Think back to your college days. You went to the college book store at the start of the semester to buy your books, and went back just four short months later to sell them. The value was never the same. Not even close. As a penny-pinching college student, depreciation was your enemy. As a business owner, depreciation is your friend.
In business, depreciation is the process of deducting the cost of company assets like buildings, vehicles, and equipment over their useful life. It’s a way of estimating how much of the asset is used each year, and planning how much to write off each year.
What qualifies as a depreciable asset?
The IRS considers something eligible for depreciation if:
- You or your business own it.
- You use it for business or in an income-generating capacity.
- It has a determinable useful life of greater than one year.
Some common small business assets are:
- Real estate
- Work vehicles
- Office equipment
- Office furniture
How to take a depreciation deduction.
The IRS allows a few methods for calculating and recording depreciation on your taxes, including:
- Straight-line depreciation: This is the simplest and most straight-forward method. You’ll depreciate the asset in equal amounts over its useful life. First, you’ll have to determine the annual amount you can depreciate. To get that number, you subtract the salvage value (the amount you can earn back by selling it at the end of its useful life) from its cost, and divide that figure by the number of years in its useful life. For example, if you purchase an office copier for $10,000 and it has a salvage value of $2,000 and a five-year life, you’d be able to deduct $1,600 in depreciation each year.
- Accelerated depreciation. You also have the option to take larger depreciation deductions in the first few years of the asset useful life, and smaller deductions later on. With this method, you’d use the IRS’s modified accelerated cost recovery system (MACRS) to calculate your deductions.
- Section 179 deduction. For certain purchases, you don’t have to depreciate the asset over its useful life. You can claim the Section 179 deduction to take the entire purchase price as a tax deduction in the year you made the purchase. However, there are limitations:
- The maximum deduction is $1,040,000, but reduced to dollar-for-dollar for qualified expenses over $2,590,000.
- Your deduction is limited to your business’ net income for the year. So, if your net income was $500,000, and you purchased assets for $600,000, your deduction is limited to $500,000. But you can opt to take regular depreciation on the remaining $100,000.
Depreciation is definitely beneficial for business owners, but tax laws change from year to year. Boris Benic and Associates provides information and advice about depreciation and other tax-related matters, so please reach out with questions.