Depreciation is the process of writing off an asset’s value over time. It’s an annual income tax deduction which permits tax filers to recover the cost of property purchase over its useful life. Or it may help you to think of this as allocating the cost of an asset across its useful life to represent how the value of that asset declines over the course of time.
For every tax tear, companies record and report a portion of the cost of their equipment, machinery, computers, buildings, and other depreciable items thereby spreading the expense of these items across their useful lives.
View our article titled What Property Can Be Depreciated? for specifics on what can and cannot be depreciated.
There are many methods of calculating depreciation which we’ll discuss here. First, it’s critical to collect all of the inputs required to calculate depreciation with any of the methods – those formula inputs are:
- Asset cost including base price, sales taxes, delivery fees, assembly fees, and installation costs
- Useful life of the asset (in our article discussing useful life we share the IRS useful life table for commonly depreciated items)
- Scrap value of the asset after its useful life (Note: Useful life is determined and provided by the IRS, which has provided acceptable useful life direction for most depreciable assets grouped into property classes)
Once you’ve collected the relevant inputs, you’re ready to calculate depreciation following one of the following depreciation methods:
- Straight Line Depreciation Method
- One of the accelerated depreciation methods such as:
- Double Declining depreciation method
- Sum of Years depreciation method
When it’s time to select a depreciation method, consider enlisting the help of a CPA as depreciation can be complex, and this is merely an introduction. An experienced CPA will be able to guide you through the process, avoiding costly mistakes along the way.