What Does It Mean to Depreciate an Asset?
When you depreciate an asset, you decrease its value over time, deducting part of the decrease from your income for tax purposes. How much you deduct per year depends on your tax basis and depreciation calculation method.
How Do You Determine Your Basis?
Calculating depreciation begins with your property’s basis, generally its cost. Events that affect the property’s value may require adjustments to your basis. If you produce or hire someone to produce the property, you generally determine your basis by capitalizing it—adding the costs of producing the property to the costs of acquiring it. There are exceptions to the uniform capitalization rules when you earn, on average, $27 million or less per year.
Why Is Depreciation Tax Deductible?
Depreciation is tax deductible for the same reason business expenses are tax deductible. Over time, the depreciable property loses value. This loss of value functions as a business expense distributed over time. The primary difference is that business expenses are generally applicable in a specific tax year, while depreciable assets may hold value for many years.
What Can You Depreciate?
To be able to depreciate property, you must:
Property that loses value or usefulness over time has a useful lifespan. You cannot depreciate certain types of property, including the following:
Land
Property you begin using and dispose of in the same year
Equipment you use to build capital improvements
Certain intangible assets, as defined by the Internal Revenue Code Section 197
Certain term interests
It can be tricky to know which assets you can depreciate. Consulting a tax professional can be helpful if you have questions.
How Do You Depreciate Assets?
To begin depreciating property, you place it into service. You place property into service by making it available for a specific business use. You can continue to depreciate the property until you fully recover your basis or retire it from service, whichever occurs first. You retire property when you permanently withdraw it from use in your business, and you fully recover your basis once you depreciate as much as allowed.
You should use the Modified Accelerated Cost Recovery System (MACRS) to depreciate most property. However, you should not use MACRS to depreciate specific, limited property.
What depreciation method to use when you cannot use MACRS varies by type. Properties used, acquired, or put into service in 1986 or earlier rely on a pre-1987 depreciation calculation method. Intangible property, including audio and video recordings, may use straight-line or income forecast depreciation. And, if you can depreciate using a method that is not based on a term of years, you may elect to depreciate it using an alternative technique.
