How to Claim Depreciation on Business Property

Depreciation is an annual income tax deduction that allows a business to recover the cost of property over the time it is used. Instead of taking a single large deduction in the year of purchase, this accounting method spreads the cost over the asset’s useful life, reflecting its gradual decrease in value. Understanding which assets qualify, what information is needed to calculate the deduction, the available methods, and how to report it are fundamental steps for any business owner.

Determining Qualifying Property

To be depreciable for tax purposes, an asset must meet several IRS requirements. You must legally own the property, and it must be used in your business or for an income-producing activity. The property must also have a determinable useful life, meaning it is expected to wear out or lose value. Finally, the asset must be expected to last for more than one year.

Common examples of depreciable property include machinery, equipment, buildings, furniture, and vehicles. You can also depreciate certain improvements that add to a property’s value or extend its usable time. If you use property for both business and personal activities, you can only deduct depreciation based on its business use percentage.

Certain assets cannot be depreciated, most notably land, as it does not have a determinable useful life. Other non-depreciable items include inventory held for sale and certain intangible assets. Routine repair and maintenance costs are deducted as business expenses in the year they occur, not depreciated over time.

Information Required for Calculation

Before you can calculate depreciation, you must gather specific information. The starting point is the asset’s cost basis, which includes the purchase price plus any costs to place the asset into service, such as sales tax, freight charges, and installation fees.

Another element is the “placed in service” date. This is the date the property was ready and available for its intended use in your business, not necessarily the purchase date. Depreciation begins from this date, regardless of when you started to use the asset.

The IRS classifies property into categories with a designated recovery period, which is the number of years for depreciation. For example, computers and related equipment are in a 5-year class, while office furniture and fixtures fall into a 7-year class. Real estate has much longer recovery periods; residential rental property is depreciated over 27.5 years, and nonresidential real property is depreciated over 39 years.

Selecting a Depreciation Method

The most common method for property placed in service after 1986 is the Modified Accelerated Cost Recovery System (MACRS). MACRS accelerates deductions, allowing for larger write-offs in the early years of an asset’s life. This system is divided into the General Depreciation System (GDS) for most property, and the Alternative Depreciation System (ADS), which is required for certain types. MACRS also uses conventions like Half-Year or Mid-Month to determine the first-year deduction.

Businesses may also use the Section 179 deduction. This is a special election to expense the full cost of qualifying property in the year it is placed in service, up to a specified annual limit. This deduction is primarily for tangible personal property, such as machinery and equipment, purchased for business use. The total Section 179 deduction is limited by your taxable income from the business.

Bonus depreciation allows for an additional first-year deduction of a percentage of the cost of qualifying new and used property. This allowance is taken after any Section 179 deduction but before regular MACRS depreciation. The percentage for bonus depreciation is phasing down; the allowance was 80% for property placed in service in 2023 and is scheduled to be 60% for 2024.

How to Report Depreciation

After calculating your depreciation deduction, you must report it to the IRS using Form 4562, Depreciation and Amortization. This form is the central document for detailing your depreciation expenses for the tax year. It is structured into several parts, each designated for a specific type of deduction, so it is important to report your figures in the correct section.

If you elect to take the Section 179 deduction, you will complete Part I of Form 4562. This is where you list the qualifying property and calculate the total expense you are claiming. Any bonus depreciation allowance is reported in Part II, and regular MACRS depreciation is calculated and reported in Part III.

Once Form 4562 is complete, the total depreciation deduction is transferred to the appropriate business tax return. Sole proprietors and single-member LLCs report this total on Schedule C (Form 1040). Those with rental real estate income report it on Schedule E (Form 1040), while corporations report it on their specific return, such as Form 1120.