The salvage value of a business asset is the amount of money that the asset can be sold or scrapped for at the end of its useful life. Anything your business uses to operate or generate income is considered an asset, with a few exceptions.
If your business owns any equipment, vehicles, tools, hardware, buildings, or machinery—those are all depreciable assets that sell for salvage value to recover cost and save money on taxes.
Discover how to identify your depreciable assets, calculate their salvage value, choose the most appropriate salvage value accounting method, and handle salvage value changes.
- Salvaging fixed assets can help reduce taxes and recover initial purchasing costs.
- A business can determine an asset's salvage value by subtracting accumulated depreciation from the initial purchase cost.
- Small business accountants use three different approaches to determining an asset’s salvage value—cost, market, or replacement cost—depending on the state of the asset.
- The salvage value of an asset directly affects depreciation accounting.
- Determining salvage value helps a business know how much to set aside to replace no longer usable assets.
What Is an Asset’s Salvage Value?
Salvage value is the monetary value obtained for a fixed or long-term asset at the end of its useful life, minus depreciation. This valuation is determined by many factors, including the asset's age, condition, rarity, obsolescence, wear and tear, and market demand.
An example of this is the difference between the initial purchase price of a brand new business vehicle versus the amount it sells for scrap metal after being totaled or driven 100,000 miles. This difference in value at the beginning versus the end of an asset's life is called "salvage value."
Other commonly used names for salvage value are “disposal value,” “residual value,” and “scrap value.” Net salvage value is salvage value minus any removal costs.
IRS Asset Depreciation Guidelines
Depreciation allows you to recover the cost of an asset by deducting a portion of the cost every year until it is recovered. Depreciable assets are used in the production of goods or services, such as equipment, computers, vehicles, or furniture, and decrease in resellable value over time.
The IRS allows a business's assets to be depreciated if they meet specific requirements:
- You must own the asset.
- The asset is used in a business or income-producing activity.
- The asset has a determinable useful life.
- The asset is expected to last more than one year.
- The asset is not excepted property (such as intangible, equipment for capital improvements, or temporary assets.)
- If the asset has joint personal and business use, the owner can depreciate only the business use percentage of the asset.
An asset's salvage value subtracted from its basis (initial) cost determines the amount to be depreciated. Most businesses utilize the IRS's Accelerated Cost Recovery System (ACRS) or Modified Accelerated Cost Recovery System (MACRS) methods for this process.
There is no universal depreciation method for all businesses or assets. Have your business accountant or bookkeeper select a depreciation method that makes the most sense for your allowable yearly deductions and most accurate salvage values.
You can stop depreciating an asset once you have fully recovered its cost or when you retire it from service, whichever happens first. You’ve “broken even” once your Section 179 tax deduction, depreciation deductions, and salvage value equal the financial investment in the asset.
How To Calculate an Asset’s Salvage Value
You can calculate salvage value by taking the original purchase cost of an asset and subtracting any accumulated depreciation over its lifetime. Use the following equation:
Salvage Value = Basis Cost - Accumulated Depreciation, or S = P – (I x Y) wherein:
S = Salvage Value
P = Original Price
I = Depreciation
Y = Number of Years
Here are some basic steps to follow to determine salvage value:
Step 1: Calculate the basis (purchase price) of the asset, including any initial taxes, shipping fees, or installation costs.
Step 2: Determine the estimated remaining useful life of the asset—research market examples of similar assets to calculate this.
Step 3: Determine how much depreciation has been taken during its class life ( the number of years the asset has been in service so far).
Step 4: Subtract the accumulated depreciation from the basis cost to arrive at the asset’s current salvage value.
You must subtract the asset's accumulated depreciation expense from the basis cost. Otherwise, you'd be "double-dipping" on your tax deductions, according to the IRS.
Salvage Value Variable Factors To Consider
Here are some key variables to consider while determining an asset's salvage value:
- Determine the asset's condition (including age, frequency of use, maintenance requirements, and environmental conditions.)
- Assess the current state of the market for this type of asset.
- Find out what it would cost to replace the asset if it’s available new.
- Estimate how long it will take to sell or dispose of the asset.
- Determine how much time and money you could save by salvaging rather than replacing.
- Determine if any environmental considerations may affect salvage value, such as hazardous materials or disposal restrictions.
- Consider whether or not any legal considerations may affect salvage value, such as pending lawsuits or liens on the property.
How Small Business Accountants Use Salvage Value
Accountants calculate the salvage value of a business's assets to determine the most economical way to dispose of an asset, such as repairing and selling or scrapping it, when using it is no longer usable. They employ one of three methods:
- The cost approach uses the costs for materials and labor needed to repair an asset, minus any depreciation.
- The market approach uses what a willing buyer would pay for the asset, minus any depreciation.
- The replacement cost approach estimates what it would cost to replace an asset with a new one, minus any depreciation.
Sometimes, an asset will have no salvage value at the end of its life, but the good news is that it can be depreciated without one. When doing accounting, put $0 whenever asked for a salvage value.
Once an asset is sold off, the amount it sold for is called the "before tax salvage value." This amount becomes income on the balance sheet and is taxable. After deducting tax on that amount, the amount you are left with is called "after-tax salvage value."
Frequently Asked Questions (FAQs)
What happens when there is a change in a depreciable asset’s salvage value?
When salvage value changes, it may cause a change in the amount of depreciation expense you can deduct. If there is a decrease in the salvage value, depreciation expense will increase and vice versa. Depending on how the asset’s salvage value is changing, you may want to switch depreciation accounting methods and report it to the IRS.
When should a business that’s computing depreciation ignore salvage value?
A business owner should ignore salvage value when the business itself has a short life expectancy, the asset will last less than one year, or it will have an expected salvage value of zero. If a business estimates that an asset’s salvage value will be minimal at the end of its life, it can depreciate the asset to $0 with no salvage value.