Do You Have to Depreciate Assets? Here’s What to Know

Businesses and individuals who own income-generating assets often face the question of whether depreciation is necessary. Depreciation allows owners to allocate an asset’s cost over its useful life, reducing taxable income. However, not all assets qualify, and failing to account for depreciation properly can lead to lost deductions and tax complications.

Mandatory vs. Elective Depreciation

Depreciation is required for business assets with a determinable useful life that lose value over time. The IRS mandates depreciation to ensure accurate income and expense reporting. If an asset qualifies, the owner must depreciate it; otherwise, they forfeit deductions and may face complications when selling the asset.

The Modified Accelerated Cost Recovery System (MACRS) is the standard method under U.S. tax law. Businesses can choose between different recovery periods and methods. Straight-line depreciation spreads the cost evenly over the asset’s life, while accelerated methods like the 200% or 150% declining balance allow for larger deductions in the early years.

Some deductions can replace or supplement depreciation. Section 179 allows businesses to expense the full cost of qualifying assets in the year of purchase, up to $1,220,000 for 2024. Bonus depreciation, set at 60% for 2024, provides another option for immediate expensing. However, assets exceeding these limits must still be depreciated over time.

Categories of Depreciable Assets

Depreciable assets must have a determinable useful life, be used in a business or income-generating activity, and lose value over time. The IRS provides guidelines on which assets qualify and how they should be classified.

Real Property

Real property includes buildings and structures used for business or rental purposes. Residential rental properties are depreciated over 27.5 years, while commercial buildings follow a 39-year schedule under MACRS. While land is not depreciable, improvements such as parking lots, fences, and landscaping may qualify under a separate depreciation schedule.

Depreciation for real property typically follows the straight-line method, spreading the cost evenly over its useful life. Certain improvements may qualify for accelerated depreciation under the Qualified Improvement Property (QIP) classification. As of 2024, QIP has a 15-year recovery period and is eligible for bonus depreciation, allowing a portion of the cost to be deducted immediately. Proper classification is important, as misclassification can lead to incorrect deductions and IRS scrutiny.

Machinery and Equipment

Machinery and equipment used in business operations have varying recovery periods depending on their classification. Common examples include manufacturing machines, office furniture, and computers. Under MACRS, most machinery and equipment fall into 5-year or 7-year property classes.

Businesses can choose between different depreciation methods. The 200% declining balance method accelerates deductions in the early years, while the straight-line method spreads them evenly. A company purchasing a $50,000 machine classified as 5-year property could claim higher deductions in the first few years using an accelerated method, improving short-term cash flow.

Certain industries have specialized depreciation rules. Farm equipment placed in service after 2017 qualifies for a 5-year recovery period instead of the previous 7-year schedule. Businesses may also use Section 179 or bonus depreciation to immediately expense qualifying equipment purchases.

Vehicles

Business-owned vehicles, including cars, trucks, and vans, are depreciable but subject to IRS limitations. Passenger vehicles used for business are classified as 5-year property under MACRS, but depreciation deductions are capped due to luxury auto depreciation limits. For 2024, the maximum first-year depreciation for a passenger vehicle is $20,400 with bonus depreciation or $12,200 without it.

Larger vehicles, such as trucks and vans over 6,000 pounds in gross vehicle weight, are not subject to these limits and may qualify for full expensing under Section 179, up to the annual deduction cap. Businesses must track business versus personal use, as only the business-use portion of depreciation is deductible. If a vehicle is used 70% for business and 30% for personal use, only 70% of the depreciation expense can be claimed.

Depreciation methods for vehicles include the straight-line method or the 200% declining balance method. Choosing the right approach affects tax liability and cash flow, making it important to evaluate the best option based on expected vehicle usage and replacement cycles.

Items Not Subject to Depreciation

Not all assets qualify for depreciation. Depreciation applies only to assets with a determinable useful life that lose value over time. Some items are specifically excluded because they do not wear out, are held for resale, or are used for personal purposes.

Land

Land is not depreciable because it does not have a finite useful life. Even if land is used for business purposes, its cost cannot be deducted through depreciation.

Certain land-related costs may be deductible or amortizable. Land preparation expenses, such as grading or clearing, are generally capitalized into the land’s cost and not depreciated. In contrast, land improvements, such as drainage systems, sidewalks, or fencing, may qualify for depreciation under a separate asset classification. These improvements typically fall under 15-year property under MACRS.

Businesses should distinguish between land and depreciable improvements when acquiring property. Misclassifying land as a depreciable asset can lead to incorrect deductions and IRS adjustments. Properly allocating costs ensures compliance and maximizes allowable deductions.

Personal-Use Property

Assets used for personal purposes do not qualify for depreciation. Depreciation is reserved for assets used in a trade, business, or income-generating activity. Common examples include a primary residence, personal vehicles, and household furniture.

If an asset is used for both personal and business purposes, only the business-use portion is eligible for depreciation. A taxpayer using a home office that occupies 15% of their residence may depreciate 15% of the home’s cost (excluding land) under home office deduction rules. Similarly, a personal vehicle used 40% for business can have 40% of its depreciation deducted.

Taxpayers should maintain clear records to substantiate business use, as the IRS may require documentation such as mileage logs or expense reports. Improperly claiming depreciation on personal assets can result in disallowed deductions and penalties.

Inventory

Goods held for sale, or inventory, are not depreciable because they are not considered long-term assets. Inventory is classified as a current asset on a company’s balance sheet and is expensed through the cost of goods sold (COGS) when sold.

Businesses must account for inventory using an appropriate valuation method, such as First-In, First-Out (FIFO) or Last-In, First-Out (LIFO), to determine taxable income. The choice of inventory accounting method affects financial statements and tax liability. In an inflationary environment, LIFO results in higher COGS and lower taxable income, while FIFO produces lower COGS and higher taxable income.

Although inventory itself is not depreciable, certain storage or handling equipment, such as shelving units or forklifts, may qualify for depreciation. Properly distinguishing between inventory and depreciable assets ensures compliance with IRS regulations and accurate financial reporting.

Consequences If You Don’t Depreciate

Failing to depreciate eligible assets leads to lost tax deductions, increasing taxable income. Depreciation is designed to match an asset’s expense with the revenue it helps generate. Without it, businesses and investors pay more in taxes than necessary, reducing profitability and limiting cash flow.

Beyond tax implications, failing to account for depreciation distorts financial statements. The balance sheet will reflect assets at their original cost rather than their depreciated value, inflating book value. This misrepresentation affects financial ratios such as return on assets (ROA) and debt-to-equity, which investors and lenders use to assess financial health. In industries where asset turnover and capital expenditures are key metrics, failing to account for depreciation can create misleading financial reports that impact business decisions and loan eligibility.