A lot of times when we ask new clients if they know what depreciation is they respond, “Yes it is when your car looses value.” While this is one type of depreciation, it is not what depreciation means from a tax stand point. Depreciation in relation to taxes is when a company buys an asset, like a computer, vehicle, building, or equipment, and instead of taking the entire expense in the year of purchase, the asset expense is taken over several years.
For example, if you purchased a computer for two thousand dollars, you don’t deduct the $2,000 right away. You would take a portion of that deduction every year for five years. Thus, the computer is depreciated over five years.
Depreciation is helpful because most businesses have less income and more expenses the first couple of years. Since a business purchases the bulk of its equipment at the start of the business, depreciation allows you to extend the deductions to years when the business has more income and needs to take more deductions.
The type of asset you are purchasing determines how many years it is depreciated. In addition, there is extra depreciation that you may be able to take the first year you purchase an asset. For example, some types of vehicles can be depreciated almost entirely in the first year, and depending on your net income, other equipment can be deducted a hundred percent in the first year.
Depreciating your assets can be a little tricky. There are many rules and many ways to strategize using those rules. It is important to educate yourself on tax topics like depreciation and consult with a tax professional to make sure you are doing things correctly. If you haven’t already, check out our CD set designed to help you save on your taxes, while avoiding being audited.
Article written by Matthew Anderson of Soulence Tax and Accounting