GAAP and MACRS differ in their selection of depreciation periods. Under GAAP, companies must estimate the service life of an asset based on both physical factors and economic factors. Under MACRS, companies follow a mandated tax life on specific assets as prescribed in relevant tax codes. An asset's tax life is generally shorter than the service life, or economic life, of the asset. Based on the types of assets, tax lives can range from three to five years for small tools and office equipment to 20 years and over 30 years for plants and real estate properties.
GAAP and MACRS mostly differ in their use of depreciation methods. Any depreciation method used under GAAP for financial reporting purposes must reflect the economic substance of a given asset's uses to ensure that depreciation charges best match economic benefits generated from the asset uses. Depreciation methods used under MACRS for tax purposes often allow accelerated depreciation expenses that help lower taxes to encourage more capital investment. Under MACRS rules, companies may use either the double-declining-balance method or the one-and-a-half-times-declining-balance method for non-real-estate assets.
Using GAAP, companies often estimate a salvage value when placing an asset in service. Salvage value is the remainder of an asset's value at the time when the asset is removed from service. For financial reporting purposes, GAAP requires that salvage value be deducted from an asset's depreciation base because a salvage value doesn't contribute to the economic benefit provided by the asset. However, under MACRS, companies need not report any salvage value on assets and can use an asset's total purchase cost as depreciation base. Assigning a zero salvage value allows increased depreciation expenses and higher tax deductions.
In addition to complying with MACRS mandates on depreciation periods, depreciation methods and salvage value, companies must also follow certain conventions when using MACRS. If an accelerated depreciation method is used, companies need to change back to the straight-line method whenever straight-line depreciation first exceeds the accelerated depreciation in a year. MACRS also uses the so-called half-year convention. Companies may allocate a half-year depreciation in the year of asset acquisition and in the year of disposition, potentially increasing the depreciation expense even if companies have bought the asset toward the end of the year or disposed of the asset at the beginning of the year.