Tax Depreciation Basics
Today we will be discussing tax depreciation now depreciation is a component of tax law that is constantly evolving of the many issues lawmakers encounter every single year no issue can more directly impact a business owner.
Than modifications to tax depreciation now in general depreciation is an expense designed to capture both the cost of an asset while taking into consideration the statutory or the economic life of an asset the goal of tax depreciation is to slow the recognition of tax deductions.
And to match the expensing of an asset to both the deterioration and the obsolescence of that asset so examples of business assets can include things such as buildings machinery vehicles furniture.
And other equipment tax depreciation allows a business owner to capture those deductions throughout the business use of that asset additionally intangible assets like goodwill patents copyrights and computer software are also depreciable or amortizable to begin taking a tax deduction the taxpayer or the business owner must meet.
Some simple requirements first that taxpayer must own the property second the asset must be used in an income producing activity in the event that an asset is used for both personal.
And for business pursuits it is necessary to remove from tax depreciation the portion of the expense that relates to personal use finally the property must have a determinable useful life of more than one year this means that expenses such as supplies.
And general materials that are commonly acquired throughout the course of business are not to be depreciated they can be expensed in the year of acquisition if the taxpayer meets those criteria tax depreciation will begin once that asset is placed in service now.
This cut this is a source of confusion for many taxpayers as they perceive the mere purchase of an asset as sufficient grounds to take a deduction to take the deduction the asset must be placed in service they placed in service date is the date that the asset is ready and available for use this means that if the asset has not arrived to your place of business.
It has not yet been installed or built or if the asset requires significant modification prior to using then the asset has then not yet been placed in service.
And cannot be depreciated tax depreciation will cease when you’ve exhausted the economic life of that asset when this takes place the asset is commonly known as being fully depreciated tax depreciation will also cease when you sell or exchange that property when you convert that property to personal use.
If you were to abandon the property if you were to transfer the property to a supplies or a scrap account or if the property’s in fact destroyed when acquiring an asset and preparing to depreciate it.
There are several things that you should be considering first you need to consider the method by which you will be depreciating the property second you need to consider the life of the asset third you need to consider the basis or the cost basis of the property fourth.
You need to consider whether the property is listed property fifth you need to determine whether you plan to elect any special tax depreciation treatment such as section.
And finally you need to consider whether you plan on qualifying for bonus tax depreciation has made available a modified method of depreciating an asset that allows a taxpayer to capture the tax depreciation deduction at an accelerated rate.
This is known as makers or the modified accelerated cost recovery system this method is commonly used for furniture and equipment but it cannot be used on certain types of assets such as real property or intangible assets.
Another method most are familiar with is this straight-line method the calculation of tax depreciation is very simple as the asset is ratably expensed after taking into consideration the basis the life and any anticipated salvage value this table has examples of some of the statutory lives.
That are mandated by note that things such as office furniture and fixtures has an economic life or a statutory life of seven years information systems meaning equipment such as computers as an economic life of five years while other assets such as vehicles have economic lives of five years.
As well the basis or cost basis is commonly known as the cost of an asset plus any amounts paid for things such as sales tax freight charges and installation and testing fees the basis can include cash debt obligations in connection with acquiring an asset or any other property.
Or services you surrender in exchange for that asset the basis is often influenced by other tax strategies such as a like-kind exchange which we will discuss in another podcast the cost basis also includes the assumption of debt meaning any liabilities that you may have assumed from the seller in connection with the transaction.
Now we’ve mentioned things like sales tax Freight and installation as costs that are included in the basis of an asset when acquiring real property such as real estate land or buildings other settlement costs are also included in that basis such as legal and recording fees abstract fees survey charges owner title insurance.
And any amount that the seller owes that you agree to pay on his or her behalf such as back taxes interest recording fees charges for improvements or repairs and sales commissions another consideration to make when depreciating is whether the asset is considered listed property.
As I mentioned previously you can only depreciate the portion of an asset that relates to business or an income producing activity vehicles are commonly viewed as assets that can serve both a business and a personal function business vehicles can often be used or be available for use while off-duty for personal reasons the portion of the asset.
That is not related to the business is considered non deductible documentation for listed property is very important this can include mileage logs and other contemporaneous documentation used in explaining the use of that vehicle or some other asset the percentage of the asset that is used for business is very important.
As it can influence your ability to utilize advantageous tax elections like bonus tax depreciation or section listed property section and bonus tax depreciation are all covered in other podcasts.
But I’d like to briefly cover these topics now section is a commonly used phrase and other business advisors it is in reference to code section which allows a taxpayer to elect a first year recovery of all or part of the cost of an asset as well as limits on the amounts of section tax depreciation.
You can take in a given year for the limit was $, bonus tax depreciation is similar to section but differs in its application under bonus tax depreciation a taxpayer can recover percent of the cost of an asset in the first year.
And then depreciate the remaining basis over the life of the asset this applies to only qualifying new assets while section applies to both new and used assets the interaction of section.
And bonus tax depreciation is very important to understand and can be better understood by reviewing our other podcasts given the complexity of these issues.