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In most contexts, “depreciation” is a bad word. It means that something went down in value, as in, “New cars depreciate by 20% the minute you drive them off the lot.”
But in a tax context, depreciation is actually one of the coolest things around.
Depreciation Overview
Internal Revenue Code Section 167 provides the rules for deducting depreciation on your tax return.
Now, if reading the tax code is your thing, great. Have at it.
But if you’d rather just get what you need to know in plain English, keep reading this article.
What Is Depreciation?
Depreciation is a tax deduction that lets you deduct the percentage of the cost of an asset over time rather than all at once in the year you purchased it.
Now, this might sound like a bummer: why don’t you get to write off the entire cost of the asset in the year you purchased it?
Well, Congress believes that a taxpayer should receive a deduction for an expense in the year in which the taxpayer receives benefit for it.
If you spend $200,000 on advertising this year, you (theoretically) received the benefit for it all this year, so you can deduct all of that expense this year.
But what if you spent $200,000 on an office building this year? This asset would benefit you over time, so you aren’t permitted to deduct $200,000 immediately but must rather deduct that $200,000 little by little, year after year, through depreciation.
How Do I Calculate Depreciation?
To calculate the depreciation on a particular asset, you must know its useful life.
The table below provides the useful lives on the most common assets used in a business.
| Useful Life | Asset Type |
|---|---|
| 5 Years | Automobiles, Computers, Information Systems |
| 7 Years | Office Furniture, Fixtures, and Equipment; Any Property Not in Another Class |
| 15 Years | Land Improvements |
| 20 Years | Farm Buildings |
| 27.5 Years | Residential Rental Property |
| 39 Years | Commercial Rental Property |
Note that assets with useful lives of five, seven, fifteen, or twenty years currently qualify for the completely optional bonus depreciation, meaning that you are able to write off their cost all in the year of purchase.
Calculating Depreciation on Real Estate
Since many other asset classes qualify for bonus depreciation as described above, the most complicated depreciation calculations typically have to do with real estate.
And to make matters even more complicated, Congress created two different methods of depreciating real estate depending on if the property is residential or non-residential.
Depreciating Residential Real Estate
If you own a piece of residential real estate such as an apartment building, small multifamily property, or single-family home, you can depreciate your property over 27.5 years.
The exact amount of depreciation taken per year depends on what month you placed the property in service.
Depreciating Non-Residential Real Estate
If you own a piece of non-residential real estate — basically anything that doesn’t qualify as residential — then you have to depreciate your property over 39 years.
The exact amount of depreciation taken per year depends on what month you placed the property in service.
Author:
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.
