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What is Depreciation?

Define Depreciation

Depreciation is the decrease in the value of property over the time the property is being used. As a tax term, depreciation refers to a way of spreading the cost of a business or investment property purchased over the period of years which is the expected useful life of the purchased property.

You recover (get back) the cost of certain business or income producing property on your tax return by taking yearly deductions for depreciation over the life of the property.

What properties are depreciable? & When to depreciate properties?

Depreciable property must be property you own that you use in your business or income producing activity. It must have a determinable useful life and it must be expected to last more than one year.

Depreciation starts when you first use the property in your business or for the production of income (placed in service date). It ends when you have deducted all your depreciable cost or you take the property out of service (no longer use the property for your business or the production of income).

How does depreciation work?

To depreciate property, you need to know:

  1. the cost or other basis of the property and
  2. the life of the property.

In general, the basis of property purchased for business use is its cost. Tax law sets the time periods that different types of property are expected to last.

For most property placed in service after 1986, depreciation is figured using the Modified Accelerated Cost Recovery System or MACRS.

What are listed properties?

The IRS designates certain types of property as Listed property and explains the special rules and depreciation deduction limits that apply. Listed property includes cars and other property used for transportation, property used for entertainment and other property such as certain computers and cellular phones. Additional rules and record keeping requirements apply when depreciating listed property.

The depreciation deduction for an individual property is usually taken yearly over the life of the property. However, section 179 of the Internal Revenue Code allows you to deduct a large portion of, or even all of, the cost of certain property in the first year you place the property in service. Deducting the cost in this way is called "expensing" (treating the property as an expense).

Which tax form to use to claim depreciation tax deduction?

The form or schedule on which you claim the depreciation deduction depends on the use of the property being depreciated. For most depreciation deductions you claim, you must complete Form 4562, Depreciation and Amortization.


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