Asset Depreciation

How to Depreciate an Asset

When your company purchases an asset, like machinery or furniture, you can write-off the value over time, instead of writing off the asset all at once. Doing this will artificially boost your net income. The IRS allows you to deduct the cost of an asset as a business expense on your company’s tax returns. To deduct the depreciation expense of an asset, it must meet the following criteria:

  • You must own the property. You’re also allowed to depreciate any leasehold improvements.
  • You must use the property in business or in an income-producing activity.
  • The asset must have a determinable useful life of more than one year.

Terms to Know

When you’re calculating depreciation on an asset, you’ll have to know the asset’s useful life and salvage value.

An asset’s useful life is the period you expect the asset to be productive. After its useful life, it’s no longer cost effective for your company to use the asset.

An asset’s salvage value is the amount you expect to sell the asset for when you dispose of it.

Straight-Line Depreciation

The easiest way to calculate the annual depreciation of an asset is the straight-line method. The depreciation is the same each year of the asset’s life.

Depreciation Expense   If you buy a piece of equipment for $50,000 and expect it to have a useful life of 10 years and a salvage value of $10,000, your depreciation expense would be $4,000 each year.

Depreciation Example

Accelerated Depreciation

You can also calculate your depreciation expense using the accelerated depreciation method. This method is useful when the productivity of the asset will be consumed at a more rapid rate during the beginning of its life.

To calculate your depreciation expense, multiply the value of the asset at the beginning of the year by twice the percentage of the straight-line depreciation rate.

Straight Line DepreciationDepreciation Expense

If you purchase an asset for $10,000, with a useful life of 5 years and a salvage value of $1,000, your asset’s straight-line depreciation rate would be 20%. Each year, you’ll multiply the value of the asset at the beginning of the year by 40% to determine your depreciation expense.

Year Beginning of Year Value Depreciation Expense End of Year Value
1 $10,000 $4,000 $6,000
2 $6,000 $2,400 $3,600
3 $3,600 $1,440 $2,160
4 $2,160 $864 $1,296
5 $1,296 $296 $1,000 (salvage value)
Total $9,000

What Does the IRS Say about Depreciation?

The IRS dictates the useful life of a purchased asset and the depreciation methods you can use. You may be able to deduct the asset using Section 179, Accelerated Cost Recovery System (ACRS), or Modified Accelerated Recovery System (MACRS).

Because depreciation deductions are complicated, talk to your accountant to determine the best course of action.

Section 179

Section 179 was created to encourage small businesses to buy equipment and invest in themselves. Under Section 179, you can deduct the full purchase price of equipment used for your business during its first year of use.

You can deduct up to $500,000, if you spend $2,010,000 or less on equipment. If you spend more than $2,010,000 on equipment, the Section 179 deduction decreases dollar-for-dollar after $2,010,000.

Advantages of Section 179

If you take advantage of Section 179, you’ll see immediate benefits.

Because the entire cost of the asset is deducted during the first year, there’s reduced recordkeeping. You don’t have to keep track of depreciation over the entire life of the asset.

Section 179 will also offset your profits, so you won’t pay as much in taxes when you claim the deduction.

Disadvantages of Section 179

Section 179, however, may not always be the best option. Whether you should use it depends on your company’s profitability this year and in future years. If you project that you’ll be a lot more profitable in future years, it’s better to deduct the cost of the equipment over its lifetime.

If you use the asset for business less than 50% of the time during its class life, you’ll have to pay back a portion of the deduction.

ACRS vs. MACRS

ACRS and MACRS are a set of tax rules for recovering property costs through depreciation deductions. Depreciation is based on a recovery period, instead of useful life.

ACRS

Under ACRS, the asset must have been placed in service before 1987. The IRS sets fixed percentages for each class of property. Generally, the recovery classes are:

  • 3 years,
  • 5 years,
  • 10 years,
  • 15 years,
  • 18 years, or
  • 19 years.

MACRS

MACRS is the new and more common set of tax rules for recovering property costs through depreciation deductions. It allows for greater accelerated depreciation over longer time periods and larger deduction amounts during the first few years of an asset’s life.  Generally, the recovery classes are:

  • 3 years,
  • 5 years,
  • 7 years,
  • 10 years,
  • 15 years,
  • 20 years, or
  • 25 years.