We’re right in the middle of tax season. If you’re a small-business owner, then you’re looking to take every single deduction you’re entitled to. One deduction you don’t want to overlook is depreciation. As experts in in accounting and taxation for small businesses, we wanted to explain what depreciation is and how you can use it to reduce your tax burden by potentially thousands of dollars each year.
What is Depreciation?
There are two ways that you can use depreciation:
- As a tax deduction: Small-business owners may reduce the value of an asset over time, due to its age and typical wear and tear. It’s an annual income tax deduction that’s listed as an expense on an income statement.
- For accounting purposes: Depreciation is also the process by which a business writes off the cost of a capital asset. Let’s say you spend $70,000 on a new truck, you wouldn’t claim the $70,000 expense upfront. Rather, you’d depreciate the asset over time, eventually claiming the full cost.
What is and what is not considered depreciable?
Assets that are typically depreciable include physical structures, computers, equipment, machinery, office furniture, and vehicles. You may also be able to depreciate intangible property such as patents or software.
Assets that cannot be depreciated include:
- Land, because it is not subject to wear and tear.
- Inventory, because it is meant for sale.
- Leased property, because you don’t own it.
How does depreciation reduce my tax burden?
Depreciation works by lowering your overall taxable income, which in turn reduces your tax burden. Here’s an example. Let’s say your business earns $100,000 in net income this year. However, you take a depreciation deduction of $25,000 on the building you own. The IRS would tax you on $75,000 of income instead of $100,000 because of the deduction. Assuming a corporate tax rate of 35% for 2017, you’d save $8,750 on taxes. Next year, assuming all the numbers stay the same, you’d save $5,250 because of the new 21% corporate tax rate.
How much of a depreciation deduction can I take?
To figure out how much you can depreciate, you need to know the initial cost of the asset and how long you can depreciate it for. The IRS requires that you write off the depreciation over the useful life of the asset, but there are limits. For example:
- Computers, office equipment, cars and trucks, and appliances can be written off over 5 years.
- Office furniture can be written off over 7 years.
- Residential rental properties can be written off over 27.5 years.
- Commercial buildings or non-residential properties can be written off over 39 years.
You can then use one of three methods to calculate how much of the asset you can depreciate:
- Straight-line Depreciation: To calculate the annual amount you can depreciate, subtract the asset’s salvage value (the amount you could get by selling it at the end of its useful life) from its cost, and divide that figure by the number of years in its useful life.
- Accelerated Depreciation: With this method, you’ll be able to take larger depreciation deductions in the first few years of the property’s useful life, and smaller deductions later on. Refer to the IRS’s modified accelerated cost recovery system (MACRS) to figure out your deductions.
- Section 179 Deduction: This allows you to deduct the entire cost of the asset in the year it’s acquired, up to a maximum of $510,000 as of 2017.
This tax season, make sure you’re taking advantage of depreciation and every other tax deduction you’re entitled to. Contact the financial experts at Tobin & Collins. For more than 50 years, Tobin & Collins has provided certified public accounting services to clients in the New Jersey and New York metropolitan area. Our exceptional team of professionals provides personal service and sound financial strategies to put our clients on the path to future success.