require you to use the ADS method, including the following:
- Listed property used 50% or less for business purposes.
- Any tax-exempt use property.
- Any tax-exempt bond-financed property.
- Any tangible property used primarily outside the U.S. during the year.
- All property used primarily in a farming business.
One example of a property that must use the ADS method is a residential rental property located in a foreign country; it would be depreciated over a 40-year recovery period. Check with your professional tax advisor for more information on which depreciation system you should use to get the best tax benefit for your business.
Even if not required, some businesses elect to use ADS. The IRS allows the election of ADS if you meet specific requirements, but the election must cover all property in the same property class placed in service during the year. To make the election, you'll need to use IRS Form 4562. The election is irrevocable for any asset class for any tax year.
- The Alternative Depreciation System is a method the IRS requires to be used in certain circumstances to calculate depreciation on business assets.
- The IRS allows two methods: Alternative Depreciation System and General Depreciation System.
- The Alternative Depreciation System increases the number of years an asset can be depreciated.
- Most businesses will use the General Depreciation System unless required to use the Alternative Depreciation System.