Wear and tear, age, deterioration and obsolescence are a few ofthe reasons why property depreciates in value. By taking adeduction for depreciation on your tax return, you can recover thecost of certain property or equipment you use in your business orfor the production of income.
If you buy a piece of equipment, depreciation of its originalcost should be included as an expense on your monthly operatingstatement. If you lease a piece of equipment, the monthly leasepayment is part of your monthly operating expenses (cash-valuedepreciation is frequently figured into the cost of an equipmentlease and need not be figured separately by you).
Many equipment-leasing agreements have a clause providing forwhat’s known as a “depreciation reserve.” This consists of settingaside money commensurate with the declining value of the vehicle.When the lease is up, the equipment is sold to either the lessee oranother third party. If it goes for a price over and above itsdepreciated value, the difference can be refunded to the lessee.If, however, the equipment is sold for a price under itsdepreciated value, the lessee must pay the difference to thelessor. This is where the depreciation reserve comes in handy.
Straight-line or uniform depreciation is the most frequentlyused method of depreciating new equipment for financial statements.In straight-line depreciation, the equipment loses an equal part ofits total value every year of its life. For your tax return,though, your accountant will most often use a tax-approveddepreciation that gives you the largest deduction on your taxreturn and goes farther in minimizing your taxes.
Suppose you buy a $15,000 printing press with a ten-year usefullife, according to your accountant’s schedule. The straight-linedepreciation rate is calculated by dividing its ten years of usefullife into the $15,000, or $1,500 a year. If you’re in the 28percent tax bracket, $1,500 in depreciation will save you $420 intaxes. Suppose you only need 20 percent down to buy a $15,000machine. Suppose, too, that you financed your press on theinstallment plan. The interest you pay on any amount owed is goingto be another deduction for you. So if you have a $12,000 loan thatcosts $1,200 in interest, you’ll wind up with another $336 (in the28 percent bracket) in savings.
The current methods of depreciation are often referred to asMACRS (modified accelerated cost recovery system), whereas themethod used for any assets acquired before December 31, 1986 isoften called ACRS (accelerated cost recovery system). Assets usedin your trade or business that were purchased before that time aredepreciated using different methods than those discussed here.Those earlier methods generally provided a larger depreciationdeduction than the current rates.
Keep in mind that many states have different sets of rules thanthose used on your federal income tax return for allowabledepreciation methods on state tax returns. You should check withyour tax professional to find out more about the rules in yourstate.
