Can our small business write off an expensive asset when we buy it?

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Your business uses assets to produce revenue. As assets are used up, you can write off the asset’s cost and post a tax deduction for the expense.

When you post an expense for a particular asset can vary, however.

Capitalizing vs. expensing assets

Small asset purchases are expensed as soon as they are purchased.

If you buy paper clips, the accounting logic is that office supplies will be used quickly, so the expense should be recognized immediately.

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More expensive assets that you use over time are expensed using depreciation. To post depreciation, you create an asset account, such as a vehicle, and post depreciation expense each year.

There are a number of depreciation methods, and each one generates a tax deduction.

Understanding depreciation

Depreciation expense matches the revenue you earn with the expense of using the asset.

Let’s say that Bob the plumber buys a $20,000 truck to perform plumbing work. Bob buys the truck on January 1 and creates a new asset, Plumbing Truck, in his accounting software.

The more work he does, the more miles he drives. Over time, the truck will start to wear out, and depreciation reclassifies the cost of asset (truck) into an expense account.

The IRS determines how you depreciate an asset and post a business expense on your tax return. If the tax laws require Bob to depreciate the $20,000 truck evenly over 5 years, the annual depreciation is ($20,000 divided by 5), or $4,000 a year.

Each asset has a corresponding depreciation account. In this case, the account is Depreciation Expense—Plumbing Truck. On December 31, Bob posts this entry:

Debit (Increase) Depreciation Expense—Plumbing Truck $4,000

Credit (Increase) Accumulated Depreciation—Plumbing Truck $4,000

Accumulated depreciation accounts for all of the depreciation since the asset was purchased. If Bob wants to know the remaining value of the truck, he subtracts the accumulated depreciation balance from the asset account.

After year one depreciation, the truck’s remaining value is ($20,000 – $4,000), or $16,000.

The $4,000 is posted as an expense on the business tax return.

Straight-line vs. accelerated methods

The IRS may require straight-line depreciation, or an accelerated depreciation method.

Straight-line depreciation means that the same dollar amount is depreciated each year over the asset’s useful life. Bob’s $20,000 truck uses straight-line depreciation of $4,000 a year for 5 years.

An accelerated depreciation method requires more depreciation in the early years, and less in later years. If the IRS assumes that the asset will be used more in the early years of service, the tax laws require an accelerated method.

Keep in mind, however, that the total amount of depreciation is the same, regardless of the method used.

The type of asset you buy determines the number of years used for depreciation.

Depreciation by asset type

As this article explains, depreciation categories are divided between real estate assets and non-real estate assets.

Here are the categories for the most recent tax year, and some common assets used in a small business:

  • Three-year property: Certain manufacturing tools
  • Five-year property: Computers, office equipment, cars, light trucks and assets used in construction
  • Seven-year property: Office furniture and appliances
  • Residential rental properties: 27.5 years to depreciate
  • Commercial buildings: 39 years to depreciate

It’s important to post depreciation expenses correctly, so check with an accountant or your accounting software provider to get help with the process.

Section 179 Property

Section 179 depreciation allows business owners to fully deduct the cost of some assets in the year that the asset is purchased.

The recently passed Tax Cuts and Jobs Act (TCJA) placed the maximum dollar deduction at $1 million.

You can deduct the full cost of tangible personal property in the year you start to use the asset. Tangible personal property refers to physical assets, such as machinery and equipment.

The rule also applies to some types of real estate. Check with an accountant to learn about the details.

If Bob bought a $5,000 piece of plumbing equipment, he could use the Section 179 deduction and expense the full $5,000 cost in the year of purchase.

Fully expensed assets

Depreciation expense stops when the entire cost of the asset is moved into the expense account.

Consider the plumbing equipment example. If Bob chooses the Section 179 method, the entire $5,000 is expensed in year one. If the equipment is considered to be five-year property and Bob doesn’t choose Section 179, he would expense the asset over time.

In many cases, fully depreciated assets can still be used in business. Bob may use the truck and the plumbing equipment for years after the assets are fully depreciated.

The IRS rules on depreciating assets are based on estimates, and may not reflect the true usefulness on the asset.

Track assets closely

Assets represent the engine that runs your business.

Pay close attention to the business assets in your accounting records. Check the accumulated depreciation accounts, so you know which assets are close to wearing out.

Create a formal plan to pay for new assets, so you can grow your business successfully over time.

This article was produced by the Quickbooks Resource Center and syndicated by MediaFeed.org.

Featured Image Credit: FlamingoImages / iStock.

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