How to Take a Depreciation Deduction on Your Tax Return
Depreciation refers to the income tax deduction which gives a taxpayer the chance to recover the cost of assets or property he bought and placed in service which means this is used in his business or trade. Fixed assets are assets that firms or businesses use to generate income. In such cases, the business owner doesn’t anticipate selling his asset in a year of buying it. Instead, the asset remains to be in service after the timeframe and will help generate a long term income. The residential real estate properties can be depreciated as well.
Some perfect examples of depreciable assets are vehicles, machinery, software and computers, furniture, buildings, and other standard pieces of office equipment.
Deprecation is difference from expense. Expenses of a business, which often include cash transactions like a business luncheon, are completely deductible within the year they were acquired. The expense of buying a tangible or fixed asset can be spread out and depreciated over several years.
Businesses choose how they will take a depreciation deduction. Either they can write off the cost as a form of expense or they can also deduct this as depreciation. When the business opts to write this off as a form of expense, the whole cost can be subtracted during the first year. They can also depreciate it then write off the value of the asset throughout its useful life expectancy. For instance, when a business buys an equipment piece worth $70,000, this can take the whole $70,000 in the first year or deduct $10,000 every year in a span of 7 years.
Time Periods to Calculate Depreciation
Different kinds of property are subject to different time periods over which they should be depreciated. The depreciation calculates how much value of the asset is going to be used up during these time periods. For instance:
- Office equipment, computers, construction equipment, and light vehicles depreciate over a 5-year period.
- Tractors and manufacturing tools depreciate over a 3-year period.
- Miscellaneous assets and office furniture depreciate over a 7-year period.
- Commercial real estate properties depreciate over a 39-year period.
- Residential real estate properties depreciate over 27.5-year period.
- Land improvements depreciate over a period of 10, 15, or even 20 years with a few exceptions.
Methods to Calculate Depreciation
The IRS Publication 946, How to Depreciate Property details thoroughly the methods for calculating depreciation. These include the following:
- Accelerate depreciation – The depreciation’s bulk happens during the earlier years, with the later deductions becoming much smaller.
- Straight-line depreciation – It is a straightforward and simple method but there is a limit in immediate gratification. Your biggest deductions will come later on. New businesses which are just starting out that expect to become more profitable after a few years often opt for this method where they defer the biggest deductions later on.
- Section 179 expense deduction – It gives businesses a chance to take a deduction for the overall value of the asset or property during the initial year. There is a cap at the deduction at $500,000. When the deduction is bigger than the business’s income, the business will then carry the value’s balance over to the later tax years.