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Is depreciation a tax deduction?
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Is depreciation a tax deduction?
Let’s face it, everybody likes nice things. And you have to treat yourself from time to time. Maybe you bought a fancy new car or splurged on a new laptop that you’ve been eyeing for months or spent $10 on an overpriced latte because you had a bad day.
What if there was a way you could write off some of these purchases on your taxes? Fortunately, we’re talking about the bigger purchases, not the latte. That’s right, allow us to tell you all about depreciation and why it is such an important tax deduction for self-employed individuals.
The IRS allows you to claim certain assets as tax deductions by depreciating them over a period of time if you’ve used them to help generate income for your business. There are specific rules about what kind of assets you can depreciate and the number of years you can write them off, so keep on reading.
Key takeaways:
- Business assets are tax-deductible through depreciation
- Depreciation can only be written off if its on items that help generate income for the business
- Only certain assets can be depreciated
Table of contents
What assets can I depreciate?
First, let’s get the meaning of depreciation out of the way. It’s simply a reduction in value over a period of time. For tax purposes, the IRS considers any asset you use to help you with your business a capital asset.
And since capital assets are generally more expensive, you can’t write off the entire cost of the asset in one year, but rather write off the business expense over a period of time. So, if you bought a heavy duty camera for $10,000 dollars, you can depreciate that expense every time you file your taxes.
You are only allowed to write off assets that you own and that are expected to last longer than a year. The IRS has a list of assets which you can depreciate. For every category of asset, there is a set period of time (known as “useful life”) over which you can claim the depreciation tax deduction. For example, you can depreciate a car over a period of five years.
How to calculate depreciation for taxes?
By deducting depreciation on your tax return, you can lower your taxable income and ultimately reduce the amount of taxes you owe to the government. You can use a self-employment tax calculator to get a full breakdown of your tax payment.
There are three ways you can depreciate your assets– the straight line method, the accelerated depreciation method and the Section 179 method. You’re allowed to write off the entire cost of an asset in one year if it costs less than $100.
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Paying self-employment taxes may become a little more challenging if you also have to pay quarterly estimated taxes to the IRS. You can use a quarterly tax calculator to check whether you owe the IRS over $1,000 in tax liability.
If you’ve never paid quarterly taxes before, don’t sweat it. Use a tax penalty calculator to figure out whether you owe any penalties for missing a tax deadline and try to pay them as soon as you are able to.
Now, the straight line method is the simplest way to calculate depreciation, but it is also the slowest way to write off an asset. For this you’ll need to determine the “salvage value” of the asset you’re depreciating. The salvage value is the price of a business asset can be sold for at the end of its use.
To find the salvage value, you have to deduct the accumulated depreciation of the asset from its initial cost. To calculate accumulated depreciation, you’ll first need to determine the asset’s “useful life” (how long it can be in use) from the IRS Publication 946.
And you don’t have to worry about getting these calculations exactly right. The IRS knows that these are estimations so you’ll be fine as long as you’re in the ballpark range.
For example, you bought a screen printer for your T-shirt printing business for $1,500 in June, and you estimate the salvage value to be $800. To calculate your depreciation, you will subtract the printer's salvage value from its cost and divide that number by the printer's useful life (7 years).
And since you only used it for half of the year in the first year of filing, you will further divide the depreciation deduction by half. From the second year, you just have to divide the depreciation amount by the useful life to get your deduction.
The second method is the accelerated depreciation method. This is the most popular depreciation method and is widely used by self-employed individuals, as it allows you to claim a larger deduction in the first few years.
Most people use the “Modified Accelerated Cost Recovery System” or MACRS for this calculation. In this method, you should divide the first year’s deduction by half regardless of the month you started using your asset, also known as the “half-year convention.”
You can also start with the MACRS method and then switch back to the straight line method. But cannot switch to the MACRS method if you already used the straight line method to depreciate an asset.
Let’s use the same example from before. So, to calculate the depreciation deduction, you will divide the cost of the printer by its useful life and then multiply it by 200%. You will then subtract the Year 1 deduction amount, the cost of the printer for Year 2 and so on.
The final method is the Section 179 method, which lets you write off the entire cost of an asset the year you start using it for your business. This deduction is capped at $1,080,000. If you’re trying to write off your vehicle using Section 179, at least 50% of the usage time should be for business purposes.
How do I claim depreciation on my taxes?
You will use Form 4562 to claim your depreciation deduction and file it alongside Form 1040. There are, however, certain assets that cannot be depreciated. Any assets you use for non-business activities or hold only for investment purposes come under this category. While you may not be able to write off every asset, you should definitely take advantage of this deduction if you want to save on your taxes.
Choosing the right method to claim your depreciation deduction can be challenging because you will need to keep good records of your self-employment deductions until the last year you claim them. It’s always best to seek professional tax help to ensure that you file your returns accurately and choose the depreciation method that saves you the most.
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