Category: Deductions and Credits
Depreciation- Understanding the Basics
Depreciation is a tax deduction that allows the taxpayer a way to recover the cost (or other basis) of certain types of property. The deduction allowance is calculated annually for the wear and tear, deterioration or obsolescence of the property.
Most types of tangible property such as equipment, furniture, vehicles, machinery and buildings are depreciable. Intangible property, such as copyrights, computer software, and patents are also depreciable.
Land is not depreciable.
In order to be depreciable, the property must meet all of the following requirements:
1. The taxpayer must own the property. Taxpayers may also depreciate any capital improvements for property the taxpayer leases.
2. A taxpayer must use the property in business or in an income-producing activity. If a taxpayer uses a property for business and for personal purposes, the taxpayer can only deduct depreciation based only on the business use of that property.
3. The property must have a determinable useful life of more than one year.
A taxpayer cannot depreciate the following property, even if the preceding requirements are met:
1. Property placed in service and disposed of in the same year.
2. Equipment used to build capital improvements. A taxpayer must add otherwise allowable depreciation on the equipment during the period of construction to the basis of the improvements.
3. Certain term interests.
Depreciation begins when a taxpayer places property in service for use in a trade or business or for the production of income. The property ceases to be depreciable when the taxpayer has fully recovered the property’s cost or other basis or when the taxpayer retires it from service, whichever comes first.
Several items must be identified to ensure the property is depreciated properly. They include:
1. The depreciation method for the property
2. The class life of the asset (see MACRS info below)
3. Whether the property is “Listed Property” (see “Listed Property” below)
4. Whether the taxpayer elects to expense any portion of the asset
5. Whether the taxpayer qualifies for any “bonus” first year depreciation
6. The depreciable basis of the property
MACRS- Most property is depreciated using the MACRS (Modified Accelerated Cost Recovery System) method. For more information on how to depreciate property properly see IRS Pub 946, How to Depreciate Property. See the section of MACRS for a list of property and their class life (ex. 3-year, 5-year, etc.). Class life refers to how long it takes that property to fully depreciate.
Listed Property includes:
* passenger automobiles weighing 6,000 or less,
* any other property used for transportation unless it is an excepted vehicle,
* property generally used for entertainment, recreation, or amusement (including photographic, phonographic, communication, and video-recording equipment)
* computers and related peripheral equipment, unless used only at a regular business establishment and owned or leased by the person operating the establishment. A regular business establishment includes a portion of a dwelling unit that is used both regularly and exclusively for business. (See Pub 587 for further details.)
To report depreciation on an item within our program, use Form 4562. You will find the depreciation entries within the Schedule C (Profit or Loss from a Business), Schedule E (Rents and Royalties) and Schedule F (Profit or Loss from Farming) sections in the Income section of the Federal Return.