Which Assets Are Depreciated?
In general, the following property is depreciated:
- It is used in a trade or business (which will be the focus of
our discussion here) or held for the production of income as an investment
property;
- It has a finite period of usefulness in your business that can
be estimated with some confidence, and that is longer than one year;
and
- It wears out, decays, gets used up, becomes obsolete, or loses
value from natural causes, but it must be expected to last longer
than one year.
Examples of depreciable assets are cars, computers, office
furniture, machines, buildings, and significant
additions or improvements (as opposed to repairs) to these kinds
of property.
Tip Recently, the IRS issued guidance that attempts
to clarify the “tangible property” rules. However, this
continues to be a complex area of taxation. There are many rules,
definitions, de minimus safe harbors, and exceptions. You should consult
your tax advisor to determine what costs are currently deductible
and what should be capitalized and depreciated over time.
Which
assets are not depreciable? Land is probably the most commonly
encountered property that is not depreciable. As a rule you
can only "recover" the cost of land when you eventually sell it, at
which point you'll subtract the cost from the sales price to determine
your taxable gain or loss. So, when you purchase a business building
and the land on which the building is situated, the cost of the land
must be subtracted from the total cost of the property. Only then
can you determine the depreciation expense for the building itself.
The
costs of clearing, grading, planting, landscaping, or demolishing
buildings on land are not depreciable, but are added to the tax basis
of the land, so they can reduce your taxable gains on the property
when it comes time to sell.
Depreciation is not allowed on
personal assets, such as a residence used by you and your family,
or an automobile used for pleasure purposes only. If an asset is
used partly for personal purposes and partly for business, only the portion of the asset used for business purposes is
depreciable.
Other items that are not depreciable are inventory
and property you lease or rent from others. However, if you pay for
some permanent improvements on property that you lease (for example,
you remodel your leased office or store), you can depreciate the cost
of the improvements.
Amortizable assets. Some
business assets are not depreciable, but the costs can be recovered
through amortization; that is, they can be deducted in a series of
equal amounts over time for a specified period. An example of this
is the cost of starting your business,
which can be deducted over a period of 180 months after the business
begins to operate.
Intangible assets, such as agreements not
to compete, franchise rights, business licenses, and patents, copyrights,
trademarks, trade names, business goodwill, and going concern value
that are acquired as part of the acquisition of a substantial portion
of a business, must be amortized over the course of 15 years.
Most
intangible assets acquired before August 10, 1993, cannot be amortized
at all; others, such as patents and copyrights, agreements not to
compete, designs and patterns, franchises, and customer or subscriber
lists, must be depreciated using the straight-line method over their
useful life.
Computer software. Off-the-shelf
computer software must be amortized over 36 months from the date of
purchase. Customized software must be amortized over a 15-year period.
As
a general rule, any intangible assets created by your business (rather
than purchased from someone else) cannot be depreciated or amortized.
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