Depreciation is a business expense applicable to the purchase of capital assets, but it can get a little tricky for owners to work out without getting in trouble with Uncle Sam.
If you buy furniture, equipment, machinery – anything for your business that has a useful life of more than one year, the IRS requires that you write off the expense over the useful life of the asset. But like everything in the tax code, there are some exceptions.
The useful life is basically five years for equipment, vehicles, and machinery; seven years for furniture and fixtures; 15 years for leasehold improvements; and 31.5 years for commercial property and home offices. To determine the useful life of other assets refer to IRS Publication 946.
Before 1987, depreciating property was a simple matter. There were a few depreciation methods, like straight line in which you divide the cost basis of the asset by its useful life. For example, if you paid $10,000 for a piece of equipment, it would have a useful life of five years.
Divide the cost by five years and your depreciation expense for the year and each subsequent year up to five would be $2,000. But today it’s a bit more complex. There are tables in Publication 946 to assist you in determining how to calculate the amount of depreciation to deduct.
There are special considerations for vehicle depreciation. If the vehicle is not considered “transportation equipment,” like a dump truck or a boom truck – that is, if the vehicle is suitable for personal use and especially if it is used personally – there are special rules.
Since 1987, the IRS has imposed luxury limits for automobiles because it got tired of business owners writing off $200,000 Maseratis. Keep in mind if it’s too much fun, it likely isn’t deductible.
If you bought a new car in 2012 that is 100% business use, you would be allowed to write off a maximum of $11,160 the first year, $5,100 in year two, $3,050 the third and $1,875 for year four and after. If you add up these numbers considering a five-year life, the total is $23,060. If you spend more than that amount on the vehicle, expect to continue taking $1,875 in depreciation until it’s used up. If you did buy a Maserati, you will be depreciating it for quite a while–or replacing it sooner than later.
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