How to Calculate Bases for Depreciations
Depreciation is a vital tax deduction available to businesses that have expensive long-term assets. Arguably the most important element in depreciation is the depreciable asset’s basis since it sets the effective limit regarding how many deductions can be claimed in relation to that asset. Therefore, it is important to maximize the carrying value of the asset while remaining within the standards set by the tax code.
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Instructions
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Determine whether the asset is depreciable. To be depreciable, the taxpayer must own the asset, the asset must have a useful life greater than one year and the asset must be used in an income-producing activity.
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Identify the type of asset acquired. Different rules apply depending on whether it is real property or personal property, so this classification is crucial. Another consideration is whether the asset is tangible or intangible. Intangible assets include goodwill, copyrights, patents, trademarks and franchise rights.
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Apply Uniform Capitalization Rules if the asset is something you produced. If you purchased the property already in its final form, go to the next step. Production means the act of building, installing or manufacturing the depreciable asset. All direct costs associated with production, as well as the portion of indirect costs that can be tied to production, are to be capitalized and constitute the basis of the depreciable asset.
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Calculate the cost of acquiring the depreciable property or properties acquired. The cost of acquisition includes all cash or property exchanged to receive the good or goods, as well as any debt obligation or liabilities undertaken. For example, the basis of a house would include the down payment as well as the mortgage attached to the house. Expenses tied to the acquisition of the asset include surveys, transfer taxes, attorney fees and R&D costs. The cost of acquisition will be your initial basis for depreciation.
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Allocate the costs to each asset if bought in bulk to determine each individual basis. Especially important when acquiring a business or a group of assets, this step establishes the basis of each individual asset. If you acquired a business, apply the Fair Market Value to the assets in the following order until the amount of consideration is depleted: Financial Securities excluding debt instruments, debt instruments and accounts receivable, inventory, all other assets excluding intangibles, all intangibles excluding goodwill and, finally, goodwill.
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Tips & Warnings
The process of calculating basis for depreciation for financial reporting purposes may differ from calculating depreciation for tax reasons. As depreciation is taken during the life of the asset, the basis will need to be decreased by the amount of the expense. Consult with a Certified Public Accountant to ensure the proper calculation of deprecation basis and expense in the proper context. Although every effort has been taken to ensure this article’s completeness and accuracy, it is not intended to be legal advice.
