Whether your business is young or well-established, you’ve probably spent a lot on necessary tools and services. Payment platforms, computer equipment, dedicated phone lines, and office supplies are just a few items you need when operating a small business.
Although spending money on equipment can sting financially, there is a silver lining–many business purchases qualify for depreciation tax write-offs.
This month’s article looks at the definition of depreciation, what items qualify, and how to maximize this IRS write-off.
WHAT IS DEPRECIATION?
Depreciation is an annual business tax deduction that allows you to write off the gradual wear and tear of property over its lifetime of usefulness.
Because most forms of tangible property lose innate usefulness or functionality over time, companies can calculate an item’s depreciation per year over the course of its expected life.
HOW LONG IS AN ITEM’S EXPECTED LIFE?
Qualifying for a depreciation write-off requires your property to have a “determinable useful life,” meaning the property must be something that objectively wears out over time.
The property also must have a “useful life” substantially longer than one year. If the property in question only maintains usefulness for less than a year, you can write it off as a general business expense.
To calculate an item’s expected lifespan, the IRS uses the Modified Accelerated Recovery System (MACRS) to calculate property depreciation.
In this system, assets are assigned to a specific asset class. Then, assets in that class receive a rate of depreciation which is used to calculate your write-off.
HOW DOES THIS AFFECT YOUR TAX LIABILITY?
Because depreciation permits the deduction of an asset’s cost over the course of its useful life, you’ll be able to write off a percentage of the item’s depreciation each year. As a result, your taxable income will also decrease slightly, thanks to the deduction.
WHAT DOES THE IRS REQUIRE FOR DEPRECIATION?
To qualify for a depreciation deduction, your asset must meet the following requirements:
- It must be property you own
- It must be used in your business or income-producing activity.
- It must have a determinable useful life.
- It must be expected to last more than one year.
TYPES OF DEPRECIATION
The IRS permits the use of 5 depreciation calculation methods:
- straight line
- declining balance
- double-declining balance
- sum-of-the-years’ digits
- unit of production
The straight-line method is the most commonly used. To calculate yearly depreciation, subtract the approximate salvage value from the asset’s purchase price. Then, divide that number by the asset’s estimated useful lifespan.
Let’s examine two examples to understand what to expect when calculating depreciation.
Example 1: Company Car
Your business buys a company car for $30,000. Using the equation discussed above, we calculate ($30,000 – $7,500) ➗ 10 years = $2,750 (10%) in depreciation per year.
Example 2: Work Laptop
Your business buys a work laptop for $900:
($900- $225) ➗ 5 years = $115 (20%) in depreciation per year
READY TO DO SOME MATH?
We didn’t think so.
When you have a business to run, you don’t have time to make depreciation schedules for your assets. This sort of issue is exactly where Taxperts like TSJ come in! Let us take the stress of managing your taxes off your plate so you can use your energy where it matters most – growing your business.