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  • Understanding Depreciation
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    What Can and Cannot Be Depreciated

    Depreciable Property

    Let’s start with what the IRS considers depreciable property:

    • It must be owned by you or your business. But there’s also an exception: If you don’t own a property but make capital improvements to it, you can still depreciate the value of the improvements.
    • You must make use of this property for your business or in an income-producing activity. If you also use the asset for personal use (say you have a home business), you can only depreciate that portion of the asset dedicated to business use.
    • It must have a “determinable useful life” that is greater than one year.

    In other words, what’s generally depreciable is income-producing property that you own and make use of for more than a year that typically will wear out or decline in value over time.

    Depreciable property includes machines, vehicles, office buildings, buildings you rent out for income (both residential and commercial property), and other equipment, including computers and other technology. In the case of property that you’re renting, you’re considered as “owning” the improvements you’ve made on it and eligible to depreciate them, so long as these are enjoyed for longer than one year. Depreciable property can be either tangible like the assets mentioned above, or intangible—patents, copyrights, computer software, and the like.

    What Can’t You Depreciate?

    What can’t you depreciate? As discussed in the Quick Summary, you can’t depreciate property for personal use, inventory, or assets held for investment purposes. You can’t depreciate assets that don’t lose their value over time—or that you’re not currently making use of to produce income. These include:

    • Land
    • Collectibles like art, coins, or memorabilia
    • Investments like stocks and bonds
    • Buildings that you aren’t actively renting for income
    • Personal property, which includes clothing, and your personal residence and car
    • Any property placed in service and used for less than one year

    Don’t forget, in terms of depreciation, that your cost basis of an asset should include not only the purchase price, but also additional costs like sales taxes, freight charges, and any installation and testing fees.

    And finally, if you improve depreciable property, that improvement, at least for tax purposes, should be treated as a separate depreciable property. This would occur if you make an addition or partial replacement to a property that adds to its value. If, on the other hand, you’re just repairing a property, you can typically deduct this as a business expense.

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    • For more information on what can and cannot be depreciated, you should go straight to the source: The IRS’s Publication 946 PDF, How To Depreciate Property.
    • As discussed in a recent SBA publication, A Tax Policy Update for America's Small Businesses, expensing rules for small businesses have been in flux in recent years. Following the recession, federal policymakers changed depreciation rules in an attempt to stimulate the economy. Now some of these rulings are in retreat. Whether you or a professional tackles your taxes and/or your books, it’s important to stay on top of these changes.
    • One such rule, in effect from 2010 to 2013, allowed business owners to expense certain types of property in the first year of its useful life (Section 179 of the tax code)—up to a limit of $500,000. That limit, beginning in the 2014 tax year, returned to $25,000. For 2018, changes to depreciation will take place, particularly to bonus depreciation. This change will allow businesses to deduct 100% of the cost of eligible property in the year it’s placed in service. For more information on changes to Section 168 and Section 179  refer to your tax preparer.They are probably your best resource.