What Is Depreciation?

Tax season is stressful enough without confusing tax terms like depreciation. Fortunately, it’s much simpler than it sounds.

This guide explains what depreciation is, how it works, and when businesses can use it.

What Is Depreciation?

Depreciation lets businesses deduct the cost of certain long-term assets over several years instead of all at once. It applies to assets with a useful life of more than one year.

For example, a computer is a long-term asset because you’ll use it for several years, so you typically depreciate its cost. Computer paper, on the other hand, is a short-term expense that’s used up quickly and is generally deducted in the year it was purchased.

Businesses continue claiming depreciation each year until they’ve recovered the asset’s cost or it reaches the end of its depreciable life.

Common Assets That Can Be Depreciated

Depreciation generally applies to tangible business assets with a useful life of more than one year. Common examples include:

• Computers
• Machinery
• Equipment
• Business vehicles
• Office furniture
• Commercial buildings
• Building improvements
• Livestock

When To Expense VS Depreciate An Asset

Whether you expense or depreciate an asset generally depends on its expected useful life.

• Expense items that will be used up within one year, such as office supplies.
• Depreciate assets with a useful life of more than one year, such as equipment, vehicles, and furniture.

If you own commercial or rental property, you may also qualify for additional depreciation strategies, such as cost segregation.

A cost segregation study can identify building components that qualify for shorter depreciation schedules, potentially accelerating depreciation deductions and increasing near-term tax savings.

How Does Depreciation Work?

The IRS has specific rules for calculating depreciation, including an asset’s recovery period and depreciation method. The rules vary depending on the type of asset.

If you’re unsure how to depreciate a business asset, consult a tax professional or accountant.

Types Of Depreciation

Businesses may calculate depreciation differently for financial reporting and tax purposes. For federal income taxes, most qualifying business property placed in service after 1986 is depreciated under the Modified Accelerated Cost Recovery System, or MACRS.

What Is Bonus Depreciation?

Bonus depreciation lets businesses deduct some or all of the cost of qualifying assets in the first year they’re placed in service instead of spreading the deduction over several years.

Not every asset qualifies, but bonus depreciation can let businesses deduct a much larger portion of an asset’s cost upfront. Eligible purchases may include machinery, equipment, certain vehicles, and qualified improvement property. Land isn’t eligible because it isn’t depreciable.

What Is Accumulated Depreciation?

Accumulated depreciation is the total depreciation recorded for an asset since it was placed in service.

What Is Recoverable Depreciation?

Recoverable depreciation is an insurance term, not a tax term. It refers to the difference between an asset’s actual cash value (ACV) and its replacement cost.

If your insurance policy includes recoverable depreciation, you may be able to recover that amount after replacing the damaged property and meeting your policy’s requirements.

Is Depreciation Different Than Amortization?

Both depreciation and amortization spread the cost of an asset over time, but they apply to different types of assets.

• Depreciation applies to tangible assets, such as equipment, vehicles, and buildings.
• Amortization applies to intangible assets, such as patents, trademarks, and copyrights.

How To Calculate Depreciation

Calculating depreciation depends on the asset you’re depreciating and the method required or allowed under IRS rules. In general, you’ll need information such as the asset’s cost, when it was placed in service, and its applicable recovery period or depreciation method.

While the math isn’t always difficult, determining the correct method and following IRS depreciation rules can be. If you’re unsure how to calculate depreciation for a business asset, it’s best to work with a tax professional or accountant.

And to get even more out of your tax return, don’t forget to check out our complete list of business tax deductions and business tax credits for additional savings opportunities.