www.taxprofessionals.com - TaxProfessionals.com
Posted by Unifirst Financial & Tax Consultant

Depreciation Schedule for Business Assets: What is it?

Depreciation Schedule for Business Assets: What is it?

If you are an entrepreneur, you can deduct purchases used to generate income for your business over time. This includes business assets, such as equipment and property. To do this, you will need to determine the depreciation schedule for the assets.

First of all, you need to choose the category of property. Typically, business assets can be divided into categories based on the number of years over which the assets can be depreciated.

The three most common categories are:

  • § Five years of ownership: office equipment, computers, vehicles, and construction materials

  • § Seven years of ownership - Appliances, office furniture, and unclassified properties.

  • § Three years of ownership: some animals, production tools, and road tractors

You can also write off an asset if you use it for business or in a trade or if it generates income for you. For leased residential buildings, the depreciable useful life is 27.5 years. For rental commercial buildings and buildings used in a business or enterprise, the depreciation period is 39 years. Keep in mind that the land itself is not depreciable. However, it is still possible to depreciate buildings and other land improvements.

Once you find the category of each business asset, you need to choose a depreciation schedule. There are two types of depreciation schedules: time-based and usage-based.

The time-based depreciation schedules in the modified Accelerated Cost Recovery System (MACRS) include:

  • § The decreasing balance (DB) method, which changes its value every year. These are: 200% downward balance method, also known as double downward balance (DDB) method, and 150% descending balance method (DB)

  • § The straight-line method (SL) distributes expenses equally over the depreciation period of an asset.

You can calculate depreciation charges for a business asset each year. To do this, multiply the depreciable cost by a percentage shown in the table for the year (year 1, year 2, etc.).

A usage-based depreciation program is an alternative program to company assets. With this program, depreciation charges for each year reflect the use of the asset. For example: for a car used for commercial purposes, the total number of miles driven can be used to determine the deduction.

Assets brought into operation this year may also be eligible for additional depreciation or the Section 179 deduction.

 

Types of depreciation

There are three main methods of depreciating your business assets:

Straight-Line Depreciation: This is the easiest method but also the slowest, so it is rarely used.

For example: You bought a copier for $1,600 at the end of March. Assuming the machine has a residual value of $400, you can write down $1,200 as the copier's life cost. A copier is considered a five-year property for tax purposes. According to the normal rules, using the straight-line method, it is possible to make the following deductions during the first three years:

   

    Period

    Calculation

  Deduction

  First year

  $1,200 / 5 x 50%* 

    $120

  Second year

  $1,200 / 5

    $240

  Third year

  $1,200 / 5 

    $240

The 50% calculation represents the "mid-year convention" for goods that are not in service throughout the year.


Accelerated depreciation

This method is the most used by small businesses. This allows you to make a higher deduction in the early years and a lower depreciation later. The most popular accelerated method is called MACRS (Modified Accelerated Cost Recovery System) in the tax world. It is not necessary to take into account the residual value, as is the case with the straight line and, in general, the so-called "mid-year convention" is used, which means that the deduction that would otherwise be allowed during the first year is reduced by half, regardless of the month in which you started using the asset in your business (Exception: if you bought more than 40% of your assets in the last three months of the year, you would use the "mid quarter convention" meaning that all assets acquired will be depreciated starting at the midpoint of that quarter.) MACRS depreciation starts at 200% of the straight-line depreciation rate, then switches to the straight-line method for the residual depreciable balance at the most opportune time to maximize its depreciation.

For example:

Suppose your business bought office furniture for $2,000 and started using it on May 1. The first three years of MACRS capital cost allowance 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 "mid-year agreement."

 

Tip: While most business owners go for accelerated depreciation, it may not be wise to make the biggest deductions in the first few years on the market. Assuming you earn more as your business grows, we recommend that you use the straight-line method, which may give you the best tax benefit in the long run.

Note: If you choose the straight-line method to depreciate an asset, you will not be able to switch to MACRS later. However, a different method can be used for assets acquired in subsequent years.

 

Section 179 Expenses Deduction 

It's a dry name for a deduction (taken from a line in the Internal Revenue Code), but it allows you to deduct the full cost (subject to certain limitations) of an asset in the year you bought and started using it for business.

Here are the rules and limitations for the 2020 tax year:

  • § Must be used in a business or trade (goods used in a rental business are generally not eligible).

  • § The asset must be tangible property, including software (not real estate).

  • § The decision to use section 179 must be made in the year in which the asset is used for business purposes.

  • § The deduction cannot exceed the income obtained (net business income and wages) for the year concerned.

  • § You must make the deduction in the year you start using the asset.

For 2020, the maximum deduction for section 179 is $1,000,000. If the total of your purchases exceeds $2,500,000, the maximum deduction will begin to be phased out.

Suppose the corporation is a partnership, an S Corp or LLC. In that case, the deduction provided for in section 179 cannot be transferred to shareholders, partners, or members unless the corporation has income. The individual must have earned income to take the deduction.

 

Bonus Depreciation 

The bonus depreciation has been changed for eligible assets acquired and put into service after September 27, 2017. The old 50% bonus depreciation rules still apply to eligible assets acquired before September 28, 2017. These assets were to be acquired new, unused. The new rules allow a 100% "expensing" bonus on new or used resources. The additional depreciation percentage phased down in 2023 - 80%, in 2024 - 60%, in 2025 - 40% and in 2026 - 20%. There will be no depreciation after 2026. This "expense" premium should not be confused with the expenses provided for in Section 179 of the Code, which has completely different rules.

100% expenses are also available for certain productions (qualified films, TV, and live shows) and for certain fruits or nuts planted or grafted after September 27, 2017.

You can choose the 50% premium depreciation for the first year instead of the 100% expense for the first year ending after September 27, 2017.


Note Any deduction provided for in section 179 that is not used in the current year because it exceeds business income can be carried forward to subsequent years. Suppose a corporation (S corporation, partnership, or LLC) has no operating income, but the shareholder, partner, or member has taxable income. In that case, it may be better for the corporation to use regular depreciation. Regular depreciation is part of the business operating loss passed on to the shareholder, partner, or member.


Why use regular depreciation?

If you're eligible, this might seem like an easy-to-use ‘expensing’ option. However, in some cases, it may be useful to use regular depreciation. This may be the case if you anticipate an increase in your business's income in the future and, therefore, the level of taxation of your business. More tax support could make the deduction more attractive in the years to come.


FOR MORE INFORMATION OR TO SEE HOW UNIFIRST FINANCIAL & TAX CONSULTANTS CAN BEST HELP YOU WITH YOUR TAX FILING NEEDS, PLEASE CLICK THE BLUE TAB ON THIS PAGE.


THANKS FOR VISITING.

Unifirst Financial & Tax Consultant
Contact Member