How to Take Depreciation Deduction on Your Tax Return

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Depreciation is an income tax deduction that allows a taxpayer to recover the cost of property or assets he’s purchased and “placed in service”—he uses it in his trade or business. A fixed asset is one that a business or firm will use to earn income. The owner does not anticipate selling it within a year of acquiring it, but rather that it will still be in service after that period of time and will help produce long-term income.

Residential real estate can also be depreciated.

Examples of depreciable assets include:

  • Machinery
  • Vehicles
  • Computers and software
  • Other office equipment
  • Furniture
  • Buildings

Depreciation is contrasted with an expense. Business expenses, which commonly include cash transactions, are fully deductible in the year they’re incurred. The expense for purchasing a fixed or tangible asset can be depreciated, spread out over a number of years.  

Businesses have a choice as to how to take a depreciation deduction. They can write the cost off as an expense or deduct it as depreciation. If they choose to write it off as an expense, they can deduct the entire cost in the first year. Or they can depreciate it, writing the asset’s value off over its useful life expectancy. For example, if a business purchases a $70,000 piece of equipment, it can take the entire $70,000 in year one or deduct $10,000 a year for seven years.

Time Periods for Calculating Depreciation

Various types of property are subject to different periods of time over which they must be depreciated. Depreciation calculates how much of an asset's value is “used up” over these periods of time.

  • Manufacturing tools and tractors: three years
  • Computers, office equipment, light vehicles and construction equipment: five years
  • Office furniture and miscellaneous assets: seven years
  • Residential real estate: 27.5 years
  • Commercial real estate: 39 years
  • Improvements to land: 10, 15 or 20 years, with some exceptions

Methods of Calculating Depreciation 

Methods for calculating depreciation are detailed thoroughly in IRS Publication 946, How to Depreciate Property. They include:

  • Straight-line depreciation: This method is simple and straightforward, but immediate gratification is limited. Your largest deductions will come in later years. New businesses that are just starting out and expect to be much more profitable in later years often choose this method, deferring the greatest deductions to a later time.
  • Accelerated depreciation: The bulk of depreciation takes place in earlier years, with the deductions in later years much smaller.
  • Section 179 expense deduction: This allows you to take a deduction for the entire value of the property or asset in the first year. It’s capped at $500,000. If the deduction is greater than your income, you can carry the balance of the value over to later tax years.

NOTE: Tax laws change periodically, and you should consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice and is not a substitute for tax advice.