How to Estimate Depreciation Expense
Depreciation is reserved for offsetting the cost of long-term business assets by deducting a portion of the cost of the asset from taxable income. To qualify for the deduction, the underlying asset must be owned by the taxpayer, used in the taxpayer's business, with a quantifiable, determinable useful life in excess of one year. An asset can begin to be depreciated as soon as it is placed in service for the money generating activity.
Other People Are Reading
Instructions
-
-
1
Calculate the asset's basis. The basis of a depreciable asset is the cost it took to acquire. So beyond just the sales price, an asset's basis includes applied taxes, legal fees accumulated in acquiring the property, and any debt you assumed that went along with the property.
-
2
Determine type of property. Certain types of property are excluded from common depreciation rules. These include intangible property (such as patents and copyrights), films, video tapes, and recordings. These assets are depreciated using the straight-line method. All other assets must use the Modified Accelerated Cost Recovery System (MACRS).
-
-
3
Determine the asset's useful life. The useful life of an asset is defined by the IRS either under the General Depreciation System (GDS) or Alternative Depreciation System (ADS). GDS is the default system although there are some assets that require the taxpayer to use ADS. If the asset is used 50 percent or less for business; it is tax exempt use property; the asset is used predominantly outside the United States; the property is financed by a tax-exempt bond; the property is used in a farming business; or the property is from a foreign country in which an Executive Order is in effect due to the country's trade restrictions, you must use ADS. You can also elect to use ADS. The GDS and ADS tables detailing the appropriate useful life for each type of asset can be found on the IRS website or in IRS Publication 946, How to Depreciate Property.
-
4
Choose the appropriate MACRS methodology. MACRS allows for a choice of depreciation schemes ranging from the straight-line method to the more complicated 200 percent declining balance method. The 200 percent declining balance method allows the taxpayer to take more depreciation deductions earlier, but for a shorter period of time. The straight-line method provides the taxpayer with a consistent, if smaller, deduction over a longer period of time. Consider what type of deductions your business requires, and select the appropriate convention based on that analysis.
-
5
Estimate Depreciation Expense using basis and useful life. If the asset is one that is excluded from using MACRS or if you chose the straight-line depreciation method, take the basis and divide by the useful life for the estimated depreciation expense. If you chose another MACRS method, use the tables in Appendix A and B of IRS Publication 946 to determine the appropriate depreciation percentage for the year you are trying to estimate expense. Using the asset's useful life and year the asset was placed in service, multiply the asset's basis by the appropriate percentage to determine the depreciation expense for the year you are trying to estimate.
-
1
Tips & Warnings
For complex returns, consult with a tax professional, such as a certified public accountant (CPA) or licensed attorney, as he can best address your individual needs. Keep your tax records for at least seven years, to protect against the possibility of future audits. Every effort has been made to ensure this article's accuracy, but it is not intended to be legal advice.
