What Is Depreciable Property?

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DEFINITION
Depreciable property is property you buy to help you make money, such as with your business.

Depreciable property is property you buy to help you make money, such as with your business. The Internal Revenue Code (IRC) allows you to deduct from your taxable income the expense of purchasing this kind of business-related asset. Because you can’t always deduct the entire cost of an asset in the year you buy it, you must depreciate some property, spreading the cost out over several years.

Depreciation is covered under Section 179 of the IRC. The rules are somewhat complex, so it can pay to understand them before you purchase a capital asset with the expectation that you can depreciate it.

Definition and Example of Depreciable Property

Depreciable property is that which is used for business or income-producing purposes. Income produced through the use of the asset must be taxable.

The property must have an anticipated usable lifespan of more than one year. This rules out purchases such as inventory. It also rules out any asset that might be expected to remain serviceable forever. Its usable life must be determinable. A vehicle should realistically remain up and running and useful for at least five years, according to the IRS. You must be the owner of the asset.

You can depreciate personal property that you use for both personal and business reasons, but you can only deduct a percentage of the cost equal to the percentage of time it’s used for business reasons.

According to the IRS, depreciable assets include “machinery, equipment, buildings, vehicles,  and furniture.”

For example, you might own and operate a cab company and you purchase a car for your fleet. It costs you $30,000. You can claim a portion of that $30,000 over five years—the depreciation time span or “class life” that the IRS assigns to vehicles. This works out to a depreciation deduction of $6,000 a year.

The IRS provides a class-life list of numerous types of property in Publication 946

How Depreciable Property Works

Most property can be depreciated using one of two methods, depending on its nature: straight-line depreciation or accelerated depreciation. As the term implies, accelerated depreciation provides the greatest tax deduction for an asset in the earlier year or years of its class life. Straight-line depreciation is the cost divided equally over the number of years of its class life.

In either case, the depreciation process begins in the year in which you place the asset in service. Placing it in service does not have to mean that you're actually using it. It might be sitting in a box in the corner. The point is that you own it. It’s available to you and you could use it if you chose to.

The process ends at the conclusion of the asset’s class life, when you sell it, or if it simply wears out or otherwise fails in some respect before its class life has run down. It would also end if you stopped using the asset for income-earning purposes and began using it solely for personal reasons, such as if you retired that $30,000 vehicle from your cab fleet to drive it yourself.

Depreciable property can also include the cost of any improvements you make to an asset, which is not to be confused with maintenance or repairs. Improvements count as a separate depreciation deduction. Repairs can also be deductible but as a business expense.

Straight-Line Depreciation

Your depreciation deduction isn’t simply a matter of what you paid for that asset divided by its class life. It’s a more complicated mathematical equation.

You must know the adjusted basis of the property and its salvage value. The salvage value is subtracted from the adjusted basis, then the resulting figure is the amount of your depreciation deduction. You’ll then divide this figure over the number of years of its class life.

You must prorate the first year if you don’t use the property for the full 12 months of its year of purchase, such as if you buy it in August. IRS Form 4562 can help you make the correct calculation. You must submit the form with your tax return.

Your adjusted basis is typically what you paid for the property plus costs incurred in purchasing it, such as sales tax, installation fees, freight charges, or any other additional fees or charges.

The Section 179 Deduction

The IRC provides for a special provision for accelerated depreciation: the Section 179 deduction. It allows you to claim all or most of the adjusted basis of an asset in the year of purchase if you place it in service that same year.

Your depreciation deduction can be no greater than your taxable business income for the year. In other words, it can’t result in a tax refund. The most it can do is reduce or erase your taxable income. But you can carry over any balance remaining to the next tax year.

The Section 179 deduction is capped at a maximum each year, but the limit is generous: $1.05 million for the 2021 tax year, the tax return you'll file in 2022. There’s also a special cap for sport utility vehicles, set at $26,200 for the tax year 2021.

Some restrictions apply to the types of property that can be depreciated this way, so check with a tax professional before moving ahead with claiming it. These restrictions address assets that are held as research or storage facilities, livestock, and off-the-shelf software that's available for purchase by the general public.

You must complete and submit Form 4562 with your tax return if you elect to use this method, if you carry over any portion of your depreciation deduction to the next tax year, or if you opt to take this deduction for a vehicle.

Property That Isn’t Depreciable

The key factor here is that depreciation is limited to property that will lose its value over time. An asset isn't depreciable if it can conceivably gain in value. This would include certain collectibles and investments such as stocks and bonds.  

Land isn't depreciable, although buildings erected on it or improvements made to it might be.  Any property you use exclusively for personal reasons is not depreciable. The asset has to help you make money. Inventory isn’t depreciable because you hold it with the intention of selling it to customers. You can’t depreciate property that’s placed in service and retired or sold within the same year.

You can claim depreciation associated with a home office or workspace if you own your home, but you must prorate the deduction based on the percentage of square footage that your work area takes up.

Do I Have To Pay Taxes on Depreciable Property?

It’s possible that you may have to “recapture” depreciation you've claimed under some circumstances. You would have to include it in your income for tax purposes in a future year. This would be the case if you stop using an item of depreciable property for business purposes at least 51% of the time. Depreciation you'd already claimed would be taxed along with your other sources of ordinary income, in this case, in the year the change occurred.

This factor can also affect what you might pay in capital gains tax if you sell the asset for a profit. You must add back in the depreciation you claimed to your adjusted basis in the asset for calculating your profit for tax purposes.

Key Takeaways

  • Depreciable property is that which is purchased with the intention that it will help you make money. It doesn’t include property used solely for personal reasons.
  • The Internal Revenue Code allows you to claim a tax deduction for the cost of the asset.
  • Depending on the nature of the asset, you can divide the cost of the property over several years, referred to as its “class life,” or you can fast-track the deduction in some cases and claim it in the year of purchase.
  • Depreciation is a highly complicated area of tax law and is subject to some limitations, so you might want to enlist the help of a professional before you claim it.

Article Sources

  1. Internal Revenue Service. "Publication 946 (2020), How To Depreciate Property."

  2. Internal Revenue Service. "Topic No. 704 Depreciation.”

  3. Internal Revenue Service. "Publication 946 (2021), How To Depreciate Property."

  4. Internal Revenue Service. "2021 Instructions for Form 4562."