Understanding Depreciation: How It Affects Your Taxes
Depreciation is an important concept for business owners, real estate investors, and self-employed individuals, as it allows you to recover the cost of certain business assets over time. Rather than deducting the full expense in the year of purchase, depreciation lets you spread out the cost over the asset’s useful life. This provides long-term tax benefits by reducing taxable income each year.
What is Depreciation?
According to the IRS, depreciation is the process of allocating the cost of a tangible asset over its useful life. Certain business assets lose value over time due to wear and tear, obsolescence, or aging. Depreciation allows businesses to recognize this gradual loss in value as a tax deduction each year, reducing taxable income and overall tax liability.
What Items Can Be Depreciated?
To qualify for depreciation, the IRS states that the asset must:
Be used for business or income-producing purposes
Have a useful life of more than one year
Lose value over time (not including land)
Common depreciable assets include:
Business Equipment & Machinery – Computers, office furniture, manufacturing equipment
Vehicles Used for Business – Trucks, company cars, delivery vans
Rental & Commercial Property – Buildings, rental homes, office spaces (excluding land)
Improvements & Renovations – Roof replacements, HVAC systems, security systems
Intangible Assets (Amortization Applies) – Patents, copyrights, goodwill
How is Depreciation Considered in Taxes?
Businesses must follow specific IRS guidelines when depreciating assets. The Modified Accelerated Cost Recovery System (MACRS) is the most common method, allowing businesses to take larger deductions in the earlier years of the asset’s life. Some assets also qualify for Section 179 expensing, which lets you deduct the full cost in the year of purchase, rather than depreciating over time.
Additionally, bonus depreciation allows for an immediate deduction of a percentage of the asset’s cost, depending on current tax laws. The IRS sets depreciation schedules based on the type of asset, typically ranging from 3 to 39 years. For example, commercial buildings are depreciated over 39 years, while business vehicles often fall into a 5-year category.
Why is Depreciation Important for Tax Planning?
Depreciation can significantly lower your taxable income and increase cash flow by spreading deductions over multiple years. Properly tracking depreciation is essential for accurate financial reporting and ensuring compliance with IRS rules. Business owners should maintain records of asset purchases, dates placed in service, and depreciation calculations.
For personalized guidance on how depreciation impacts your business or investment properties, The Tax Doctor is here to help. Contact us to ensure you’re maximizing tax-saving opportunities while staying compliant with IRS regulations.
Source: IRS Topic No. 704 - Depreciation
