How Does Asset Depreciation Work?
If you’ve recently launched your business and are trying to account for all of your expenses, you’ve probably come across the term “asset depreciation.” What does it mean and how does it work? Here’s a brief guide to this complex term.
Asset depreciation applies to any business expense that has a useful life of more than one year. Expenses subject to depreciation include purchases of items like cars, computers, desks, and electronic equipment, and even physical office space, which can lose their value over time due to factors like decay, wearing out, or obsolescence. These purchases are known as “capital assets.”
In deducting such expenses, you are not permitted to deduct the entire purchase price in the year you buy it. Instead, you must determine the asset’s “useful life” according to the IRS' Publication 946. This refers to the period of time the asset preserves some portion of its value. The IRS chart includes two choices for classification, GDS or ADS, and three depreciation methods. Generally, you’ll use the GDS straight-line method, but read this section of the document to understand when you may use an alternative method.
Deduct a percentage of the item’s purchase price over a period of years. Check Publication 946’s Appendix B to determine your item’s “useful life.” An office chair should depreciate in value over a period of seven years, according to the chart. This means that you would divide the item’s value by the number of useful years to find out your yearly deduction. If you bought a chair for $700 on January 1, 2010, you could claim an annual deduction of $100 for that chair until its “useful life” ends on January 1, 2017.
If you decide to sell a capital asset during its useful life, you are subject to taxes on the sale. If you sell the asset for more than you paid for it (plus any improvements you may have made to it), you’re subject to capital gains tax. If you take a loss, you can deduct the amount of value lost as a business expense. Learn more about capital gains and losses from the IRS.
The rules of asset depreciation can be fairly complicated, and these tips are just the tip of the iceberg. For more details on how to depreciate your business assets, talk over the matter with an accountant, who’ll be able to discuss how the IRS’ regulations apply to your specific circumstances.