What Is Depreciable Base for Tax and Accounting?

The depreciable base is a foundational figure in both accounting and tax calculations. It represents the portion of a tangible asset’s total cost that can be systematically written off as a depreciation expense over its useful life. This figure is the starting point for any depreciation calculation, whether for internal financial reporting or for filing federal income taxes.

Determining the Initial Cost Basis

The first step in any depreciation calculation is to establish the asset’s initial cost basis. This is not merely the purchase price but a comprehensive sum of all costs incurred to acquire the asset and prepare it for its intended use. The basis begins with the amount paid to the seller, net of any trade discounts, and includes other direct costs.

Additional costs include sales taxes paid at purchase and other expenses capitalized as part of the total cost, such as:

• Freight, shipping, and delivery charges
• Installation and setup
• Testing expenses

For example, if a business buys a machine for $50,000, pays $3,000 in sales tax, $1,500 for delivery, and $2,500 for installation and testing, its initial cost basis for the machine is $57,000.

For real property, the concept is similar. While land itself is never depreciable, the basis of a building includes its purchase price plus costs such as legal and accounting fees, recording fees, surveys, and title insurance. These expenditures are included because they are necessary to place the asset in service.

Calculating the Depreciable Base

After establishing the initial cost basis, the next step is calculating the depreciable base, which differs for financial accounting and tax reporting. The primary difference is the treatment of salvage value, which is the estimated residual worth of an asset at the end of its useful life. For financial accounting under Generally Accepted Accounting Principles (GAAP), this estimate is part of the calculation.

For financial reporting, the formula is: Depreciable Base = Initial Cost Basis – Estimated Salvage Value. This means the company will only depreciate the portion of the asset’s cost it expects to use up. For instance, if the $57,000 machine is expected to have a salvage value of $7,000 after its useful life, the depreciable base for accounting purposes would be $50,000.

Tax depreciation rules in the United States operate differently. The Modified Accelerated Cost Recovery System (MACRS) is the primary method used for federal income tax purposes. A defining feature of MACRS is that it disregards salvage value entirely. Therefore, for tax purposes, the depreciable base is the asset’s full initial cost basis. In our example, the depreciable base for the IRS would be the full $57,000. This distinction is important for tax planning, as a higher depreciable base leads to larger depreciation expenses, which in turn reduce taxable income.

Adjustments to Basis Over Time

An asset’s basis is not a static figure and can be adjusted over its life. The most common increase is from a capital improvement, which is an expenditure that adds to the asset’s value, prolongs its useful life, or adapts it to a new use. The cost of such an improvement is added to the asset’s basis.

This is distinct from routine repairs and maintenance, which are costs incurred to keep an asset in its normal operating condition. These expenses are not added to the basis; instead, they are deducted as operating expenses in the year they are paid. For example, replacing the engine in a delivery truck is a capital improvement that increases its basis, while changing the oil is a maintenance expense.

The basis of an asset is decreased over time by the depreciation deductions claimed each year, which is tracked as accumulated depreciation. An asset’s initial basis minus its accumulated depreciation is called its “adjusted basis” or “book value.” This adjusted basis is the figure used to calculate gain or loss when the asset is ultimately sold or disposed of. Other events, such as casualty or theft losses for which a deduction is taken, can also reduce the basis.