Depreciation
What is "depreciation'"?
Depreciation is, really, a deduction over time for the cost of fixed assets: equipment, vehicles, and other things that you buy. Depreciation takes into account an asset's useful life. The code says the car has a five year useful life, so you would depreciate a car over five years. The code says that furniture has a useful life of seven years, so you would write-off one-seventh of the cost of the asset, each year for seven years. Alternatively, you can elect to expense the cost of certain assets. Certain vehicles are exempted, but you can write-off, in one year, the cost of certain assets, so you should check with your tax provider.
Over how many years must I depreciate a piece of equipment?
The tax code actually has a table that specifies how long you should depreciate different pieces of equipment and different items. A piece of commercial rental property, for example, is depreciated over 39.5 years. A telephone system is depreciated over five years. So the length of time over which equipment depreciates is not an election. There are specific requirements and specific time periods that have to be adhered to.
What is "straight-line depreciation"?
Straight-line depreciation is just as it infers. The same amount is deducted each year, so if you're depreciating a five-thousand dollar piece of equipment over five years, you would deduct a thousand dollars each year, kind of on a straight line.
What is "accelerated depreciation" and what are its advantages?
When you depreciate an asset, you can always elect to depreciate it on a straight line basis, which is to take the same deduction each year over the life of the asset. Or, you may elect to depreciate it on what we call an accelerated basis. The tax code provides for that, and generally it's about twice what you would get on a straight line basis. Now, if you sell or dispose of the asset before the end of its useful life, you may have to recapture as income the increase in the depreciation from using the accelerated system. Let's say for example that you bought a copier for $5,000, and it's to be written-off over five years. Two years into having the copier, you decide to get rid of it, or "scrap" it. On a straight line basis you would have written off $2,000; on an accelerated basis, you may have written of $4,000 so at that point, you have $2,000 of excess depreciation. That $2,000 may be subject to recapture, and may be taxed at a lower rate than your regular rate, but may be subject to recapture.
What are the advantages of depreciating an asset?
Most people are usually motivated to get the greatest deduction that they can in any given year, so the ability to expense under Section 179, the purchase of an asset, is appealing to many more than just depreciating. But there may be a point where you chose depreciation over what we call the expensing election. One thing that comes to mind is if you have a corporation, for example, and the corporation already has a loss. If you claim the expensing election of Section 179 depreciation you won't be able to use it. You'll have to carry it forward. So if you choose the regular depreciation option, you can actually increase your loss. If you happen to be an owner of a personal service corporation that zeroes out income every year, if you take a year end bonus or salary and generally don't have an income, you may not be able to deduct Section 179 depreciation, that's the depreciation you write off all in one year, because that depreciation can't increase a loss or create a loss. But if you opt for a regular depreciation over the asset's normal life, you may in fact be able to create a loss in the corporation. So there are rare times when regular depreciation might actually be preferable.
