The Ultimate Guide to Year-End Depreciation

When it comes to your small business taxes, everyone wants to find a way to lessen their tax burden. The easiest way to do just that is by having a keen understanding of depreciation and its effect on your business and assets. 

Unfortunately, depreciation isn’t a single-solution sort of problem. There are many ways to use depreciation to reduce your business taxes, so it’s important for you to have a solid understanding of the options and how they can help your business.

Types of Depreciation Deductions

When you start the process of deducting depreciation for your taxes, you need to understand your options—but knowing if you should use a straight-line or a double-declining balance depreciation method isn’t exactly intuitive. 

To help you better understand your choices and their individual functions, we’ve prepared a short list of the more common depreciation methods for you to peruse.

Straight-Line Depreciation 

If you like consistency and predictability, a straight-line depreciation method might be for you. True to its name, this method means your annual calculations and deductions will be consistent from start to finish. Additionally, if you know your property won’t be overused early on and will depreciate consistently (like office furniture, appliances, or livestock), the straight-line method is likely a safe bet.

To figure out your yearly depreciation cost, you need to subtract the salvage value of the property/asset from its original purchase amount. From there, you’ll divide that number by the useful life of the item. For example:

$50,000 (purchase amount) – $2,000 (salvage value) / 10 years = $4,800 (annual depreciation amount)

Keep in mind, whatever piece of property you use for your calculations likely fits into a specific, IRS-determined, year-based category. But don’t worry—we’ll cover those a little later.

Double-Declining Balance

Where the straight-line depreciation method is simple and predictable, a double-declining balance method gets more complicated. Instead of deducting the same amount every year, this accelerated depreciation method means writing off a large chunk of the property cost early on and then a decreased amount thereafter. The double-declining balance method might be a great option for determining depreciation for a new work truck purchase where you know it will see some heavy use right away. 

The calculation used for a double-declining balance depreciation method utilizes some of the same information you had for your straight-line depreciation calculations. So once you’ve established your asset cost (or purchase amount for the first-year calculations), its salvage value, and useful life, you’re ready to plug the information into the following equation.

2 x (asset cost – salvage value) / useful life of the asset = your yearly depreciation amount

Unfortunately, because the depreciation amount is supposed to change over the years for this method, you’ll need to repeat the calculations annually but with a different asset cost. Each year you calculate depreciation, your asset cost subtracts the amount you wrote off last year from the current cost. To make this a bit easier to understand, here are a few examples.

Year 1:

2 x ($50,000 – $2,000) / 10 years = $9,600

*$50,000 was the original price of the asset and $2,000 is the salvage value.

Year 2:

2 x (($50,000 – $9,600) – $2,000) / 10 years = $7,680

*$50,000 – $9,600 (or $40,400) is the value of the asset after the previous year’s write-offs are deducted. $2,000 is—and will remain—the salvage value.

Year 3:

2 x (($40,400 – $7,680) – $2,000) / 10 years = $6,144

Section 179

As probably the most straightforward depreciation method, the Section 179 method allows you to deduct the entire cost of your property within its first year of use. It’s a great solution if you don’t want to worry about calculations or repeating the depreciation process over the life of your property.

As simple as that may seem, there are some limitations. Estates and trusts, for example, can’t use a Section 179 deduction method, but there are additional rules involving the allowed deductible amounts in regards to property type and much more. Make sure you do your research to ensure you only use this depreciation method on the appropriate assets.

Which Assets Depreciate?

Have you ever asked yourself, “Can I write off my blank?” or “Are my office supplies depreciable?” With how confusing taxes and anything government-related can be, it’s no surprise that many people feel a little lost and overwhelmed. Thankfully, the IRS provides a webpage (albeit a lengthy one) that details everything you need to know about how to depreciate property. 

Instead of expecting you to read through more than 100 pages and 50,000 words of legalese, we’ve gone ahead and found the most important parts and pulled them out for you. You’ll notice the IRS divides the items into year groupings. That signifies the number of years over which those assets can depreciate.

3-Year Property

• Over-the-road tractor units
• Horses and racehorses
• Qualified rent-to-own property, including: computers and peripheral equipment, televisions, stereos, camcorders, appliances, furniture, washing machines and dryers, refrigerators, and other similar property

5-Year Property

• Automobiles, taxis, buses, and trucks
• Any qualified technological equipment
• Office machinery (such as copiers and the like)
• Breeding cattle and dairy cattle
• Appliances, carpets, furniture, etc., used in a residential rental real estate activity
• Certain geothermal, solar, and wind energy property
• Any machinery equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement items) used in a farming business

7-Year Property

• Office furniture and fixtures (such as desks, files, and safes)
• Used agricultural machinery and equipment, grain bins, cotton ginning assets, or fences used in a farming business (but no other land improvements)
• Railroad track
• Any property that does not have a class life and has not been designated by law as being in any other class
• Certain motorsports entertainment complex property
• Any natural gas gathering line

10-Year Property

• Vessels, barges, tugs, and similar water transportation equipment
• Any single-purpose agricultural or horticultural structure
• Any tree or vine bearing fruits or nuts
• Qualified small electric meter and qualified smart electric grid system

15-Year Property

• Any retail motor fuel outlet, like convenience stores
• Any municipal wastewater treatment plant
• Initial clearing and grading land improvements for gas utility property
• Electric transmission property (that is a section 1245 property) used in the transmission at 69 or more kilovolts of electricity
• Any natural gas distribution line
• Any telephone distribution plant and comparable equipment

20-Year Property

• Farm buildings (other than single-purpose agricultural or horticultural structures)
• Initial clearing and grading land improvements for electric utility transmission and distribution plants

25-Year Property

• Property that is an integral part of the gathering, treatment, or commercial distribution of water, and that, without regard to this provision, would be 20-year property
• Municipal sewers
• Residential rental property
• Nonresidential real property (section 1250 property), such as an office building, store, or warehouse

It’s Time to Tackle Your Taxes

Now that you have a better understanding of which assets depreciate and how to calculate depreciation for your small business assets, you’re ready to go forth and conquer your year-end taxes. If the process is still a little fuzzy, however, you can always get professional bookkeeping help from one of our experts at Lendio.