Depreciation of Business Assets

Because business assets like computers, copy machines and other equipment wear out, you are allowed to write off (or "depreciate") part of the cost of your assets over a period of time. These tips offer guidelines on depreciating your small business assets for your best tax advantage.

An asset is property, such as a computer, copy machine, car, truck or other equipment you acquire to help produce income for your business.

For tax purposes, there are six categories of non-real estate assets. Each has a designated number of years that assets in that category can be depreciated. Here are the most common:

•     Three-year property (tractors, certain manufacturing tools, some livestock, etc.)
•     Five-year property (computers, office equipment, cars, light trucks, assets used in construction, etc.)
•     Seven-year property (office furniture, appliances, property that hasn't been placed in another category,    etc.)

•  27.5 year (residential rental property)
• 39 year (commercial property, buildings, factories)

Land is not depreciable (it doesn't wear out), but land improvements, such as roads, sidewalks or landscaping may be written off over periods of 10, 15 or 20 years depending on the specific nature of the asset.

NOTE: When you use TurboTax Business and TurboTax Home & Business software to prepare your business return, we do the math for you. All you do is answer a few simple questions about each asset.

Types of Depreciation

There are three primary methods you can use to depreciate your business assets:

Straight-Line Depreciation

It's the simplest, but also the slowest, so is rarely used.

For example:

You buy a copy machine for $1,600 at the end of March. Assuming the machine has a salvage value of $400, you can depreciate $1,200 of the cost over the life of the copier. A copy machine is considered 5-year property for tax purposes. Under the normal rules, using the straight-line method, you can take the following deductions in the first three years:

 

Period	Calculation	Deduction
First year	$1,200 / 5 x 75%*	$180
Second year	($1,200 / 5)	$240
Third year	($1,200 / 5)	$240

 

The 75% calculation represents the "half-year convention" described above.

For new assets put into use in 2008, however, Congress has approved special 50% bonus depreciation. So for five-year property, you figure your first-year depreciation deduction by taking 50% of the cost, and then applying the regular schedule to the rest of the cost.

Here’s how it works for that copier:

 

Period	Calculation	Deduction
First year	$800 bonus depreciation   +400 /5 x 75%	$860
Second year	$400 / 5	$ 80
Third year	$400 / 5	$ 80

 

Accelerated Depreciation

This method is the most commonly used by small businesses. It lets you take a larger deduction in the first few years and a smaller write-off later. In the tax world, the most common accelerated method is called MACRS (Modified Accelerated Cost Recovery System). You don’t have to take salvage into account, as you do with straight line, and you use what’s called the "half-year convention," which means that half the deduction amount is allowed in the first year, regardless of what month you started using the asset for business. (If you acquired more than 40% of your assets in the last three months of the year, you would use the "midquarter convention," meaning that all the assets acquired in each quarter would be depreciated starting at the midpoint of that quarter.) It starts with applying 200% to the cost and switches to straight-line depreciation at the most opportune time to maximize your write-off.

For example:

Here’s how it works under the normal rules: Your business bought $2,000 worth of office furniture and started using it May 1. Office furniture falls into the 7-year category. The first three years of MACRS depreciation deductions would be:

 

Period	Calculation	Deduction
First year	$2,000 / 7 x 200% x         50%*	$286
Second year	($2,000 - $286) / 7 x 200%	$490
Third year	($2,000 - $776) / 7 x 200%	$350

 

*The 50% calculation represents the "half-year convention" described above.

For new assets put in use in 2008, you get the 50% bonus depreciation. So the calculation would look like this:

 

Period	Calculation	Deduction
First year	$1,000 bonus  depreciation   + $1,000 / 7 x 200% x 50%	$1,143
Second year	($2,000 - $1,143) / 7 x 200%	$ 245
Third year	($2,000 - $1,388) / 7 x 200%	$ 175

 

TurboTax Tip: Although accelerated depreciation is usually chosen, it may not be prudent to take the biggest deductions in the first years that you are in business. Assuming that you will earn more income as the business grows, you may want to use the straight-line method, which will give you the best long-term tax benefit.

NOTE: If you choose the straight-line method to depreciate an asset, you cannot switch to MACRS later. However, you may use a different method for assets acquired in each subsequent year.

Section 179 Expense Deduction

It's a dry name for a deduction (taken from a line in the IRS tax code) but it allows you to deduct the entire cost (subject to certain limitations) of an asset in the year you acquire and start using it for business.

Here are the rules and limitations:

• The asset must be tangible personal property (not real estate).
• It must be used in a trade or business (property used in a rental activity is generally not eligible).
• You must take the deduction in the year you start using the asset.
• The decision to use Section 179 must be made in the year the asset is ready to use for business.
• The deduction cannot be more than your earned income (net business income and wages) for the year.

For 2008, the maximum Section 179 deduction is $250,000. If your total acquisitions are greater than $800,000 the allowable deduction is phased out.

If the business is an S corporation, partnership or multi-member LLC, it cannot pass the Section 179 deduction on to shareholders, partners or members unless the business has income. The individual must also have earned income to take the deduction in 2008.

The Section 179 deduction cannot be taken on investment or retirement income.

NOTE: TurboTax walks you through the Section 179 deduction for applicable assets, and handles the calculations, too.

TurboTax Tips

• Any Section 179 deduction that is not used in the current year because it is greater than your business income can be carried over to subsequent years.
• If a business (S corporation, partnership or  LLC) has no operating income but the shareholder, partner or member has taxable income, it would be better for the business to use regular depreciation. Regular depreciation becomes part of the business operating loss that passes through to the shareholder, partner or member.

It might seem like a no-brainer to use expensing if you qualify. But in some cases, it might pay off to use regular depreciation. That could be the case if you expect your business income—and hence your business tax bracket—to rise in the future. The higher tax bracket could make the deduction worth more in later years.

Updated for tax year 2008