Understanding depreciation helps you understand the value of your entity. This blog will take a look at what is and what is not a depreciable asset, how the depreciation life of assets affects your taxes, how nonprofit groups can record them, and how professional accounting support helps you keep track of your fixed assets and plan your purchases, so they have the greatest impact.
Understanding Depreciable Assets
Things like trucks, computers, desks, warehouses, and machinery all have lifespans. These tangible assets are all bought to serve a business purpose, and as they age, the less effective they are at what they do and the less value they have.
Businesses record this loss of value as depreciation, and there are many ways to measure and record it, according to GAAP and tax purposes. Depreciation refers to an accurate representation of an asset’s loss of value over time. Depreciation stops when the asset is taken out of service or when its “book value” reaches zero.
While the process of depreciating assets is complicated and in many cases should be something left to a professional, it accomplishes three important functions:
- Measure and record an expense – Depreciation helps you figure out how much value your assets lost over the year. It is different from other expenses as it is an estimate of value lost from a balance sheet item. While no cash is spent, value is lost and therefore must be subtracted from revenue when calculating profit.
- Lower your tax bill – As with many expenses, depreciation qualifies as a deduction. What makes depreciation different and more complicated is it is a deduction you can take for the same asset over multiple tax years.
- Valuing your business – As your assets lose value, so does your business. Fixed assets are listed on the balance sheet, and the value of each of those assets is reduced by a contra account called “accumulated depreciation.”
What Qualifies as a Depreciable Asset?
While the term “asset” is usually a tangible object, intangible assets like patents, copyrights, and computer software are also considered assets. A fixed asset is something that loses value when it is placed in service and is ready and available for use.
The IRS has five specific requirements for something to be classified as a depreciable asset:
- It must be something the business owns.
- It must be used in the business or have some income-producing capacity.
- It must have an estimated useful life that can be calculated.
- The asset must have a lifespan that is reasonably expected to last one year.
- It cannot be included on the IRS list of specific exclusions.
What Are Non-Depreciable Assets?
- Land – While land is considered property, it isn’t ever considered “used up” and therefore doesn’t lose inherent value.
- Current assets – Current assets are assets that are used or disposed of in a year. They can include accounts receivable, prepaid insurance, and certain supplies.
- Cash – While the buying power of money is influenced by inflation and deflation, cash itself maintains face value and cannot be depreciated.
- Personal assets – Even if a personal asset is used from time to time by the business, it has to be legally owned by the business in order to be depreciated.
How the IRS Handles Depreciation
Where the book value of an asset is closely aligned to its market value and actual use, tax depreciation is based on its classification, and many businesses keep two separate depreciation records for tax and financial purposes. Depreciation for tax purposes uses the Modified Accelerated Cost Recovery System (MACRS). This method depreciates more value in the first few years and less over later years which front-loads the tax benefits for certain fixed assets.
For some property, businesses are allowed to elect to use a Section 179 deduction which deducts the entire cost of an asset in the year it is acquired up to a maximum value.
Get the Most Out of Your Assets
Tax planning and tax strategies for depreciation are much easier when you have a trusted tax professional in your corner. Our years of experience means we handle any small business tax issue that comes your way. Through our relationship-oriented approach, we focus on helping our clients succeed with tax services, audits and review, and other client accounting services.