When a business buys something that will last for years, such as a vehicle, machinery or computers, the cost is generally not deducted all at once. Instead it is recovered over time through depreciation. Understanding the basics helps you keep the right records and read your financial statements correctly.

What the IRS says

The IRS guide to the subject is Publication 946, How To Depreciate Property. It explains which property can be depreciated, when depreciation begins, the methods used and special provisions that may let you deduct more of the cost sooner. In general, property is depreciable if you own it, use it in your business or income-producing activity, it has a determinable useful life and it is expected to last more than one year. Land is generally not depreciable.

How depreciation appears in your books

In bookkeeping, a large purchase is recorded as a fixed asset on the balance sheet. Each period, part of the cost is moved to a depreciation expense on the profit and loss, and the total so far is shown as accumulated depreciation. The asset's net book value is its cost less accumulated depreciation.

Depreciation for your financial statements and depreciation for your tax return can differ. Your tax preparer will calculate the tax figures; your books need the information that makes that possible.

Repairs or improvements?

Not every spend on an asset is a new asset. Routine repairs that keep property in working order are often deductible expenses, while improvements that better or restore property, or adapt it to a new use, are often capitalised. Publication 946 discusses how repairs and improvements are treated. When in doubt, keep the invoice and a description of the work and let your preparer decide.

Records you need for each asset

  • Description of the asset
  • Date acquired and date placed in service
  • Cost, including sales tax, freight and installation where relevant
  • Business-use percentage, if the asset is also used personally
  • Date and amount of any sale or disposal

The IRS recordkeeping guidance explains that records should support the figures on your return, and assets often need records for as long as you own them and for a period after.

Vehicles

Cars and trucks have additional rules about business use and recordkeeping. The IRS covers these in Publication 463.

A fixed asset register

The simplest tool is a fixed asset register: a list of every asset with the details above. We maintain one for clients so that depreciation entries in the books and schedules for the preparer come from the same source.

Key terms

  • Placed in service: the date an asset is ready and available for its intended use. Depreciation generally begins then.
  • Basis: generally the cost of the asset, including amounts such as sales tax, freight and installation.
  • Recovery period: the number of years over which an asset's cost is recovered under the applicable tax rules.
  • Accumulated depreciation: the total depreciation recorded on an asset so far.
  • Disposal: selling, scrapping or otherwise removing an asset from service. Record the date and any proceeds.

How we help

Our accounting services include a fixed asset register and depreciation entries, and our tax services prepare the year-end package your preparer needs.