Depreciation – The Deduction that Keeps on Giving

In business, there are expenses of operation and management, all usually deductible against income for taxes. For most, you spend the money, then you take the deduction which results in savings of tax dollars based on your tax rate. If you are paying 30% as a tax rate, you spend $100 for a deductible business expense, you offset income by that $100 and save $30 for income tax.

Depreciation or Write-off Decisions

Depreciation is a whole different ballgame. Check with your tax advisor or CPA before deciding how to treat major equipment, machinery, vehicle, or real estate purchase deductions for taxes. You can use the IRS Section 179 deduction for some things, writing the entire cost off in the year of the purchase. However, if you are in a lower income/profit year and expect a better year or years in the future, you may want to depreciate the item to get deductions in those higher income yearsi.

Building Purchase Example

Suppose you have decided to buy a building for your business, whether retail, warehouse, or manufacturing does not matter. If the building will be used solely for your business, you will be depreciating it over time. The cost is such that you cannot write it off in the year of purchase anyway. Assuming some numbers:

Cost of the building and land is $200,000

Land value of $50,000 is deducted for the structure depreciable value of $150,000

That value is depreciable over 27.5 years (usually, get advice)

Each year you can deduct $150,000/27.5 = $5,455

You are paying a mortgage payment on the property, and you can deduct the interest on the mortgage as well. You can also deduct maintenance, normal upkeep repairs, utilities cost, and real estate taxes too. Those deductions are money you are paying out of pocket during the year, and it is great to be able to reduce your tax liability by those amounts.

However, that $5,455 is a bonus, as you are not paying that out of pocket. You are already paying the mortgage, taking all those other deductions, and you can deduct the depreciation amount every year that you own the building. Using that 30% example tax rate, you would save $1,636 every year, and every dollar counts. There are also instances where you can accelerate depreciation, taking a larger amount in early years, but get the advice of your tax professional to see if you can in your situation.

There are also rules for the recapture of depreciation, especially if you did take more in the early years of ownership. They kick in if you sell the property. There are IRS forms to calculate any recapture you may owe. Hopefully, it will be a small hiccup in the profitable sale of the building. If you can accelerate, the decision should consider early years income versus anticipated income in future years.

As with most tax-advantaged actions, it is best to consult with your CPA or tax professional, as rules change, and your business income does as well.

i Publication 946 (2020), How To Depreciate Property, IRS.gov

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