Tax Insight for Small Enterprises: How Depreciation Can Reduce Your Expenses

Maximizing Your Deductions This Tax Season

Tax season has arrived, and if you're a small business owner, it’s the perfect opportunity to capitalize on every deductible expense available to you. One deduction that often slips under the radar is depreciation, which reflects the gradual decrease in the value of your business assets. This deduction can significantly reduce your taxable income and lighten your tax burden.

The Power of Depreciation

Utilizing depreciation can lead to substantial income tax deductions, potentially saving small business owners thousands of dollars annually. However, navigating the calculation and claiming processes can often feel overwhelming.

Depreciation allows you to spread the cost of your assets over their useful life while accounting for factors like age and wear. Each year, you can deduct a portion of the asset’s value as an expense on your income statement. This deduction is claimed when you file your tax return.

A Deeper Dive into Asset Depreciation

Let’s say you invest $30,000 in a new piece of equipment; instead of reporting that entire expense at once, you can depreciate that figure over the asset’s lifespan. Depreciable assets encompass a wide range of items, including buildings, computers, machinery, vehicles, and even intangible assets like patents or copyrights. However, keep in mind that certain items, like land and inventory, are excluded from depreciation.

According to financial planner Jason Reiman from Tucson, depreciation usually applies to business-owned properties, equipment, and smaller assets like computers and smartphones.

Understanding Cash Flow and Depreciation

While depreciation lowers your taxable income, it’s essential to grasp that it doesn’t influence your actual cash flow or cash balance, as this deduction is classified as a non-cash expense.

Consider a scenario where you own a restaurant generating $100,000 in net income after accounting for expenses. If you deduct $25,000 for depreciation on your building, the IRS will tax you on only $75,000, potentially saving you $8,750 at a corporate tax rate of 35%.

How to Calculate Your Depreciation Deduction

The next hurdle is determining the amount you can deduct. To benefit from depreciation, you must own the property, which should have a useful life of over one year. You start depreciating the asset as soon as it’s put to use, and you cease depreciation once the total cost is recovered or if you stop using it for your business.

The IRS specifies various timelines for depreciating different assets: computers and office equipment can be depreciated over five years, while commercial buildings can take up to 39 years.

Methods of Depreciation: What You Should Know

To ascertain your depreciation amount, you’ll need to know the asset’s initial cost and its depreciation period. There are three primary methods you can choose from:

Straight-Line Method: This method allows for an equal deduction each year. To calculate your yearly deduction, subtract the salvage value from the asset's cost and divide by its useful life. For instance, a $1,000 computer with a salvage value of $200 and a five-year lifespan would yield an annual deduction of $160.

Accelerated Method: Here, larger deductions are front-loaded into the early years of the asset's life. Many small businesses prefer this approach and utilize the IRS’s MACRS for assistance.

Section 179 Deduction: This permits you to write off the entire acquisition cost of an asset in the year of purchase, up to $25,000 from 2015 onward.

Final Thoughts on Depreciation

By identifying and accurately calculating depreciation, you can enjoy significant tax benefits and make the most of your business investments. Take full advantage of these deductions to keep your business thriving while navigating the complexities of taxes.