How Do You Use Depreciation in Your Taxes?

dollarDepreciation is an annual income tax deduction that allows taxpayers to recover the cost or other basis of certain property over the time the property was used for business activities. Basically, it is an allowance for businesses for the wear and tear, deterioration or obsolescence of assets.

Most types of property (except land) can be depreciated if they meet certain requirements – including buildings, machinery, company vehicles, office furniture and equipment. Certain intangible property also can be depreciated, such as patents, copyrights and computer software.

To be depreciable, the asset property must meet all the following requirements. It must:
·    Be owned by the taxpayer
·    Be used in the taxpayer’s business or income-producing activity
·    Have a determinable useful life
·    Be expected to last more than one year

The amount of tax deduction as a result of asset depreciation can be calculated using different methods allowed by the tax code. Straight line, units of production, sum of years and double declining balance are all acceptable ways to determine depreciation.

The most popular and easiest method is straight line depreciation. This provides an equal distribution of asset depreciation over the useful life of the asset.

For example, a company purchases a van for $22,500 with a useful life of four years. After four years, it is said to have a salvage value, or the value of the asset at the end of its useful life, of $2,500. To calculate the deduction, subtract the salvage value from the purchase value ($22,500 – $2,500 = $20,000). Divide the balance by the number of years of useful life to get the annual depreciation deduction ($20,000 / 4 years = $5,000).

Unless there is a big change in the adjusted basis or useful life of the van, the $5,000 will stay the same throughout the time the taxpayer depreciates the property. If, in the first year, the property is used for less than a full year, the taxpayer must prorate the depreciation deduction based on the number of months in use.

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