Is it tax time again? If you own a small business, you should be considering every single business deduction you’re eligible for. Many entrepreneurs overlook depreciation which is part of those deductions. Depreciation is the daily downturn in the value of the property, which can be utilized to offset income from your business.
Depreciation can result in valuable income tax deductions that can help you save thousands of dollars every year. However, it’s a bit tricky how to claim the deduction and how to calculate it. In this article, we’ll help you out and understand how it works.
What is Depreciation?
Depreciation gives small business owners the opportunity to reduce the value of an asset in the course of time, due to its decay, wear and tear, and age. It’s a yearly income tax deduction that’s recorded as an expense on an income statement.
Depreciation is also a process where a business writes off the cost of a capital asset. Eligible businesses can use a direct asset write-off. This grants them to claim a deduction for the business portion of the asset’s purchase cost – under the suitable threshold – in the year every asset was bought and first used or installed and ready to be used.
What Assets are Depreciable?
Typically, the assets that are depreciable are buildings, computers, machinery, equipment, office, furniture, and work vehicles, however, you may also depreciate intangible property including copyrights or patents, according to the IRS.
On the other hand, properties that can’t be depreciated are:
- land (doesn’t get used up and can’t be subject to wear and tear)
- inventory (it is meant for sale)
- leased property (you are not the owner)
Generally, depreciation is used against buildings owned by the equipment, business, and even small-scale items such as cellphones and computers. Depreciation can be utilized to lessen the tax burden since you are reducing your overall taxable income. However, it’s crucial to understand that depreciation will not affect your company’s cash flow or its definite cash balance, since it’s a non-income expense.
How Much Depreciation Deduction Can I Take?
It can be frustrating to determine how much depreciation deduction you can take on your assets. Don’t worry, we’ll help you understand this. For you to be able to use depreciation as a deduction, you should be the owner of the property, and it should have a “useful life” of more than one year. The IRS will require you to write off the depreciation over the effective life of the asset. You may start to depreciate the property after it’s in use, and you discontinue to depreciate it after being completely recovered its cost or you stop utilizing it in your business.
For instance, appliances, computers, office equipment, cars and trucks can be written off for up to five years. Office fixtures and furniture like desks can be written off over seven. Residential rental properties may be written off over 27.5 years, while, and commercial buildings or non-residential properties can be written off over 39 years, according to Publication 946 by IRS.
If you want to know how much you can depreciate, you should be able to determine the initial cost of the asset and how long is the period you can depreciate it for. Here are some of the depreciation methods you can use to calculate:
1. Straight-line method: In this method, you have to depreciate the property an equal amount per year over its effective life. In order to come up with the yearly amount you are entitled to depreciate, deduct the asset’s salvage value (the amount you can get acquire by selling it at the end of its useful life.
Here’s an example, if you bought a computer for $1,000 and it has a salvage value (the estimated resale value of your asset at the resolution of its useful life) of $200 and five years of life, you can deduct $160 in depreciation every year.
2. Accelerated method: According to TurboTax and Nerd Wallet, this is the method where you can take bigger depreciation deductions in the first several years of the property’s useful life, and smaller deductions later on. This is normally used by small business owners.
For you to be able to how much will be your deductions, you should use the MACRS or modified accelerated cost recovery system of IRS and refer to the IRS’s percentage table guide located in Publication 946, Appendix A.
3. Section 179 Deduction: This method will allow you to subtract the overall cost of the asset in the year it’s acquired, up to an extreme of $25,000 starting in 2015.
Tax depreciation is an important aspect of taking care of your small business and it’s something that you should be appreciating. However, if you want to spend more of your time growing your small business than identifying difficult tax rules, it can be a great idea to hire a tax professional to help and assist you.