You’ve likely heard the terms depreciate and depreciation when it comes to tax matters. But do you really understand the basics of these concepts and how they apply to your taxes?
In layman’s terms, the basic concept of depreciation revolves around an income tax deduction. This IRS write-off allows a taxpayer to recover the cost of certain pieces of property. Depreciation is designed to be an annual allowance for the deterioration, wear and tear, or general obsolescence of a specific piece of property due to how much this property has been used over time.
Types of Property That Are Depreciable
Aside from land, most tangible property of a certain value and function can be depreciated on your tax return over the course of several years.
Examples of tangible items you can depreciate include:
- Buildings, i.e. commercial office space
- Vehicles, i.e. cars, trucks, boats, etc.
- Machinery, i.e. 3-D printers
- Equipment, i.e. computers, iPads, medical devices, etc.
- Furniture, i.e. desks, bookcases, etc.
Examples of intangible items you may be able to depreciate include:
- Patents on inventions
- Copyrights on materials
- Computer software that becomes obsolete, etc.
How to Claim a Depreciation Deduction
To be eligible for a depreciation deduction on a certain piece of property, you must meet these IRS requirements:
- You must own the property you are depreciating. However, you can depreciate capital improvements on property you lease.
- You must use your depreciable property in some type of income-generating activity, such as in a small business like a consulting firm or mom-and-pop restaurant. If you use property for both personal and business purposes, you can only deduct the depreciation on this property for your business use of it.
- Depreciable property must have a determinable useful life of at least one year.
Depreciation begins when a taxpayer puts a piece of property in service for use in a business or for another type of income-earning interest. This property is no longer depreciable when the taxpayer has fully recovered the cost of the property or when the taxpayer retires it from use – whichever occurs first.
Keep in mind that you are generally not allowed to depreciate the following types of property:
- Any property you actively use and dispose of in the same year.
- Some equipment that is used to build capital improvements
- Some term interests
As a taxpayer, you must identify several items to ensure the proper depreciation of property. This includes the following:
- Your desired depreciation method for the property
- The specific class life of the asset at-hand
- If it’s considered “Listed Property”
- If you opt to expense any portion of the asset
- If you qualify for any “bonus” first-year depreciation
- The depreciable basis of the property at-hand
In most cases, the Modified Accelerated Cost Recovery System is the accepted depreciation method used for depreciating most types of property.
What Tax Form Is Used For Depreciation?
You must use Form 4562: Depreciation and Amortization to properly report any depreciation deductions you are claiming when filing your return with the IRS.