ADS Depreciation: When the Alternative System Is Required
The Alternative Depreciation System — who must use it, who may elect it, and how it changes recovery periods
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
ADS (the Alternative Depreciation System) is the slower of MACRS's two depreciation systems. It uses straight-line depreciation over longer recovery periods than the General Depreciation System, and it is mandatory for certain property — including property used predominantly outside the United States, tax-exempt use property, and buildings owned by real estate businesses that elect out of the business interest limitation.
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What is ADS and how does it differ from GDS?
MACRS has two tracks. GDS is the default: accelerated methods (200 or 150 percent declining balance) over shorter lives. ADS is the alternative: straight-line only, over lives that are the same or longer, with the same first-year conventions. The IRS publishes separate percentage tables for ADS. Because ADS is slower in the early years, no one chooses it for tax savings; it applies because the law requires it, or because a business wants an even deduction for financial reasons and elects it.
| Property | GDS recovery period | ADS recovery period |
|---|---|---|
| Cars and light trucks | 5 years | 5 years |
| Computers | 5 years | 5 years |
| Office furniture and most equipment | 7 years | 10 years (varies by asset class) |
| Land improvements | 15 years | 20 years |
| Qualified improvement property | 15 years | 20 years |
| Residential rental property | 27.5 years | 30 years |
| Nonresidential real property | 39 years | 40 years |
The ADS life for equipment comes from the asset's class life in Publication 946's tables, which is often longer than its GDS period — the 7-year GDS class covers assets with class lives of at least 10 but less than 16 years, so their ADS period runs 10 to 15 years — and personal property with no class life, 7-year under GDS, is 12-year under ADS.
When is ADS mandatory?
ADS is required for: property used predominantly outside the United States during the year; tax-exempt use property (leased to a tax-exempt entity, with exceptions); tax-exempt bond-financed property; certain imported property covered by an executive order; listed property (cars and other property of a type used for entertainment) whose business use is 50 percent or less; and — the case that reaches the most small businesses — nonresidential real property, residential rental property, and qualified improvement property held by a real property trade or business that has elected out of the section 163(j) business interest limitation. Farming businesses that elect out of the interest limitation must use ADS for property with a recovery period of 10 years or more, and a farming business that elects out of the section 263A uniform capitalization rules must use ADS for all farm property placed in service while that election is in effect.
The real estate election is the one to know. A landlord or developer whose interest expense would otherwise be limited can elect out of the limitation, but the price is ADS on all of the business's buildings and improvements — 30 years instead of 27.5 for residential, 40 instead of 39 for nonresidential, 20 instead of 15 for improvements — and the election is irrevocable.
Can I elect ADS voluntarily?
Yes. A taxpayer may elect ADS for any class of property placed in service during the year (for real property, the election is made property by property). The election applies to all property in that class placed in service that year and cannot be revoked. Reasons a business might elect it: to match book depreciation for lender covenants, to smooth deductions into higher-income years, or because the business is in a loss position where accelerated deductions have no current value and would only add to a net operating loss.
How does ADS affect bonus depreciation?
Property that must be depreciated under ADS is generally not eligible for bonus depreciation — the statute excludes "any property to which the alternative depreciation system under subsection (g) applies," determined without regard to an election to use ADS. Property for which ADS is merely elected remains eligible. This is the second cost of the real estate interest-limitation election: the business's qualified improvement property, which would otherwise be bonus-eligible 15-year property, becomes ADS 20-year property with no bonus depreciation.
Worked example
A landlord with US$6 million of commercial buildings and a large mortgage finds the section 163(j) limitation disallowing US$90,000 of interest a year. Electing out of the limitation restores the full interest deduction but moves the buildings from 39-year GDS to 40-year ADS (a negligible change) and a planned US$400,000 tenant-improvement project from 15-year bonus-eligible qualified improvement property to 20-year ADS with no bonus — a first-year deduction of about US$10,000 instead of US$400,000. Whether the election pays depends on how much interest is disallowed against how much improvement work is planned; the answer changes when the projects do.
Frequently asked questions
What is ADS depreciation?
ADS is the Alternative Depreciation System within MACRS: straight-line depreciation over recovery periods that are generally longer than the General Depreciation System's. It is required for specific categories of property and may be elected for any property.
When is ADS mandatory?
For property used predominantly outside the United States, tax-exempt use and tax-exempt bond-financed property, listed property with business use of 50 percent or less, and the real property of a real estate business (or certain farm property) that has elected out of the business interest limitation, and farm property of a farming business that elected out of the uniform capitalization rules.
Can I elect ADS voluntarily?
Yes, for any class of property placed in service in the year, and property by property for real property. The election is irrevocable for that property.
How does ADS affect a real estate business that elected out of the interest limitation?
Its buildings move to 30- or 40-year straight line and its qualified improvement property to 20-year straight line with no bonus depreciation. The interest deduction is preserved; the depreciation is slower.
Official sources
Publication 946 states: “Your use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period you use. You must generally use GDS unless you are specifically required by law to use ADS or you elect to use ADS.” — Internal Revenue Service, Publication 946, How To Depreciate Property, https://www.irs.gov/publications/p946
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