What is accelerated depreciation?
Depreciation is part of the U.S. tax code that allows businesses to account for the wear and tear that reduces or depreciates property value over its lifetime by deducting it from their earnings. This in turn reduces the taxes they owe on their earnings. Accelerated depreciation allows businesses to minimize their taxable income in the near term.
How does accelerated depreciation work?
Accelerated depreciation effectively allows businesses to front-load their tax deductions for depreciation. It does so by allowing investors to claim higher expenses, and thus face a lower tax burden, in the near term for the investments they have made. This can improve the economics for long-lived projects with high capital expenditures as it allows for use of these tax savings in early years to more rapidly pay down debt.
The federal Internal Revenue Service (IRS) groups assets into categories and assigns depreciation schedules over a certain number of years, the length of which is shorter than their economic lifetimes. After deductions associated with depreciation are exhausted and the asset is fully depreciated, the tax burden will rise. Thus, the benefit of accelerated depreciation compared to economic, or straight-line, depreciation is in the time value of money. The current depreciation timeline ranges from three to 50 years, depending on the type of asset. The Modified Accelerated Cost Recovery System (MACRS) system also provides certainty about the depreciation timeline.
Key Design Considerations for Accelerated Depreciation
What types of infrastructure should be covered? A wide range of assets are currently eligible for accelerated depreciation, from office equipment to computers to manufacturing plants. Exactly what types of carbon removal infrastructure are currently ineligible and would be appropriate for accelerated depreciation?
What timeline (defined as the “recovery period”) is most appropriate? This ranges from three to 50 years in the current accelerated depreciation schedule depending on the type of asset, which is likely sufficient for carbon removal infrastructure.
Should projects have a fixed rate of depreciation, or should it vary? Allowing for higher depreciation rates in the near term benefits capital-intensive projects, such as technology-based carbon removal.
Accelerated depreciation already applies to a number of low-carbon energy technologies like solar, wind and geothermal (as well as to many other non-energy-related assets). It is applied through the MACRS, which was established in 1986 as a method of determining depreciation periods for certain types of property, ranging from three to fifty years. Since MACRS was established, renewable energy property, including wind, solar, geothermal and others have been assigned a five-year useful lifetime, which has helped spur investment and provide market certainty. Carbon capture projects that earn the majority of revenue from sale of captured CO2 also fall under a MACRS recovery period of five years (under the asset class that includes manufacture of chemicals). However, if the bulk of project revenue does not come from the sale of CO2, the project may fall under a different asset class that may depreciate more slowly.
- MACRS depreciation and renewable energy finance: https://www.ourenergypolicy.org/wp-content/uploads/2014/01/MACRSwhitepaper.pdf
- Summary of MACRS for solar: https://www.seia.org/initiatives/depreciation-solar-energy-property-macrs
- History of bonus depreciation: https://programs.dsireusa.org/system/program/detail/676
- Summary plus arguments for and against accelerated depreciation: http://www.crfb.org/blogs/tax-break-down-accelerated-depreciation