Most people aren’t going to need to know how to depreciate a fixed asset unless they own a business. And if you own a business, you probably should be having someone help you set up a computer program to keep track of income and expenses and help you file your tax returns. But maybe you’re here because you really want to know what exactly it means to depreciate a fixed asset.
For a business, an asset can be any number of things. It could be a car, a large piece of machinery, even a building. When you buy the asset, it immediately begins depreciating – or losing value. Most of us have heard that the minute you drive that new car off the lot after purchasing it, it is worth several hundred to several thousand dollars less than you paid for it. That is depreciation.
If you’re a business, you should include that asset you just purchased on your books. When you first add it to your list of assets, you will put it in the books at the amount you paid for it. However, once you’ve had it a while, it’s obviously not worth as much. So a business needs to depreciate the asset. Please note that the IRS has very specific guidelines for how long you should take to depreciate various assets. You will need to determine what class your particular asset falls into and depreciate it accordingly.
But let’s use a very basic example. You buy a car for $20,000. You add it to your assets for $20,000. A car has a 5 year life. So every year, if you depreciate it evenly, you’ll take $4,000 off the current value of that car. That $4,000 in that year is an additional “expense” of owning that car. You can reduce your taxable income by that amount without actually spending any money. But remember, this is for business only. You can’t depreciate property used for personal use. The difference between what you paid for an item and the depreciation you’ve taken against it is approximately what the item is worth at any given time.
The IRS does provide some help with depreciation schedules. See here (http://www.irs.gov/taxtopics/tc704.html) for a place to start. But depreciation can be very confusing. You have to determine the asset class and what method to use. For some assets, it’s easy to know what method to use for depreciation. Sometimes it can be hard to determine exactly what asset class your particular asset belongs to! Then there are often choices to make for that particular asset. Various factors can make a difference in how you want to depreciate the asset.
Depreciation really only affects your taxes. Although the amount you depreciate in any given year reduces your taxes like any other business related expense would, you aren’t actually paying money out like you would for almost every other expense. It’s a benefit of having a business with fixed assets.
This is only a basic explanation of how to depreciate a fixed asset. But if you do have assets to depreciate, follow the IRS rules carefully. Don’t be afraid to enlist a good accountant to help you keep your business books in good order.