Definition of the Accounting Term Depreciation
Depreciation describes methods of allocating the value of a piece of capital equipment over a period of several years. Different types of machines have different depreciation periods because they last for different numbers of years. Tax depreciation can be separate from the actual useful life of a piece of equipment. In addition, there are several ways to calculate depreciation and some methods accelerate depreciation to recognize a loss earlier for tax purposes.
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Ownership Eligibility
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The Internal Revenue Service specifies the terms of eligibility for claiming a depreciation deduction. According to the IRS, the owner of the property is the one who can claim a deduction. This includes owners of property who lease the property to someone else for a payment, as well as property owners who buy machines such as cars and take on a debt because of their purchase of property. It does not include people who lease cars and do not purchase ownership rights for the car.
Book Value
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Depreciation is not always the same as the book value of an item. Book value includes guides such as the Blue Book that record the resale value of items such as cars. The amount of depreciation on federal and state tax returns may differ from the value that a car will sell for at market. Sellers may sell a car or another piece of equipment for more than the value after depreciation calculations, which will create a gain that they will have to pay state and federal taxes on.
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Depreciation Methods
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There are several methods of calculating depreciation. The simplest depreciation method is the straight-line method, which provides a constant decrease in the value of the asset. For example, a car may have a depreciation period of five years. If the car cost $20,000, the owner reports depreciation expenses of $4,000 during each of the five years. This does not mean that the car will stop functioning after five years.
Accelerated Depreciation
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Some depreciation methods accelerate recognition of a loss. These methods may be part of a government stimulus, or they may simply recognize that cars and other items lose value much faster immediately after a purchase than after a few years of use. The double declining balance method is one method of accelerating depreciation. According to the State of Missouri, a purchaser of a $16,000 asset reports $4,800 in depreciation during the first year and $1,290 during the sixth and final year using the double declining balance method.
Placement into Service
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Depreciation deductions require the owner to report the placement of an item into service. Placing an item into service means that it is available for use for the owner to start receiving benefits from using the item. For buildings, this means that the building is available for tenants to rent. For a piece of machinery in a factory, it means that the machine is ready for a use such as making products.
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References
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