What is Tax Depreciation and How to Calculate Your Deduction

What is Tax Depreciation and How to Calculate Your Deduction?

Some assets lose value over the course of time, regardless of the effort you invest in their maintenance. To make the matters worse these are usually major investments like vehicles and property. So, does it make sense to pay the same amount of taxes for an asset that’s now worth significantly less than it was when it was first constructed/manufactured? Of course not! This is why there’s a thing known as tax depreciation, that can be used to calculate a deduction that you’re eligible for, due to the damage made by the aging process on the asset in question. With that in mind and without further ado, here are several things you need to know about tax depreciation and several tips to help you calculate your deductions.

1. Straight line or diminishing value depreciation

The first thing you need to consider is the approach that you’re about to take to the issue of depreciation. Keep in mind that you don’t have to stick to a single depreciation method forever, nor do you have to apply this method on all of your properties. The rule that you have to stick to is – one depreciation approach for a single asset per the calendar year. That being said, let’s look into these two methods.

First of all, you have the straight-line method, which is much simpler to deal with, as such, it’s used by the majority of organizations and individuals. What this means is that you get a fixed value drop per year. This is completely opposite from the method known as the diminishing value depreciation, which adjusts the total price after each depreciation estimate. You see, once the asset gets depreciated, what’s left (the new total value) is called the adjusted tax value. With the diminishing value depreciation approach, each year, you’re taking this adjusted tax value as the basis for further depreciation and deductions.

1. Useful life

Another term worth learning a thing or two about is the term useful life. What this means is that the asset you own has a point beyond which it becomes devoid of any value (its value reaches zero). In most scenarios, however, there’s no such thing as a zero value, instead, people use the term salvage value, which is the maximum possible value drop.

For instance, if you purchase an asset worth $10,000, with a salvage value of $3,000 and the useful life of two years, once this period expires the straight line depreciation expense would be $4,500. Why? Well, the calculation for the straight line method is fairly simple, you take the initial value of $10,000 and subtract the salvage value, which is $3,000 and what you’re left is $7,000. Then, you divide this figure by the useful life, which is two years in this fictional scenario and you get the figure of $4,500.

1. A survey and an estimate

In the example listed above, we made an incredibly simple calculation, yet, some people have an incredibly hard time calculating their deduction. Why is this so? Well, simply due to the fact that things are never as simple in practice as they are in theory. First of all, we used a straight line method which is a lot simpler, even though it might not be a more profitable one. Then, we used round numbers which makes the calculation even simpler.

Final and the most important cheat that we’ve used is the idea that we somehow just know the total value of both the asset and the salvage. In practice, you would have to consult tax depreciation surveyors to make these estimates. Even then, the reliability of the information that you receive would depend on their skill and reputation. As you can see, things are never as simple as they may seem.

1. Car depreciation

When speaking about the depreciation, most people assume we’re talking about property, however, one’s vehicle is an asset that’s eligible for a car depreciation, as well. The number of companies that handle their own supplies and manage their own fleets is on the rise, which is yet another thing to keep in mind. Finally, even if you run a one-person startup or a home-based business, you still might be eligible for a depreciation deduction.

First of all, there are some requirements that you have to pass. For starters, the car needs to be owned by you and you need to use it for business. Most importantly, you have to choose whether you want to use the standard mileage rate method or the car expense method, seeing as how you simply can’t go with both. Keep in mind, however, that the mileage method requires some admirable record keeping skills, even though it can save you more money. So, if you aren’t willing to commit to this, you might want to go with car expense method as a less effort-intensive technique.

1. Look for other tools and platforms

Keep in mind that the tax depreciation is something that concerns a lot of entrepreneurs out there, which is why it’s fairly easy to find tools and platforms, capable of helping you calculate the depreciation rate. As we said earlier on, this is definitely something best left to professionals, nonetheless, in some scenarios, you might want to make some preemptive calculations of your own, just to stay on the safe side.

In conclusion

At the very end, you need to understand that there are some myths and misconceptions about depreciation that you’ll have to face sooner or later. For instance, just because the building you’re in was built in the 80s, it doesn’t mean that it’s too old for depreciation. On the other hand, if the building is 50 years old, this might be a major issue.

Lastly, you need to know which rules apply to what. For instance, mining assets and similar categories abide by a completely different set of rules. This, nonetheless, is so industry-specific that it requires an elaborate estimate of its own in order to get a grip on. As for the standard assets like property and corporate vehicles, the above-listed definitely applies.