Generally, the depreciation rules are used to try to match the expense of an asset to the income the asset helps the company earn. However, through the utilization of different sections of the Internal Revenue Code, there are opportunities to accelerate depreciation and expense capital assets earlier in their useful lives for tax purposes.
Businesses depreciate long-term assets for both tax and accounting purposes. However, businesses can use different depreciation rules for financial statement and tax purposes. For example, when a company prepares its financial statements, the company can record a depreciation expense which spreads the initial cost of the asset over the asset’s useful life. However, for tax purposes, businesses must depreciate these assets in accordance with the Internal Revenue Service rules that dictate how and when the company can take the deduction. Through these rules, there are some opportunities to move the depreciation expense into earlier periods.
Types of Depreciable Assets
Asset depreciation applies to all business assets acquired with a cost that exceeds the company’s capitalization threshold and with a useful life of more than one year. These include assets such as purchases of cars, computers, desks and electronic equipment. Some of the less common items include physical office space and potentially intangible asset. Generally, these capital assets are items that may lose value over time due to decay, wearing out or obsolescence.
If the company sells a capital asset during its useful life, the company may be subject to taxes on the potential gain from the sale. If the company sells it for more than the company paid for it or more than the adjusted basis of the property, the company may be subject to capital gains tax or depreciation recapture. If the company takes a loss, the company can deduct the amount of value lost as a business expense.
Depreciation Methods
Straight-line or uniform depreciation is the most frequently used method of depreciating capital assets for financial statements. Under this method, the equipment loses an equal part of its total value every year of its life. For the company’s tax return, a tax accountant will be able to usethe IRS-approved depreciation rules to gain the largest deduction for the company, if desired or move the expense into different periods for planning purposes.
Generally, for financial statement purposes, the company is not permitted to deduct the entire purchase price in the year capital assets are bought. The asset’s useful life needs to be determined and an annual expense is claimed each year over the asset’s useful life. For tax purposes, the useful life and methods allowed are mandated and the rules can be found in Publication 946. There are also provisions in the code that allow for an accelerated method tax writes off depreciation costs more quickly in order to minimize taxable income. Companies are generally permitted to use the double-declining balance method for tax purposes.
Depreciation can be a complex issue. However, we can help you determine what your options are and how to review and plan the company’s strategy in regards to utilizing the depreciation options available. Contact us today, and we’ll help with the depreciation expense planning for your business.
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