You generally cannot deduct in one single year the entire cost of property you purchase for business if the property has a useful life substantially beyond the tax year. Instead, you can depreciate it. Depreciation recovers the cost over a number of years by deducting a part of the cost each year. Depreciation thereby accounts for annual wear and tear, deterioration, or obsolescence of a property.
You can depreciate most kinds of tangible property such as buildings, machinery. vehicles, furniture, and equipment. Likewise, you can depreciate (amortize) certain intangible property such as patents, copyrights, and computer software. Property can be depreciated subject to the following requirements: the property must be owned or leased by the taxpayer; it must be used for business or an income-producing activity; and it must have a determinable useful life of more than one year.
Even if a property meets these requirements, a taxpayer cannot depreciate equipment used to build capital improvements. Allowable depreciation on this equipment during the period of construction must be added to the basis of the improvements. You cannot depreciate land nor claim depreciation on property held for personal purposes. For example, if you use a car for both business or investment and personal purposes, only the business or investment use portion may be depreciated.
Depreciation begins when a taxpayer places the property in service for his or her business or to produce income. The property ceases to be depreciable when the taxpayer has fully recovered the property’s cost or other basis or when the taxpayer retires it from service, whichever happens first. Generally, if you are depreciating property you placed in service before 1987, you must use the Accelerated Cost Recovery System (ACRS) or the same method you used in the past. For property placed in service after 1986, you generally must use the Modified Accelerated Cost Recovery System (MACRS). These systems dictate what percentage of the cost a taxpayer can deduct each year.
You must identify several items to ensure the proper depreciation of a property, such as the class life and basis of the asset, the depreciation method to be used, whether it is “Listed Property”, and what portion of the cost is to be depreciated. For example, you may choose to deduct portions of the cost as a business expense. Instead of taking depreciation deductions, you may also elect under Internal Revenue Code Section 179 to recover all or part of the cost of qualifying property, up to a limit, by making this deduction in the year you place it in service.
Use Form 4562 (Depreciation and Amortization) to report depreciation on a tax return.
Additional information can be found at www.irs.gov in Publication 946 (How to Depreciate Property), and in Publication 534 (How to Depreciate Property Placed in Service Before 1987).