Depreciation allocates the cost of a tangible asset over its useful life. It appears as an expense on financial statements, reducing taxable income.
Common Methods
- Straight-line: Equal expense each year (most common)
- Declining balance: Larger expense in early years
- MACRS: IRS-approved accelerated method for tax purposes
Example
A $50,000 vehicle with 5-year life: Straight-line depreciation = $10,000/year. After 3 years, book value = $20,000.
Depreciation Recapture
When you sell a depreciated business or rental asset for more than its depreciated book value, the IRS "recaptures" the depreciation you claimed — taxing that portion at up to 25% (for real estate) rather than the lower long-term capital gains rate. This is a common surprise for rental property owners at sale time.
Section 179 and Bonus Depreciation
Businesses can often deduct the full cost of qualifying equipment in the year of purchase (rather than spreading it over years) under Section 179 or bonus depreciation rules, up to annual limits set by the IRS — a major factor in year-end business purchase decisions.