CARL WATTS & ASSOCIATES

July 29, 2013

www.carlwatts.com
office@carlwatts.com
Washington DC
 tel/fax 202 350-9002
TOP
Depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property. It is an allowance for the wear and tear, deterioration, or obsolescence of the property.


Whether you have your own business or are self-employed, depreciation can represent a significant expense that reduces your taxable income.

It is called tax depreciation, as opposed to the accounting (or book) depreciation, because it is recorded on the income tax return and is based on the IRS rules (IRS Publication 946). Here are some of the most important IRS guidelines regarding depreciation for tax purposes.

All kinds of tangible property can be depreciated (except land), such as buildings, machinery, vehicles, furniture, and equipment. You also can depreciate certain intangible property, such as patents, copyrights, and computer software.

To be depreciable, the property must meet all the following requirements:

  • It must be property you own (even if it is subject to a debt).
  • It must be used in your business or income-producing activity. If you use property to produce income (investment use), the income must be taxable. You cannot depreciate property that you use solely for personal activities.
  • It must have a determinable useful life, meaning that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes.
  • It must be expected to last more than one year, meaning that the asset must have a useful life that extends substantially beyond the year you place it in service.

As mentioned above, you cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping.

Other properties that cannot be depreciated include: property placed in service and disposed of in the same year; equipment used to build capital improvements; intangibles (you may amortize costs for some intangible assets); and certain term interests.

You begin to depreciate your property when you place it in service for use in your trade or business or for the production of income.

You place property in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.

If you place property in service in a personal activity, you cannot claim depreciation. However, if you change the property's use to use in a business or income-producing activity, then you can begin to depreciate it at the time of the change. You place the property in service on the date of the change.

You stop depreciating property either when you have fully recovered your cost or other basis or when you retire it from service, whichever happens first.

You must identify several items to ensure the proper depreciation of a property, including:

  • The depreciation method for the property;
  • The class life of the asset;
  • Whether the property is “Listed Property”;
  • Whether you elect to expense any portion of the asset;
  • Whether you qualify for any “bonus” first year depreciation;
  • The depreciable basis of the property.
Tax Depreciation
Troubles viewing this message? View in browser online here
The simplest depreciation method is straight-line depreciation. Under straight-line depreciation, you spread an even percentage of an asset's cost over each year of its life. The IRS publishes detailed tables of lives by classes of assets. For example, computers use a 5-year expected life and office equipment uses a 7-year expected life. Under a 5-year straight-line depreciation schedule, you can deduct 20% of an asset's cost each year until you have fully deducted the entire price.

The Modified Accelerated Cost Recovery System (MACRS) depreciation system lets you take a higher tax deduction during the early years of an asset in exchange for a lower deduction as the asset gets older. This tax deduction is especially useful for new businesses that need as much income as possible to become established. MACRS does not create a higher depreciation deduction; it just speeds up the recognition of the deduction.

Generally, if you are depreciating property you placed in service before 1987, you must use the Accelerated Cost Recovery System (ACRS) or the same method you used in the past. For property placed in service after 1986, you generally must use the Modified Accelerated Cost Recovery System.


The income forecast method of depreciation is usually applied to intangible assets such as motion picture films, videotapes, patents, books, copyrights and sound recordings.

Another way to accelerate your business' depreciation deduction is through the 179 deduction. By electing the 179 deduction, you can deduct up to $500,000 of asset acquisition costs per year. You do not have to follow a depreciation schedule and can realize the entire deduction in the asset's first year. You can only use the 179 deduction for tangible personal property for your business. This includes computers, machinery, cars and furniture. You cannot use the 179 deduction for longer-term assets, such as real estate.

You have to use Form 4562 to figure your deduction for depreciation and amortization. You’ll need to attach Form 4562 to your tax return for the current tax year if you are claiming any of the following items.

  • A section 179 deduction for the current year or a section 179 carryover from a prior year.
  • Depreciation for property placed in service during the current year.
  • Depreciation on any vehicle or other listed property, regardless of when it was placed in service.
  • A deduction for any vehicle if the deduction is reported on a form other than Schedule C (Form 1040) or Schedule C-EZ (Form 1040).
  • Amortization of costs if the current year is the first year of the amortization period.

You must submit a separate Form 4562 for each business or activity on your return for which a Form 4562 is required.

If you are an employee and you deduct job-related vehicle expenses using either actual expenses (including depreciation) or the standard mileage rate you may use either Form 2106 or Form 2106-EZ.

The IRS requires that you hold all records showing the business, investment and personal use of your property.

Tax laws involving depreciation are complex. Consultation with a qualified tax preparer or accountant is always our recommendation.