Appreciating Your Depreciation

July 13, 2012

As an income tax deduction, depreciation can be somewhat challenging to determine. While it enables taxpayers to obtain an allowance for the wear and tear, deterioration, or obsolescence of property purchased, it must meet specific requirements in the eyes of the IRS.

For example, the property must be used in business or in an income-producing activity. This means that if it is also used for personal purposes, only a portion of the depreciation can be deducted.

Here are a few other requirements of depreciation that are worth keeping in mind:

  • The property must be owned or leased by the taxpayer.
  • The property must have a determinable useful life greater than one year.
  • There are also certain types of property that do not qualify for depreciation:
  • Property placed in service and disposed of in the same year.
  • Equipment used to build capital improvements.
  • Certain term interests

It’s important to note that depreciation starts when a taxpayer first places property in service for use in a trade or business or for the production of income. It stops being depreciable when it is retired from service or when the taxpayer recovers the property’s cost or other basis.

To take advantage of depreciation as a tax deduction, there are several items that must be identified:

  • The depreciation method of the property
  • The class life of the asset
  • Whether the property is “Listed Property”
  • Whether any portion of the asset will be expensed
  • The depreciable basis of the property

As part of the American Recovery and Reinvestment Act (ARRA), enacted in February 2009, there is now an extended period of bonus depreciation and an increase in the deduction. This bonus is for a limited period of time, and allows many small businesses that invest in new property and equipment to write off most or all of their purchases on a single tax return. Normally, businesses recover capital investments through annual depreciation deductions spread over a number of years. These special provisions of ARRA were created to encourage investments by enabling businesses to write them off quicker.

Most property will use the Modified Accelerated Cost Recovery System (MACRS). More information on MACRS can be found in the IRS’s Publication 946, How to Depreciate Property. Form 4562, Depreciation and Amortization is required to report depreciation on a tax return.

To learn more about depreciation and the limited opportunities for additional deductions as part of the ARRA, we encourage you to call Wallace & Associates today at . By obtaining the knowledge you need regarding depreciation of your business’s working property, you may be able to save substantially on your taxes.