What is depreciation?

What is depreciation?  In business, we deduct our expenses from our income.  Business “stuff” we use, deplete, or wear down lowers our revenue and our taxable income.  If the “useful life” of the “stuff” we use to produce income extends beyond one tax year, we need another way to still recover our original cost. This “long-term” method of cost recovery is called depreciation. There are five tests for depreciating property:

  • You must own it.
  • You must use it (place in service) for business or other income-producing activities.
  • You must be able to determine its useful life.
  • The useful life must be greater than one year.
  • It must be qualified property according to IRS rules as stated in IRS Pub 946, How to Depreciate Property.

For property placed in service after 1986, you generally use the Modified Accelerated Cost Recovery System (MACRS).  Prior to 1987, other methods to recover costs, like for example, Accelerated Cost Recovery System (ACRS), were used as detailed in IRS Pub 534, Depreciating Property Placed in Service Before 1987.

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Phillip Schein, EA

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Phillip Schein, EA

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