The information in this article is up to date through tax year 2019 (taxes filed in 2020).
When you work for yourself, almost all your business-related expenses can be deducted on your tax return. But instead of deducting the full cost of an item the year you purchased it, depreciation lets you spread your tax deduction out over time.
Depreciating property for taxes
Many of the items you purchase for your business are durable enough to last beyond just one year in service, but they do lose value over time – whether it’s due to wear and tear or other reasons. The principle behind depreciation is that you can deduct the cost of these assets over the course of their entire useful life. Here are some examples of property that you can depreciate:
- Office furniture
- Work computer
- Off-the-shelf computer software
- Business vehicle
- Machines and equipment
Patents and copyrights are depreciable assets as well, but land is not.
Property depreciation requirements
To be depreciable, your property must meet the following requirements:
- You own the property. If you took out a loan to pay for the property, you are still considered the owner.
- You use the property for your business or to earn income.
- The property is something that wears out, gets used up, or loses value over a distinct amount of time. This is also known as the item’s useful life.
- You expect to use the property for several years. Property that will not last more than one year cannot be depreciated. Instead, you will deduct it as a business expense on your same year tax return.
How Depreciation Works
Depreciation begins the first year you use your property for your business or trade. It ends once you have recovered the full cost or when you stop using it for your business – whichever comes first. The total amount you will depreciate includes the price you paid for the property plus any sales tax, shipping, installation and testing fees (if applicable).
To calculate how much your deduction will be each year, you will need to choose a depreciation method.
Methods for Calculating Depreciation
Using the straight-line method, you will deduct the same amount every year throughout the item’s useful life.
Using the accelerated method, your deduction will be larger the first year and gradually get smaller as the property approaches the end of its useful life.
Using bonus depreciation, you can deduct up to 100% of the cost of your qualified property the first year it is in service. This can only be used for items that are purchased new. There is no deduction limit for bonus depreciation.
With Section 179, you can deduct the entire cost of your property the first year it is put into service. Both new and used property qualify for the Section 179 deduction. The total amount you can deduct for Section 179 is limited to $1 million, but this is not usually an issue for small or medium-sized businesses.
Benefits of Section 179 and Bonus Depreciation
It costs a lot to establish a new business. The initial expense of purchasing equipment, materials, and even new electronics tends to hit new businesses especially hard. Deducting the full cost of these assets right away relieves some of your overall financial burden by significantly reducing your tax bill that first year. Depreciating the cost would mean less relief up front, at a time when you might need it most.
There can be other benefits to deducting the full cost of an item in a single year. Computers, for example, tend to become obsolete in a short period of time. If think you will replace your computer every couple of years, it probably makes financial sense to deduct the full value each time you purchase a new one. Otherwise, if you depreciate the expense but then you retire your computer before you have recovered the full cost, you will lose some of the value.