What Qualifies as Depreciable Property?
Understand how businesses recover asset costs as a tax deduction and the principles guiding the accounting process from an asset's purchase to its disposal.
Depreciation is an annual income tax deduction that allows a business to recover the cost of property over its useful life. This accounting method acknowledges the wear and tear, age, or obsolescence of an asset used to generate income. Because you cannot deduct the entire cost of property in a single year if it is a capital expenditure, depreciation allows you to spread the expense over several years. This system of cost recovery applies to various types of property, including machinery, equipment, buildings, and vehicles.
Qualifying Property Characteristics
For property to be depreciable for tax purposes, it must meet a specific set of criteria from the Internal Revenue Service (IRS). You must own the property, whether outright or subject to a mortgage. It must be used in a business or other income-producing activity, as property used exclusively for personal reasons does not qualify. If an asset, like a vehicle, is used for both business and personal activities, only the portion attributable to business use can be depreciated.
The property must also have a determinable useful life, meaning it is expected to last for more than one year. This acknowledges that assets lose value as they are used to generate revenue. Common examples of depreciable property include machinery, equipment, buildings, vehicles, and office furniture.
Non-Depreciable Property
Certain types of property are excluded from being depreciated. The primary exclusion is land, which is not considered to wear out or become obsolete. While buildings and land improvements on a property can be depreciated, the value of the land itself must be separated from the structure’s cost.
Other assets that cannot be depreciated include inventory, which is property held for sale to customers. The costs for inventory are recovered through the cost of goods sold when the items are sold. Property that is placed in service and disposed of within the same year also does not qualify for depreciation. Certain intangible properties and term interests are also non-depreciable.
Determining the Basis and Recovery Period
Before calculating depreciation, you must determine the asset’s basis, which is your investment in the property for tax purposes. For a purchased asset, the basis is its cost, which includes the purchase price, sales taxes, freight, and any installation or testing fees. Essentially, any cost required to purchase the asset and prepare it for its intended use is included in its basis.
If property is acquired by other means, the basis rules differ. For a gifted property, the basis is the same as the donor’s adjusted basis. When converting personal property to business use, the basis for depreciation is the lesser of its fair market value at the time of conversion or its adjusted cost basis. This prevents taxpayers from claiming a higher basis for depreciation than the property’s actual value when it enters business service.
The recovery period is the number of years over which an asset’s cost is depreciated under the IRS’s Modified Accelerated Cost Recovery System (MACRS). MACRS assigns assets to property classes with pre-determined recovery periods. Common recovery periods include:
- Computers and office equipment have a 5-year recovery period.
- Office furniture and fixtures have a 7-year recovery period.
- Land improvements, such as fences or paving, have a 15-year recovery period.
- Residential rental property is depreciated over 27.5 years.
- Commercial buildings are depreciated over 39 years.
Any asset without a specified class life is assigned a 7-year recovery period.
Common Depreciation Methods
The Modified Accelerated Cost Recovery System (MACRS) is the standard depreciation method for most tangible property placed in service after 1986. MACRS is an accelerated system, allowing for larger deductions in the early years of an asset’s life and smaller deductions in later years. This method is the default for assets like vehicles, machinery, and office furniture.
Section 179 Deduction
The Section 179 deduction allows a business to treat the cost of certain qualifying property as an expense instead of a capital expenditure. This means the full purchase price can be deducted in the year the property is placed in service, up to a specified limit. For 2025, the maximum deduction will be adjusted for inflation from the 2024 limit of $1,220,000. This amount begins to phase out if total acquisitions exceed a certain threshold, which was $3,050,000 in 2024.
A limitation of this deduction is that it cannot exceed the business’s net taxable income for the year. The deduction is available for tangible personal property, such as machinery and equipment, used in an active trade or business.
Bonus Depreciation
Bonus depreciation is an additional first-year deduction for the cost of qualifying new or used property. Unlike Section 179, there is no annual dollar cap or taxable income limitation on the amount of bonus depreciation claimed. This deduction is taken after any Section 179 deduction but before regular MACRS depreciation. It applies to MACRS property with a recovery period of 20 years or less, such as computer equipment, furniture, and land improvements.
The allowed percentage for bonus depreciation is subject to change. For property placed in service in 2025, the bonus depreciation rate is 40%. This rate is scheduled to decrease to 20% in 2026 and be eliminated after that unless extended by Congress.
Tax Implications of Selling Depreciable Property
When a business sells depreciable property, it must calculate the gain or loss, which is the difference between the sale price and the property’s adjusted basis. The adjusted basis is the asset’s original cost minus all depreciation deductions taken.
A rule known as “depreciation recapture” requires that some or all of the gain from the sale be treated as ordinary income rather than a capital gain. The amount of gain taxed as ordinary income is limited to the total depreciation previously claimed on the asset.
For personal property (Section 1245 property), the recaptured gain is taxed at ordinary income rates. For real property (Section 1250 property), the gain from straight-line depreciation is taxed at a maximum rate of 25%. If an asset is sold at a loss, depreciation recapture does not apply.