Accounting

Why Depreciation Matters for Your Small Business

Jun 05, 2020 • 4 min read
Business owner working on depreciation financial documents
Table of Contents

      There are so many obscure tidbits of knowledge and unique responsibilities that come with small business ownership that it’s hard to keep them all straight. One you might not know very well is a process called depreciation. It’s a government-recognized reality, and you can make it work in your favor.

      What Is Depreciation?

      Everyone knows when you buy a brand new car that it loses value the moment you drive it off the lot. That’s the essence of depreciation. In a more specific sense, depreciation is the process of value reduction in a piece of property over a certain amount of time. What many people don’t know is that it can happen to a number of purchases you’ll make as a small business owner (not just on cars). The key, however, is finding a way to make depreciation work to your advantage—and there is a way to make it happen.

      How Depreciation Can Help Your Business

      As a business owner, you’ll inevitably take out a loan or front the costs to acquire specific items for your business. Whether that’s a fleet vehicle, a new piece of specialized equipment, or some other asset doesn’t matter. Whatever you purchase will likely lose its value over time. Instead of deducting the total amount of the purchase up front as an expense, deprecation allows you to recover the cost of the property over the course of its life. That means you can make some of the money you spent on it back each time you file your taxes—or at least reduce the amount of your taxable income, which boosts your tax savings.

      Types of Property That Depreciate

      Unfortunately, not everything you purchase will depreciate in a way you can use for taxes. According to the IRS, there is a very specific list of items you can and can’t use for depreciation. Here are the basics:

      • Machinery (agricultural machinery, printers/copiers, off-the-shelf computer software)
      • Equipment (qualified technological, communication, or medical equipment)
      • Buildings (rental properties, offices, farm buildings)
      • Vehicles (forklifts, boats, fleet vehicles)
      • Furniture (desks, files, safes)
      • Animals (livestock, fur-bearing animals, racehorses)

      While your business may not have a racehorse to worry about, you likely possess other pieces of property that will lose their value over time, so it’s important to know how to handle those deduction calculations.

      Choosing Your Depreciation Deduction

      When filing taxes and choosing your depreciation deduction, the process can get a little confusing. There are many different types of depreciation calculations you can use. To make the process easier, we’ve outlined 3 of them.

      Straight-line

      As the name suggests, this method means you’ll calculate and deduct a consistent amount of money, every year, for the useful life of the property. To figure out the annual depreciation cost, you need to subtract the salvage value of the property from its purchase amount, then divide that number by the years your business will use the item. For example:

      $100,000 (purchase amount) – $20,000 (salvage value) / 10 years = $8,000 (annual depreciation amount)

      Accelerated

      When you use an accelerated depreciation method, you start with a larger amount and then decrease it. When deducting the costs, you’ll deduct more the first year, and then let the number taper off for the remaining years of the property’s useful life. 

      Section 179

      Handling depreciation with a Section 179 method allows you to deduct the entire cost of your property the first year you start using it. However, there are limitations on the amount you can deduct based on property type and other factors, so it might be a good idea to have a professional take a look at your books and handle the details for you.

      About the author
      Bjolan Holyoak

      Bjolan Holyoak is a small business finance writer based in Utah. As a copywriter for Lendio, he fuels the American Dream by giving small business owners the information they crave. He believes that with the right panache, financial information can be as much of a "breath of fresh air" as a hike in the Utah mountains.

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