What Does Fully Depreciated Mean?

The term “fully depreciated” is used in business and accounting to describe long-term assets. These are tangible items, such as equipment, vehicles, or buildings, that a company uses for more than one year. For an asset to be fully depreciated means its cost has been entirely accounted for as an expense over its operational life.

The Concept of Full Depreciation

Depreciation is the accounting process of allocating the cost of a tangible asset over its useful life. Instead of recording the entire expense of a major purchase in one year, a business spreads it out. This process uses the asset’s original cost, its estimated useful life, and its projected salvage value, which is the asset’s estimated residual value at the end of its useful life.

An asset becomes fully depreciated when its accumulated depreciation equals the asset’s cost minus its salvage value. At this point, the asset’s net book value—its original cost less accumulated depreciation—is reduced to its salvage value. If the salvage value is zero, the net book value will also be zero, signifying the entire cost has been allocated as an expense.

For instance, a company purchases machinery for $10,000 with an estimated useful life of five years and a salvage value of $0. Using the straight-line method of depreciation, the annual depreciation expense would be $2,000. After five years, the accumulated depreciation would total $10,000, making the asset fully depreciated.

Accounting for a Fully Depreciated Asset

Even when an asset is fully depreciated, it is not removed from a company’s accounting records as long as it remains in use. The asset’s original cost and its total accumulated depreciation continue to be reported on the balance sheet. This shows stakeholders that the company still possesses and utilizes the asset, even though its book value is minimal or zero.

The primary accounting implication is that no further depreciation expense can be recorded for a fully depreciated asset. The accumulated depreciation account cannot exceed the asset’s original cost. This holds true even if the asset continues to be productive long past its initial estimated useful life, as it remains on the balance sheet at its cost, offset by the accumulated depreciation.

This treatment continues until the asset is disposed of, either through sale, scrapping, or another form of removal from service. At that point, both the asset’s cost and its accumulated depreciation are removed from the balance sheet.

Tax Implications of Selling a Fully Depreciated Asset

The sale of a fully depreciated asset has direct tax consequences. Since the asset’s tax basis has been reduced to its salvage value, any cash received from the sale usually results in a taxable gain. This gain is calculated as the sale price minus the asset’s adjusted basis. For an asset with no salvage value, the entire sale price is considered a gain.

This gain is often subject to “depreciation recapture.” The Internal Revenue Service (IRS) requires that a portion of the gain, up to the total amount of depreciation previously claimed, be taxed at ordinary income tax rates rather than more favorable capital gains rates. This rule, from Section 1245 of the Internal Revenue Code, prevents businesses from converting ordinary income into capital gains.

If the $10,000 machine from the earlier example is sold for $1,500 after being fully depreciated, the entire $1,500 is a taxable gain. Because this gain is less than the depreciation taken, the entire $1,500 is “recaptured” and taxed as ordinary income. If the asset were sold for $11,000, the first $10,000 of the gain would be recaptured as ordinary income, and the remaining $1,000 would be a capital gain under Section 1231.