How to Compute Depreciation

There are various methods for deducting the cost of equipment, fixtures, and vehicles you use in your business.

  • First-year expensing (Section 179): Lets you deduct up $500,000 in 2013. Lower deduction amounts apply to certain vehicles.
  • Bonus depreciation: This is another first-year deduction that allows a deduction for 50% of the cost for new property place in service.
  • Regular depreciation: Most business equipment is depreciable under MACRS depreciation (Modified Accelerated Cost Recovery System - pronounced MAKERS).
    • MACRS includes an accelerated method, which produces higher deductions in the early years of the property's recovery period than the MACRS straight-line method. Straight-line depreciation produces equal amounts of deprecation over the property's recovery period.

The Ordering Process for Computing Depreciation

Because there are three different types of depreciation deductions available, there is an ordering procedure you must follow for claiming them.

The deduction amount figured for each type of deduction is subtracted from the cost basis of the property. When basis reaches zero, the property if fully depreciated.

The ordering procedure is as follows:

  • First-year expensing is figured first. If basis remains after subtracting the first-year expensing deduction, move on to bonus depreciation.
  • Bonus depreciation is figured next. If basis remains after subtracting bonus depreciation, move on to regular depreciation.
  • Regular depreciation is figured last and is applied to the basis remaining after having subtracted both first-year expensing plus bonus depreciation from the cost basis of the property.

The total of first-year expensing, bonus depreciation (if any), and regular depreciation (if any) represent your total depreciation deduction.

Claiming Regular Depreciation Under MACRS

To claim regular depreciation, as apposed to first-year expensing and bonus depreciation, you use depreciation tables to determine the amount of your annual depreciation deduction for each piece of depreciable property you place in service.

The depreciation table you use depends on three factors:

1. Type of property depreciated:

  • 3-year property: (e.g., devices used for manufacturing food and beverages, special tools)
  • 5-year property: (e.g., cars, copiers, heavy general purpose trucks, (unloaded weight less than 13,000 pounds)
  • 7-year property: (e.g., office furniture and fixtures including desks, files, cell phones, fax machines, musical instruments).
  • 10-year property: (e.g., vessels, barges, tugs)
  • 15-year property: (e.g., includes land improvements such as fences, sidewalks, shrubbery, roads, bridges)
  • 20-year property: (farm buildings, municipal sewers)

2. Convention used:

  • Half-year
  • Mid-quarter
  • Mid-month

3. Depreciation method:

  • Accelerated MACRS 200% or 150% or straight-line depreciation)

Once you know which table to use, you merely go to the table and do the following:

  • Check the recovery year column for the applicable year.
  • Decide whether to use the accelerated MACRS table (200% or 150% declining balance) or the straight-line depreciation table.
  • Once you identify the recovery year, multiply the original basis of the property by the applicable rate listed in the column to the right of the recovery year.
    • Important! The tables assume 100% business use. If business use is less than 100% you must multiply the depreciation figured at 100% business use by your business-use percentage.
    • For example, if your depreciation amount according the the table is $2,000 (100% business use) and your business-use percentage is 80%, your deduction is $1,600 (80% x $2,000).
  • You continue applying the rates for each year to the original basis of the property. You do not reduce the original basis by the previous year's depreciation deduction.

Bonus Depreciation for 2012 and 2013

The American Taxpayer Relief Act of 2012 extended the 50% bonus depreciation through 2013. Bonus depreciation applies to qualified property purchased new and placed in service in 2013 (same for 2012). The property must be used over 50% for business.

First-year Expensing Deduction (Section 179)

The American Taxpayer Relief Act of 2012 (the "Act"), which was signed into law January 1, 2013, retroactively extended the $500,000 section 179 deduction limitation to 2012. The law also applies to 2013.

In addition, for 2012 and 2013, the cap on equipment purchases before the deduction begins to get phased out is $2,000,000.

The $500,000 maximum deduction gets phased out dollar for dollar if purchases during the year exceed $2,000,000.

For example, if you purchase $2,300,000 worth or equipment, your first-year expensing deduction is $200,000 ($500,000 minus $300,000).

QuickBooks Self-Employed
For Freelancers and independent Contractors

- Organize your financial data into one central accounting system on the cloud
- Software kept up to date.
- Your data kept secure
- Anytime, anywhere data access.
- Pay your quarterly estimated taxes online.
- Export Schedule C to TurboTax at year-end for faster filing.
- Save up to 50% off QuickBooks Self-Employed. Track every deduction! Start your free trial now!

Have an accounting or bookkeeping question? Email it to me.