A depreciable property also referred to as a depreciable asset, is any property that can be depreciated in accordance with the Internal Revenue Service (IRS) rules. These are generally long-term assets, which can vary from furniture, fixtures, real estate, vehicles, and office equipment to machinery. When they have depreciated, the value of these items is considered a business expense, and it is deducted from the company’s tax return.
In contrast to other types of assets, a depreciable property simply loses its value with age, especially when it is used up or becomes obsolete.
What Property Can Be Depreciated?
A property can be depreciated based on certain factors. The factors may be determined by the ownership, purpose, and usefulness of the property. For instance, it must be entirely owned by an individual and utilized for a business or income-producing purpose. Whenever you use an asset for both business and personal purposes, you can depreciate only the part of it for business. Moreover, these assets must have a definite useful life expectancy and must last for more than a year.
The International Revenue Service (IRS) Publication 946, “How to Depreciate Property”, clearly outlines these requirements. The Internal Revenue Service (IRS) provides such a great deal of information since it is a revenue service of the U.S. government. As a state agency, it is responsible for a variety of duties, including tax collection, tax law enforcement, and taxpayer services. Additionally, the IRS performs criminal investigations and supervises tax-exempt organizations and retirement plans.
Back to the point, the rule in the said publication applies irrespective of the depreciation method or how fast an asset loses its value over time. As you can see, it’s pretty easy to recognize a depreciable property.
What is Non-Depreciable Property?
A non-depreciable property is an asset that is generally held for investment, used for personal purposes or inventory. This type of property does not generate any income and its value does not necessarily decrease over time.
A land property owned by an individual, for example, cannot be depreciated as it is considered to have an infinite lifespan. This is in contrast to a depreciable asset, which must have a specific useful life. Other non-depreciable types of property include art, stock investments, prepaid liabilities, buildings that do not generate income, or personal property like a car or residence. Basically, they all fall into the opposite category of a depreciable asset.
What are Examples of Depreciable Property?
Income-generating real estate buildings, computers, manufacturing machinery, and automobiles are several examples of depreciable property. Even though these are all clearly tangible items, intangible properties can also be depreciated over time so long as they are in compliance with IRS rules. There are a number of intangible assets that can be depreciated, including computer software, copyrights, patents, and the like.
What are the 4 Depreciation Methods?
A depreciable property can be valued using a number of different depreciation methods. The most common four methods of depreciation are listed below.
- Straight Line
- Declining-Balance
- Sum-of-the-Years Digits
- Units of Production
Every company or individual can choose from each of these options based on their needs and preferences. Therefore, you have to do a thorough assessment of your property before deciding how to value it. Especially since property depreciation is important. In the next section, we’ll look at each of these methods in greater detail to help you gain a better understanding of it.
1. Straight Line
The straight-line method, also known as the fixed instalment method and physical depreciation, is the easiest way to calculate a property’s depreciation. The value is calculated by subtracting the asset’s cost from its expected salvage value, and then dividing the result by the number of years it’s expected to last. Proceed to deduct the same salvage value each year after that.
To put it simply, the formula of a straight line is:
Annual Depreciation Expense = (Cost of an asset – Salvage Value)/Estimated life expectancy of an asset
Specifically,
- The cost of an asset is the actual price of the property.
- The salvage value refers to the asset’s value after its useful life has ended.
- The life expectancy of an asset is the number of years it will be in use.
This depreciation method is most appropriate when the value of the property decreases evenly over time at around the same rate. Machinery and office equipment are great examples since you expect to use such assets until you scrap them. Additionally, the straight-line method is suitable for small businesses that may not have an accountant or with limited resources, since it is easy to use and rather simple.
2. Declining-Balance
The declining-balance method, otherwise known as accelerated depreciation, accounts for higher depreciation costs in the first few years of a property. The value of assets under declining balance is written off differently every year since it depreciates more quickly than with the straight-line method, where the value depreciates evenly.
Typically, the double-declining balance method is calculated as follows:
Depreciation Expense = (Cost of an asset at the beginning of the year x Depreciation Rate)/100
As noted earlier, it has higher costs at the beginning and smaller depreciation expenses as time progresses. The purchase of a car is a good example of an asset that falls under this category. It loses value relatively quickly and then less over time. Different approaches can be taken when using the declining-balance method. Even so, businesses that wish to recover more of an asset’s value upfront will benefit from this depreciation method.
3. Sum-of-the-Years Digits
In another form of accelerated depreciation system, Sum-of-the-Years Digits (SYD) divides the annual depreciation into fractions according to the number of years the asset has been in service. Despite its similarity to the declining-balance method, it actually does less.
Here is how the sum-of-the-years digits are calculated:
Depreciation Expense = Depreciable Cost x (Remaining useful life of the asset/Sum of Years’ Digits
Specifically, the depreciable cost = Cost of asset – Salvage Value; and the Sum of years’ digits = (n(n +1))/2 (where n = useful life of an asset)
SYD is ideal for those who want to recover the value of an asset upfront but in an even distribution. This also works well for assets whose value decreases during their first few years of use.
4. Units of Production
The units of production are a way to calculate depreciation based on how much work a particular asset performs, hence its name. This is often determined by the number of hours the asset is used or the number of units it has to produce. Clearly, the units of production is a simple depreciation method that clearly works for office equipment and widgets, machinery, and the like.
For unit-of-production calculation, the formula is:
Depreciation Expense = (Number of units produced / Life in a number of units) x (Cost – Salvage value)
It is evident that businesses that can write off the useful lifespan of a particular piece of equipment or machinery will benefit tremendously from this depreciation method. They can even take a higher depreciation rate in the early years of using the asset and a lower rate in the later years when they rarely use it. In a way, this is also similar to the SYD depreciation method.
Whenever you have difficulty calculating such factors, you can always ask experts, such as property depreciation consultants for assistance.
What is a Depreciable Cost?
Depreciable cost, also known as net book value, refers to the remaining value of an asset after subtracting the accumulated depreciation from its total cost of it. However, keep in mind that the cost of an asset is not just its usual purchase price, but includes expenses incurred from repairs, upgrades, or taxes made.
Depreciable costs are calculated as follows:
Depreciable cost = Cost of an Asset – Cumulative Depreciation
Depreciable costs will vary greatly since each asset has its own useful life. Nevertheless, calculating the depreciable cost allows businesses to evaluate their capital spending habits and adjust them accordingly. There are various ways to do this.
There is even an online property depreciation calculator that anyone can use to assess data. Alternatively, you can choose among the four depreciation methods previously discussed. Also, you can try to make a 5-year property depreciation table to get a clear overview of your depreciable cost.
Is Depreciable Property a Capital Asset?
No, a depreciable property is not considered a capital asset. It is because the IRS defines a capital asset as everything you own for personal or investment purposes. Capital assets include investments in stocks, personal automobiles, household furnishings, and residences. Clearly, these properties are all non-depreciable, just as stated earlier in the article.
A capital asset differs significantly from a depreciable piece of property. Since the latter is mainly used as part of a business or for income-generating purposes. Buildings, equipment, and vehicles used for trade or business are all subject to this, even if they have been fully depreciated.