What is depreciation and tax deductions?

You can depreciate fixed assets, such as machinery, furniture, fixtures, and real estate (except land), used in a business. Because depreciation laws change, seek a tax expert’s advice. For example, the 1986 Tax Reform Act provides that for the first year you use an asset, you can take only half the deduction normally allowed for a full year’s depreciation. When you dispose of the asset, or in its last year of useful life, you can take the other half year of depreciation.

“Straight line” and “accelerated” depreciation are the two main ways of accounting for the decrease in a fixed asset’s worth caused by annual wear and tear.

Straight-line depreciation
Take a fixed asset (for instance, a business computer) and divide its total cost ($7,000) by its useful life in years (5); the result is a $1,400 value loss annually, the amount of your yearly tax deduction on your asset. For the first year you would be entitled to a $700 depreciation deduction.

Accelerated depreciation
The advantage here is in the reduction of payments during the early years of an asset’s useful life. This is done by taking greater deductions for depreciation at the beginning of an asset’s life and smaller ones at the end. The double, or 200 percent declining balance, method is one accelerated depreciation method. It allows D
you to apply twice the straight-line rate per year to the declining balance. For example, you could depreciate that $7,000 business computer with its 5 year working life at 40 percent per year, taking percentages of the yearly remaining value of the computer: during the second year the computer is worth $4,200, which is what you depreciate then; in the third year it’s worth $2,520; and so on, subject to the half-year convention. You can also write off up to $10,000 of the amount you spend to acquire depreciable personal property. Ask your accountant if this method is for you.