Maximize Your Savings with Small Business Tax Tip Understanding Depreciation


Business owners can take this valuable income tax deduction by depreciating the value of property or assets. Know what’s happening with your free credit report and know when and why your score changes.

In this informative blog post, we will explore the concept of depreciation and how it can be utilized as a valuable small business tax tip to save you significant amounts of money. Discover how depreciation reflects the decline in value of assets over time and why it’s important to grasp its potential tax benefits.

Its tax time, and as a small business owner you should be looking to take every single business deduction youre entitled to. One deduction you may have forgotten about is depreciation: the continual decline in the value of property, which can be used to offset income from your business.

Depreciation can lead to valuable income tax deductions that save small business owners thousands of dollars each year. But figuring out exactly how to calculate and claim the deduction is where things can get a little confusing.

What is depreciation?

Depreciation allows small business owners to reduce the value of an asset over time, due to its age, wear and tear, or decay. Its an annual income tax deduction thats listed as an expense on an income statement; you take a depreciation deduction by filing Form 4562 with your tax return.

Depreciation is also the process by which a business writes off the cost of a capital asset. When you spend, say, $30,000 on an asset, you wouldnt necessarily claim a $30,000 expense upfront; rather, youd depreciate the asset over time, eventually claiming the full cost.

Assets that are typically depreciable include buildings, computers, equipment, machinery, office furniture and work vehicles, but you might also be able to depreciate intangible property such as patents or copyrights, according to the IRS. Property that cannot be depreciated includes land (since it does not get used up and it is not subject to wear and tear), inventory (since it is meant for sale), and leased property (since you dont own it).

Commonly, depreciation is taken against buildings owned by the business, equipment, and even smaller items like computers and cellphones, says Jason Reiman, a financial planner and advisor based in Tucson, Arizona.

You use depreciation to decrease your tax burden, since you are lowering your overall taxable income. But its important to understand that depreciation does not affect your companys cash flow or its actual cash balance, since its a non-cash expense.

For example, lets say you own a restaurant that earns $100,000 in net income this year — the money youve made after accounting for all costs of operating your business, including operating expenses and investments — but you take total depreciation deductions 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. At a corporate tax rate of 35%, youd save $8,750 on taxes.

How to figure depreciation

Here comes the tricky part: figuring out how much of a depreciation deduction you can take on your assets.

In order to use depreciation as a deduction, you must be the owner of the property, and it must have a useful life of more than one year. The IRS requires that you write off the depreciation over the useful life of the asset. You can begin to depreciate the property once its in use, and you stop depreciating it when youve fully recovered its cost or you stop using it in your business.

Computers, office equipment, cars and trucks, and appliances can be written off up to five years; office furniture and fixtures such as desks can be written off over seven years; residential rental properties can be written off over 27.5 years; and commercial buildings or non-residential properties can be written off over 39 years, according to IRS Publication 946.

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. You can then use one of three depreciation methods:

Straight-line method: Youll depreciate the property an equal amount each year over its useful life. To come up with the annual amount you can depreciate, subtract the assets 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.

For example, if you purchase a computer for $1,000 and it has a salvage value of $200 and a five-year life, you’d be able to deduct $160 in depreciation each year.

Accelerated method: With this method, youll be able to take larger depreciation deductions in the first few years of the propertys useful life, and smaller deductions later on. This is the method most commonly chosen by small businesses, according to TurboTax.

Youd use the IRSs modified accelerated cost recovery system (MACRS) and refer to the IRSs percentage table guide in Publication 946, Appendix A to figure out your deductions.

Section 179 Deduction: This allows you to deduct the entire cost of the asset in the year its acquired, up to a maximum of $25,000 beginning in 2015.

Depreciation is something that should definitely be appreciated by small business owners. But since youd rather spend time growing your small business than figuring out complicated tax rules, hiring a tax professional is likely a smart move.

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small business tax tip

small business tax tip

small business tax tip