Why Should a Company Depreciate Its Buildings?
The IRS allows a company to depreciate a building that it uses for business purposes. A business can depreciate all buildings placed into service after 1986 using the straight-line depreciation method. The business depreciates residential rental property over a period of 27-1/2 years and a building used for commercial purposes over a period of 39 years. The ability to write off a portion of the cost each year provides a business with a number of significant benefits.
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Cost Recovery
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Depreciation is a cost recovery system implemented by the IRS to promote the purchase of assets that help to produce income. By depreciating any asset, the business recoups some of the capital spent in purchasing that asset. General use and everyday wear and tear reduce the value of the building. Because it is likely that a company will not fully recover the cost of a building because of this deterioration, the IRS permits the business to depreciate the asset over time.
Reduction of Income
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Depreciation is an expense against income. Therefore, it reduces the amount of ordinary taxable income for the current tax year. By depreciation a building that a company owns, it eliminates a portion of the income that the IRS would otherwise tax in a given year. The more the depreciation expense for one year is, the more that the company reduces its income.
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Deferred Taxation
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Given a certain location or purpose, a company might be aware that a building will not likely depreciate over a certain period. However, depreciating the property in the current year defers the tax payments on part of the income until after the building is sold. For example, if a company depreciates $25,000 of a building this year, it reduces its taxable income for this year by that amount. When the business sells the building in a later year, the company must recapture that $25,000 of depreciation and pay ordinary income taxes on that amount.
Freeing Up Capital
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By using depreciation, the company frees up capital for other purchases. During a period of growth, this is extremely important. For planning purposes, it may be more important to have access to the capital at the current time to buy extra machinery or equipment. By depreciating a building, the company does just this and then incurs the taxes related to any excess depreciation after selling it.
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