For your small business, you might make some big purchases on items to keep you in operation. When it’s time to report your expenses for taxes, using depreciation in your accounting books could help you save money.
You depreciate high-cost assets that will stay in your business for a long time. Usually, depreciation applies to items that are worth more than $100 and have a life expectancy of at least one year.
For example, if you own a pizza shop, you will want to depreciate a new oven. The oven costs more than $100 and you will use it for more than one year. This expense is different from the flour you buy. Flour costs less than $100 and you use it up in less than one year.
Why depreciate assets?
Depreciation is a business income tax deduction. When you depreciate an asset, you spread the cost of the item out over a fixed number of years. Instead of deducting the entire cost of an asset in one year, you deduct parts of the cost over the years you use it.
Depreciating an asset instead of claiming it as a direct business expense helps maintain your long-term spending goals. You claim a depreciated asset as a non-cash expense. This means you can deduct the item before you pay for it. Because you report the cost over years, you claim the deduction for the asset longer.
Think of the deductions like this: Depreciation is like having one piece of chocolate every day for the next five years, and deducting direct expenses is like having five year’s worth of chocolate in one day.
Depreciation helps your finances stomach the big-ticket items. By spreading the cost out over the asset’s lifespan, you extend the tax deduction benefits from the expense.
Depreciation also allows you to decrease the value of an asset. Because you use an asset over time, it shows some wear and tear and eventually has less value. If you depreciate an asset, you can more accurately report the net value of the item on your taxes each year.
Depreciation categories
The IRS separates assets into different classes. Each class is assigned a period of time that you will likely use the asset for your business.
For example, the IRS puts computers in a different class than office supplies. A computer has a class life of several years and needs to be depreciated. But office supplies are used up quickly, so you deduct them in the year they were purchased.
You can find class life information here:
- IRS Instructions 4562, Depreciation and Amortization
- IRS Publication 946, How to Depreciate Property
Assets to depreciate
Using IRS-approved depreciation methods allows you to deduct an asset’s full value. You need to deduct assets over a fixed time frame rather than just in the year you bought them. The assets must be deductible expenses.
Examples of items you can depreciate include:
- Computers and software
- Printers, fax machines, and copiers
- Furniture
- Buildings
- Vehicles
- Equipment, appliances, and tools
Usually, you depreciate fixed assets. You cannot depreciate land because it does not show a steady decrease in value. Talk to your accountant about which assets to depreciate.
Inventory list
To ease the depreciation process, create an inventory list of business assets. Be sure to include the following information in your inventory list:
- Clear description of the item
- Date you purchased the item
- Date you started using the item for business
- Cost of the item
- Today’s fair market value
You can complete your inventory list anytime and update it as you buy more assets. When an item is new, the value may be the same as the original cost. But, used items may have a lower value. Be sure to keep a list of your inventory’s value up to date.
Here is a sample inventory list:
| Description | Purchase Date | Business Use | Cost | Value |
|---|---|---|---|---|
| Computer | 1/4 | 1/4 | $708.56 | $708.56 |
| Desk | 1/8 | 1/8 | $125.00 | $125.00 |
| Bookcase | 2/1 | 3/1 | $210.75 | $200.00 |
Depreciating your small business assets
Deducting large expenses over the course of an asset’s life can be beneficial to a small business. Depreciating items helps you determine how to calculate business net worth. Depreciation also prepares you for future spending by deducting items for several years. Talk to your accountant about assets you can depreciate.
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This article has been updated from its original publication date of September 5, 2012.
This is not intended as legal advice; for more information, please click here.
