Assets bought for a business are written off across the years they are useful rather than all at once, and there is more than one way to do it.
The method changes the pattern of the deduction, not the total. Where it matters is that the accounts and the tax computation often use different methods deliberately, which creates a difference that has to be tracked for as long as the asset is held.
This covers the main methods and what each produces, the system used for tax purposes, how the accelerated elections interact with ordinary depreciation, and how the accumulated amount appears on the balance sheet.
Depreciation is the systematic allocation of an asset's cost over its useful life. It reduces taxable income each year the asset is in service. Choosing the right depreciation method affects both your financial statements and your tax bill.
The Four Depreciation Methods
1. Straight-Line Depreciation
- Formula: Annual Depreciation = (Cost - Salvage Value) / Useful Life
- Example: Equipment costs $50,000, salvage value $5,000, useful life 10 years. Annual depreciation = ($50,000 - $5,000) / 10 = $4,500/year.
- Best for: simple assets with consistent use over time.
2. Double-Declining Balance (DDB)
- Formula: Annual Depreciation = 2 x (1 / Useful Life) x Beginning Book Value
- Example: Same equipment, Year 1: 2 x (1/10) x $50,000 = $10,000. Year 2: 2 x (1/10) x $40,000 = $8,000. Accelerated front-loading of depreciation.
- Best for: assets that lose value quickly in early years (vehicles, technology equipment).
3. Units of Production
- Formula: Depreciation per unit = (Cost - Salvage Value) / Total Expected Units. Annual depreciation = Depreciation per unit x Units produced/used that year.
- Example: Machine produces 500,000 units over its life. ($50,000 - $5,000) / 500,000 = $0.09 per unit. If 60,000 units produced in Year 1: $5,400 depreciation.
- Best for: manufacturing equipment where usage, not time, drives wear.
4. Sum of Years Digits (SYD)
For a 5-year asset, SYD = 5+4+3+2+1 = 15. Year 1 depreciation fraction = 5/15. Year 2 = 4/15. Accelerated but less aggressive than DDB.
Businesses accept whatever life the software suggests and never write down why. Decide it from what the asset will actually be used for, record the reasoning once per class of asset, and apply it consistently. Consistency between years matters more to a reader than the precise number of years.
Anu Gupta, CA, EA, B.Tech · LinkedInMACRS: The IRS Method for US Tax Purposes
Modified Accelerated Cost Recovery System (MACRS) is mandatory for US tax depreciation on assets placed in service after 1986. MACRS uses assigned recovery periods and front-loaded depreciation tables.
| Asset Type | MACRS Recovery Period |
|---|---|
| Computers, copiers | 5 years |
| Vehicles (non-luxury passenger) | 5 years |
| Office furniture, fixtures | 7 years |
| Residential rental property | 27.5 years (straight-line) |
| Commercial real property | 39 years (straight-line) |
| Qualified improvement property | 15 years |
Section 179 vs Bonus Depreciation
| Provision | How It Works |
|---|---|
| Section 179 | Immediate expensing of qualifying asset cost in year of purchase. 2024 limit: $1,160,000. Cannot create a loss. |
| Bonus Depreciation | Additional first-year depreciation percentage on qualifying property. Bonus % has been phasing down from 100% (2017-2022), VERIFY current rate. |
Accumulated Depreciation on the Balance Sheet
Accumulated depreciation is the total depreciation charged against an asset since it was placed in service. It appears as a contra-asset on the balance sheet, reducing the gross asset cost to the net book value (carrying value).
Net Book Value = Gross Cost - Accumulated Depreciation
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Frequently Asked Questions
Does depreciation reduce cash flow?
No. Depreciation is a non-cash expense, it reduces taxable income and book income but does not require a cash outlay (the cash was spent when the asset was purchased). In the cash flow statement, depreciation is added back to net income in the operating section.
What is the difference between depreciation and amortisation?
Depreciation applies to tangible assets (equipment, buildings, vehicles). Amortisation applies to intangible assets (patents, trademarks, customer lists, software, goodwill). Both allocate cost over useful life.
Can land be depreciated?
No. Land does not have a finite useful life and is not depreciable under US GAAP or tax rules. Only the building on the land is depreciated.
Do we have to use the same method for the accounts and for tax?
Not necessarily, and in many businesses they differ deliberately. The accounts aim to spread the cost over the period the asset is genuinely useful, which is a commercial judgement. The tax computation follows the rules the tax authority sets, which may allow a faster write-off. Where they differ the difference is tracked rather than reconciled away, and it is one of the reasons a tax charge rarely equals the headline rate applied to profit.
How do we decide how long an asset will last?
By what the asset will actually be used for, not by a default in the software. The questions worth asking are how long you expect to run it, what the replacement cycle has historically been in your business, and whether it will have any value at the end. Write the reasoning down once per asset class, because consistency between years matters more to a reader of the accounts than the precise number of years you chose.
Written by
Anu Gupta, CA, EA, B.Tech
Anu works with US businesses on tax and entity questions at Profitjets, from choosing a structure to the filings that follow it. She writes about the decisions owners make once and then live with for years. Connect on LinkedIn
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