Submitted by Anthony Brunson, P.A. Certified Public Accountant & Business Advisors
A business asset is property you acquire to help produce income for your company. This can be durable equipment from computers to office furniture to tractors.
Depreciation is a way of allocating the cost of the asset over its expected usable life by expensing a portion of the cost over several years. This accounting method provides a tax deduction while also reflecting, on the books, the asset’s decline in value over time. Additionally, it helps a company determine (and plan for) the time when it will be necessary to replace the asset.
The IRS sets rules for calculating depreciation and taking an allowance on your tax return. Publication 946 from the IRS offers a comprehensive guide to depreciating property, but let’s consider an overview of the rules that are most likely to apply to businesses.
Depreciation categories and methods
There are six general categories of non-real estate assets; each category comes with a designated number of years over which the assets can be depreciated. The three most commonly used categories are:
- Three-year property: tractors, certain manufacturing tools, some livestock
- Five-year property: computers, office equipment, cars, light trucks and assets used in construction
- Seven-year property: office furniture and appliances
There are three primary methods you can use to depreciate business assets:
- Straight-line depreciation.This method spreads the depreciation evenly over the useful life of the asset, resulting in the same deduction amount each year. It is a simple approach, but it takes longer to reap tax benefits. You should use it when you expect your business income and business tax bracket to increase in the future.
- Accelerated depreciation.This method is more commonly used. With it, you take a larger deduction in the first few years of the asset’s life and a smaller write-off in subsequent years. The most common accelerated method is called the Modified Accelerated Cost Recovery System. MACRS depreciation starts at 200% of the straight-line depreciation rate and then switches over to the straight-line method later.
- Section 179 expense deduction.This method allows you to deduct the entire cost — with certain limitations — of an asset the year you acquire it and start using it for business. Two important limitations are that the asset must be tangible property, not real estate, and that the deduction can’t be more than your earned income for the year.
The method you choose for calculating depreciation will depend on such factors as the purpose of your financial statements, tax considerations and overall management preference.
Bonus depreciation
In addition to the standard approaches to calculating depreciation, you can elect to take a 100% special depreciation allowance, known as bonus depreciation, for equipment acquired after Sept. 27, 2017, and in use before Jan. 1, 2023. This bonus depreciation falls by 20 percentage points each year, so equipment acquired in 2024 is eligible for a 60% bonus depreciation.
This bonus depreciation allowance generally applies to equipment with items such as new and used heavy equipment and machinery, whether purchased or leased, off-the-shelf software and business-use vehicles. The idea is to motivate investment in new equipment. The bonus depreciation is scheduled to be phased out in 2027.
Some states don’t allow bonus depreciation. Consider both federal and state depreciation rules in your tax planning. It’s also important to consult with your accountant or tax adviser for specific advice on how to approach depreciation for your business.