What is Depreciation?
Depreciation spreads the cost of a long-lived business asset over the years it is used, rather than deducting it all at once.
When a business buys equipment, vehicles, furniture or buildings, the cost generally is not deducted immediately as an ordinary expense. Instead, it is recovered over time through depreciation, because the asset helps produce income for several years.
Book vs tax depreciation
- Book depreciation spreads cost over useful life for financial statements, commonly straight-line
- Tax depreciation follows IRS rules, mainly MACRS, with set recovery periods and conventions; the IRS explains them in Publication 946
Tax rules also allow faster write-offs through Section 179 expensing and bonus depreciation, and small purchases may be expensed under the de minimis safe harbor.
Example
A business buys a $25,000 machine expected to last ten years with no salvage value. Straight-line book depreciation is $2,500 a year. For tax, the business might use MACRS, bonus depreciation or Section 179, producing a different deduction in the first year.
What is depreciable
Property used in business or held for producing income, with a determinable useful life of more than a year. Land is not depreciable. Inventory is not depreciated; it flows through cost of goods sold.
Recording it
Depreciation expense is recorded on the income statement, and the same amount is added to accumulated depreciation on the balance sheet. The asset's cost minus accumulated depreciation is its book value.
Recordkeeping
Keep invoices, placed-in-service dates and business-use percentages for every asset in a fixed asset register. When an asset is sold, prior depreciation affects the gain; see depreciation recapture.
Related terms
- Cost of Goods Sold: Cost of goods sold is the direct cost of the products a business sold during a period.
- Accumulated Depreciation: Accumulated depreciation is the total depreciation recorded on an asset since it was placed in service.
- Book Value: Book value is the amount at which an asset or a business is carried on the balance sheet.
- Ordinary and Necessary Expenses: Ordinary and necessary is the basic test a business expense must meet to be deductible.
Browse more definitions in the small business glossary.
FAQs
Frequently asked questions
Can I deduct equipment in the year I buy it?
Often, through Section 179 or bonus depreciation, subject to limits. Otherwise the cost is recovered over several years.
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